Chapter 3: Supply and Demand

define: supply curve

shows the relationship between quantity supplied and the price

define: competitive market

a competitive market is a market in which there are many buyers and sellers of the same good or service, none of whom can influence the price at which the good or service is sold.

define: supply schedule

a supply schedule shows how much of a good or service would be supplied at different prices

define: demand curve

a demand curve is a graphical representation of a demand schedule. It shows the relationship between quantity demanded and price.

define: demand schedule

a demand schedule shows how much of a good or service consumers will want to buy at different prices

define: individual demand curve

an individual demand curve illustrates the relationship between quantity demanded and price for an individual consumer

define: input

an input is a good or service that is used to produce another good or service

define: complements

two goods are complements if a rise in the price of one good leads to a decrease in the demand for the other good.

define: normal good vs. inferior good

when a rise in income increases the demand for a good, it's considered a normal good. When a rise in income decreases the demand of a good, it's considered an inferior good.

define: law of demand

the law of demand says that a higher price for a good or service, all else equal, leads people to demand a smaller quantity of that good or service.

define: substitutes

two goods are substitutes if a rise in the price of one of the goods leads to an increase in the demand for the other good.

What causes shift in supply curves?

1) Changes in input prices: To produce an output, you need inputs. If the price of inputs increases, overall production of that good becomes more costly, so producers are less willing to supply the final good at any given price, and so the supply curve shifts to the left (decreases). A fall in the price of an input makes the production of the final good less costly, so supply increases and the curve shifts right. 2) Changes in the prices of related goods/services: a single producer often produces a mix of goods rather than a single product. Supplying any one good depends on the prices of the producers other co-produced goods. If goods are *complements in production* then production may be easier when done together, so they have a direct relationship. When the relationship is inverse, the goods are substitutes in production. 3) Changes in technology: as technology becomes more efficient, it becomes cheaper to produce items b/c cost of production has decreased. Output will increase as production remains relatively cheap, sometimes even if demand grows. 4) Changes in expectations: When suppliers have some choice about when they put their good up for sale, changes in the expected future price of the good can lead a supplier to supply less/more of that good today. 5) Changes in the number of producers: when more producers enter a market, there's a greater quantity being supplied.

Summary of Supply and Demand:

1) Changes in the equilibrium price and quantity in a market result from shifts of the supply curve, the demand curve, or both. 2) An increase in demand increases both the equilibrium price and the equilibrium quantity. A decrease in demand decreases both the equilibrium price and equilibrium quantity. 3) An increase in supply drives the equilibrium price down but increases the equilibrium quantity. A decrease in supply raises the equilibrium price but reduces the equilibrium quantity. 4) Often, fluctuations in markets involve shifts of both the supply and demand curves. When they shift in the same direction, the change in equilibrium quantity is predictable but the changes in equilibrium price is not. When they shift in opposite directions, the change in equilibrium price is predictable but the change in equilibrium quantity is not. When there are simultaneous shifts of the demand and supply curves, the curve that shifts the greater distance has a greater effect on the change in equilibrium price and quantity.

What causes shifts in the demand curve?

1) Changes in the prices of related goods/services: If there are a pair of goods, and the price of one good makes consumers raise more likely to buy the other good, then those two are substitutes. If a rise in price of one good makes consumers less willing to buy the other good, then those two goods are complements. 2) Changes in income: as the economy gets stronger, and higher income levels, consumers are willing to make more purchases at every given price. Most goods are normal, which means that the demand for them increases as consumer income increases. Some goods are inferior, which means that as income rises, demand for those goods decline. 3) Changes in tastes 4) Changes in expectations of future prices: if the price is expected to fall in the future, current demand will decline because consumers will wait for that price fall. If the price is expected to rise in the future, current demand will increase in anticipation. 5) Changes in the number of consumers: population growth may lead to higher demand for certain goods

Objective:

1) Competitive markets and how they're described by the supply and demand model 2) Demand curve and supply curve 3) Difference between movements along a curve and shifts of the curve 4) The ways supply and demand curves determine a market's equilibrium price and equilibrium quantity 5) How price moves the market back to equilibrium in the case of a shortage or surplue

Demand Curve

If price of a good falls, consumers generally respond by using more of it. So, the amount of a good consumed by individuals depends partly on price. Demand vs. Quantity demanded: An increase in demand means a rightward shift of the demand curve; a decrease in demand means a leftward shift of the demand curve. It's important to make distinctions between changes in the quantity demanded (movements along a demand curve) and shifts of a demand curve. Changes in demand = shifts of the curve, and changes in quantity demanded = movement along the demand curve.

Supply and Demand: A Model of a Competitive Market

In a competitive market, no individual's actions have a noticeable effect on the price at which the good or service is sold. 5 key elements of this model: demand curve, supply curve, set of factors that cause both curves to shift, the market equilibrium (price and quantity at equilibrium), and the way the market equilibrium changes when the supply and/or demand curve shifts.

Supply Curve

The quantity of a good suppliers want to supply depends on the input prices they need to pay, and also on the price they are offered (which typically needs to at minimum cover the cost of production. A supply curve depends on 5 factors: input prices, prices of related goods/services, changes in technology, expectations, and number of producers

Why do all sales and purchases in a market take place at the same price?

There are some markets where the same good can be sold for many different prices, and this is because they can be differentiated, etc. But in any market where the buyers and sellers have both been around for some time, sales and purchases tend to converge at a generally uniform price, so we can safely talk about the market price. If there's a surplus of a good/service, the price will eventually fall because suppliers cannot find consumers willing to buy their good at that high price, especially when other producers are offering lower prices. The prevailing price will eventually be pushed down towards equilibrium. When the market price is below the equilibrium price, then there will be a shortage of a good, and the buyers are frustrated because people who want to purchase a good cannot find willing sellers at the current prices. In this situation, buyers will offer more than the prevailing price or sellers will realize that they can charge higher prices, and the prevailing price will be driven up.

define: equilibrium price, market-clearing price, equilibrium quantity

a competitive market is in equilibrium when price has moved to a level at which the quantity of a good or service demanded equals the quantity of that good or service supplied. The price at which this takes place is the equilibrium price, also referred to as the market-clearing price. The quantity of the good or service bought and sold at that price is the equilibrium quantity.

define: supply and demand model

a model of how a competitive market behaves

define: shift of the demand curve vs. movement along the demand curve

a shift of the demand curve is a change in the quantity demanded at any given price, represented by the shift of the original demand curve to a new position. A movement along the demand curve is a change in the quantity demanded of a good arising from a change in the good's price.

define: shift of the supply curve vs. movement along the supply curve.

a shift of the demand curve is a change in the quantity supplied at any given price, represented by the shift of the original supply curve to a new position. A movement along the supply curve is a change in the quantity demanded of a good arising from a change in the good's price.

define: individual supply curve

illustrates the relationship between quantity supplied and price for an individual producer

define: quantity demanded

the quantity demanded is the actual amount of a goo or service consumers are willing to buy at some specific price

define: quantity supplied

the quantity supplied is the actual amount of a good/service people are willing to sell at some specific price

define: shortage

there is a shortage of a good or service when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level.

define: surplus

there is a surplus of a good or service when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level.