Demand and Supply

Law of Demand

As the price of a product falls, the quantity demanded of the product will usually increase, ceteris paribus (there is a negative causal relationship between price and quantity demanded). 1. Income effect: when price falls, people experience increase in "real income," which reflects about income will buy. More real income, more likely to buy more of the product. 2. Substitution effect: when price falls, product will be relatively more attractive to other people than other products whose prices have unchanged. 3. Principle of decreasing marginal benefit: since marginal benefit falls as quantity consumed increases, consumer will be induced to buy each extra unit only if its price falls.

Law of Supply

As the price of the product rises, quantity supplied of the product will usually increase (there is a positive causal relationship between price and quantity supplied) Higher prices mean more potential profits, so producer will increase profit, so firm faces an incentive to produce more output

Social Surplus

At the point of competitive market equilibrium, sum of consumer and producer surplus is maximum. Importance? If we interpret demand curve as marginal benefit curve and the supply curve as marginal cost curve, then market equilibrium occurs when MB=MC. This means that the extra benefit to society of getting one more unit of the good is equal to the extra cost to socity of producing one more unit. This means society's resources are being used to produce the right quantity of the good, allocative efficiency! Allocative+Productive efficiency, producing what society wants most at lowest possible cost.

Role of Price Mechanism and Market Efficiency

Economy on PPC, must decide where on PPC to produce (what to produce), question of resource allocation. If a society is changing the combination of goods they are producing, they are reallocating resources, and moving along the PPC; this will involve opportunity cost. How to decide allocations? Well, the price mechanism! This means prices as signals and incentives. Ex. from product market: say demand increases, shift to the right. There will be a shortage so the price of strawberries begins to rise and will continue to until the shortage disappears. The higher price signaled to producer that a shortage in the strawberry market had emerged and is an incentive for producers to increase quantity supplied. But new higher price is a signal and incentive for consumers: it signals that strawberries are now more expensive and is an incentive to buy less. Ex. From resource market: the labour market measures the price of labour against the quantity of it. If the supply of labour increases (say, because of immigrant workers) the labour supply curve shifts to the right. At the old wage, there is a surplus of workers. This causes the wage to start falling until the surplus disappears. The falling wage acts as signal and incentive to firms that there is a surplus and to hire more labour for cheaper (people need the jobs). The falling wages also signals workers, providing them with incentive to work less.

Non-price determinants of supply

Increases in costs of FoP, for example an increase in wages, increases the firm's costs of production meaning they can supply less. Technology: improved technology lowers costs of production, making production more profitable and giving incentive to increase supply. Price of related goods (competitive supply): competitive supply of two or more products refers to production of one or the other by a firm. For example, a farmer growing wheat and corn may choose to sell more corn if corn is more expensive Price of related goods (joint supply): joint supply of two or more products refers to production of goods derived from a single product so that it is not possible to produce more of one without producing more of the other, For example, butter and skimmed milk are both produced from whole milk. If an increase in the price of one leads to an increase of supply of milk, there will be an increase in the other as well. Producer (firm) expectations: If firms expect price of product to rise, they may whithold some of their current supply with the expectation they will be able to sell it at a higher price. This decreases the supply. Taxes (indirect and on government): Firms treat taxes as costs of production, so increase of tax decreases supply. Subsidies: The introduction of a subsidy is equivalent to a fall in production costs. Number of firms: Increase in the number of firms producing a good increases supply "Shocks": sudden unpredictable events like hurricanes or the discovery of oil

Market Demand

Sum of all individual demands for a good. Also sum of consumer's marginal benefits.

Allocative Efficiency

The competitive market realizes allocative efficiency, producing the combination of goods mostly wanted by society, thus answering the what to produce question. This means productive efficiency is also realized, involving production with the fewest possible resources (how to produce).

Consumer Surplus

The difference between the highest price consumers are willing to pay for a good and the price actually paid.

Producer Surplus

The difference between the price received by firms for selling their good and the lowest price they are willing to accept represents the firms' cost of producing an extra unit of the good (or marginal cost) and is shown by the supply curve This is because the lowest price firm is willing to accept must just be enough to cover its cost of producing each unit (marginal cost).

Demand

The quantity of a good/ service consumers are willing and able to buy at different possible prices during a particular period of time, ceteris paribus.

Non-Price Determinants of Demand

Variables other than price that influence demand. These cause shifts in the demand curve. Income: Normal Goods: directly proportional Inferior goods: inversely proportional Prices of Substitutes: Directly proportional Complements: inversely proportional Tastes/ Preferences: directly proportionaly Demographic: size of population, change in age structure of population, change in income distribution Government Policy Changes

Market Equilibrium

When quantity supplied is equal to quantity demanded, and there is no tendency for the price to change. Intersection of the Demand and Supply curve houses equilibrium price and equilibrium quantity. During market disequilibrium, there is is excess demand (shortage) or excess supply (surplus).

Changes in Demand (demand curve shifts)

When there is an increase in demand there is a shortage. This causes an upward pressure on price, and price increases causing a movement up the supply curve to where it intersects with the new demand curve. Excess demand is eliminated and new equilibrium reached.

Changes in Supply

When there is an increase in supply there is a surplus. This exerts a downward pressure on price, and it falls until a new equilibrium is reached.

Supply

various quantities of a good/service a firm is willing and able to produce and supply to the markey for sale at different possible prices, during a particular time period