Economics Demand and Supply Review

Non-price determinants of supply

-Costs of factors of production: For example, if a factor price rises, production costs increase, production becomes less profitable and then firm produces less. -Prices of related goods: joint supply. For example an increase in the price of butter will lead to an increase in the quantity supplied and also to an increase in the supply of the other joint product(s). -Taxes (indirect taxes or taxes on profits): The imposition of a new tax or its increase represents an increase in production costs, so supply will fall. -Subsidies: Subsidies encourage production by lowering costs of production and thus increasing supply. -'Shocks' or sudden unpredictable events such as weather conditions, war, etc. -The state of technology: Improvements should increase supply -Expectations: Producers who expect the demand for their product to rise in the future may assume that the higher demand will lead to a higher price and thus increase supply.

Non-price determinants of demand

-Income: If income increases demand for inferior goods falls If income falls demand for normal goods rises -Prices of substitute goods: If price falls then demand falls If price increases then demand increases -Prices of complimentary goods: If price falls, demand increases If price increases, demand falls -Preferences and tastes -Demographic changes such as changes in number of buyers

The law of supply

According to the law of supply, there is a positive causal relationship between the quantity of a good supplied over a particular period of time and its price, ceteris paribus: as the price of a good increases, the quantity of the good supplied also increases and vice versa.

Evaluation of "the best allocation of resources from society's pov is at competitive market equilibrium."

Advantages: -Long-run equilibrium in perfectly competitive markets meets two important conditioterm-46ns: allocative efficiency (maximal community surplus) and productive efficiency This includes the maximum satisfaction attainable by society and best allocation of resources. Disadvantages: -real-world markets include many issues that are assumed away in the model of perfect competition, including pollution, inventions of new technology, poverty, discrimination in labor markets, imperfect information. -Competitive markets are unrealistic in the real world and not seen very often.

movement along demand curve vs shift of the demand curve

Any change in price produces a change in quantity demanded, shown as a movement on the demand curve. Any change in a non-price determinant of demand leads to a change in demand, represented by a shift of the entire demand curve.

a movement along a supply curve vs a shift of the supply curve

Any change in price produces a change in quantity supplied, shown as a movement on the supply curve. Any change in a determinant of supply (other than price) produces a change in supply, represented by a shift of the whole supply curve.

Market

Any kind of arrangement where buyers and sellers of goods, services or resources are linked together to carry out an exchange. These can be local, national or international.

Ceteris paribus in demand and supply

Assumption that all other variables stay constant. (e.g. that all things other than price that can affect how much the consumer is willing and able to buy are assumed to be constant and unchanging.)

Utility

Benefit or satisfaction provided by the consumption of a good or service. This can be total utility (total satisfaction from consuming different units of a commodity) or marginal utility (the additional utility derived from the consumption of the extra unit of a commodity.)

Competitive markets

Composed of a large number of sellers and buyers acting independently, so that no one individual seller has the ability to control the price of the product sold. Instead, the price of the product is determined by the interactions of many sellers and buyers, through the forces of demand and supply,

Allocative efficiency

Concerned with the optimal distribution of goods and services leading to the optimal allocation of resources from society's pov. (Among the points on the PPC, the point that is chosen is socially preferred where D=S or where MSB=MSC).

The negative slope of the demand curve in reference to decreasing marginal benefit/utility

Consumers buy goods and services because they provide them with some benefit, or satisfaction also known as utility. The greater the quantity of a good consumed, the greater the benefit derived. However, the extra benefit provided by each additional unit (marginal utility) increases by smaller and smaller amounts. Since each successive unit of a good consumed produces less and less benefit, you will be willing to buy each extra unit only if it has a lower and lower price. The slope of the demand curve boils down to the principle of decreasing marginal benefit: since marginal benefit falls as quantity consumed increases, the consumer will be induced to buy each extra unit only if its price falls.

Complementary goods

Goods that are often consumed together ( bread and butter)

Substitute goods

Goods that satisfy a similar need (coke and Pepsi)

the positive slope of the supply curve

Higher prices mean that the firm's profits increase, and so the firm faces an incentive to produce more output. Lower prices mean lower profitability, and the incentive facing the firm is to produce less. Therefore, there is a positive relationship between price and quantity supplied.

The signalling and incentive function of price resulting in a reallocation of resources when prices change as a result in changes in supply.

If supply increases due to an increase in the quantity or quality of the factors of production thereby the reduction of their cost, then supply shifts from S1 to S2 and the price remains at P. There Is therefore an excess supply of Qs-Qd. As supply is greater than demand, this sends out a signal to producers that the price is too high (e.g. low sales) and therefore there is an incentive for them to decrease the price to make more profit. As the price decreases, this sends a signal to consumers that the price has decreased and is an incentive for them to increase their demand lean to a movement along the demand curve and settling at Q1. At this point, there has been a contraction of supply and an expansion of demand. A new equilibrium is met at D,S2 where excess supply (surplus) is rationed away. Resources have been reallocated at a lower price of P1 and at a higher quantity of Q1.

Diagram for demand of substitute goods

If the price for DVD player falls and its demand increases, the demand of DVD's will increase leading to a subsequent shift of the demand curve of DVD's to the right.

Diagram for demand of complementary goods

If the price of chicken falls, then the quantity demanded of chicken will rise and thus the quantity demanded of beef will fall, leading to a shift of the demand curve to the left. (Wise versa)

The signalling and incentive function of price resulting in a reallocation of resources when prices change as a result in changes in demand.

If there is a change in the determinants of demand resulting in an increase in demand such as a shift In tastes in favour of the good, then the demand curve will shift from D1 to D2, and the price will remain at P. Demand is now at Qd whilst supply is at Qs at a price of P1. There is an excess demand equivalent to Qd-Qs. A signal is then sent to producers that the price is too low including excessive queues, waiting lists for good, competition, etc.) There is therefore an incentive for producers to increase their price to make their production of the good more profitable. They therefore increase price from P1 to P2. This sends out a signal to consumers that the price is higher and is therefore an incentive to cut down demand which results in a contraction along the new demand curve and an expansion of the supply. The excess demand has been rationed away as a new equilibrium is made at S,D2, where there is a perfect allocation of scarce resources. Resources have been allocated at a higher price from P1 to P2 and at a higher quantity from Q1 to Q2. This happens as 'an invisible hand' with no government intervention.

how changes in the determinants of supply lead to new market equilibrium

In Figure 2.11(a), the initial equilibrium is at point a where D intersects S1, and where equilibrium price and quantity are P1 and Q1. An increase in supply (say, due to an improvement in technology) shifts the supply curve to S2. With S2 and initial price P1, there is a move from point a to b, where there is disequilibrium due to excess supply (by the amount equal to the horizontal distance between a and b). Therefore, price begins to fall, and there results a movement down S2 to point c where a new equilibrium is reached. At c, excess supply has been eliminated, and there is a lower equilibrium price, P2, but a higher equilibrium quantity, Q2. A decrease in supply is shown in Figure 2.11(b) (say, due to a fall in the number of firms). With the new supply curve S3, at the initial price P1, there has been a move from initial equilibrium a to disequilibrium point b, where there is excess demand (equal to the distance between a and b). This causes an upward pressure on price, which begins to increase, causing a move up S3 until a final equilibrium is reached at point c, where the excess demand has been eliminated, and there is a higher equilibrium price P3 and lower quantity Q3.

The possibility of a vertical supply curve and causes

In special circumstances, the supply of a good is vertical at a fixed quantity. A vertical supply curve tells us that even as price increases, the quantity supplied cannot increase and remains constant. The quantity supplies is independent of price. There are two reasons why this can occur: 1) There is a fixed quantity of the good supplies because there is no time to produce more of it. (E.g. fixed quantity of theatre tickets. No matter how high the price, it is not possible to increase the number of seats in a short period of time.) 2) There is a fixed quantity of the good because there is no possibility of ever producing more of it. (E.g. original paintings or other antiques.)

Joint supply

Joint supply of two or more products refers to production of goods that are derived from a single product, so that it is not possible to produce more of one without producing more of the other. This means that an increase in the price of one leads to an increase in its quantity supplied and also to an increase in supply of the other joint product(s).

Market supply

Market supply is the sum of all individual firms' supplies for a good.

relationship between producer's supply and market supply

Market supply is the sum of all individual firms' supplies for a good. The market supply curve illustrates the law of supply, shown by a positive relationship between price and quantity supplied.

productive efficiency

Producing goods and services for the lowest cost. (said to occur on PPC).

how choice results in an opportunity cost

The basic economic question is that humans have unlimited/infinite wants with limited/finite resources and thus must make choices. For example, because most individuals do not have infinite income, they must choose what to consume and must take into consideration the opportunity cost of such a consumption. This refers to the next best alternative foregone as a result of consumption. The quantity demanded (Q2) is larger than the quantity supplied (Q1). The price of strawberries therefore rises and will continue to rise until the shortage disappears. This happens at Q3P2, where the new demand curve intersects the new supply curve. This has happened because the new, higher price signalled information to producers that a shortage in the strawberry market has occurred. This price increase is also an incentive for producers to increase the quantity of strawberries supplied from Q1 to Q3, as strawberry production will be more profitable. The new higher price now signals to the consumers that strawberries are now more expensive, and is an incentive for them to buy less. They therefore move along the demand curve from B to C, buying less strawberries than at original price, Q3 instead of Q2. The increase in the price of strawberries resulted in a reallocation of resources. More resources are now allocated to strawberry production, affecting the answer to the "what to produce" question.

how scarcity necessities choices answer the "what to produce" question

The condition of scarcity forces societies to make choices about the what to produce economic question, which is a resource allocation question. Choices involve an opportunity cost because of foregone (or sacrificed) alternatives that could have been chosen instead. Assuming an economy is producing on its PPC, it must decide on what particular point on the PPC it wishes to produce, this involves the choice of what to produce and of how to produce (allocation of resources) The PPC is curved because Producers that specialise in one good (schools) will be less efficient at producing another good (motorcars) than those producers that specialise in that good. Is is impossible to build more schools or motorcars without sacrificing the quantities produced of the other good. Eg. the opportunity cost of making more schools is the number of motorcars that are not produced/sacrificed as a result. At point Z, the skilled workers in each industry will be specialising in the production at which they are best and so both sets of workers will be at their most proactive. If an economy wishes to change the combination of goods it wishes to produce, it will reallocate its resources, changing the answer of "what to produce" and "for who to produce" In a market economy, it is simply prices in free markets, resulting from the interactions of demanders and suppliers, which make the decisions of where to be in a PPC.

Producer surplus

The excess of actual earnings that a producer makes from a given quantity of output, over and above the amount the producer would be prepared to accept for that output.

interaction of demand and supply to produce market equilibrium

The existence of a surplus or a shortage in a free market will cause the price to change so that the quantity demanded will be made equal to quantity supplied. In the event of a shortage, price will rise; in the event of a surplus, price will fall. The forces of demand and supply cause the price to change until the market reaches equilibrium.

The signalling and incentive function of price

The key to the market's ability to allocate resources can be found in the role of prices as signals and prices as incentives. As signals, prices communicate information to decision-makers. As incentives, prices motivate decision-makers to respond to the information.

Inferior goods

When demand for it varies inversely with income. E.g. second hand clothes, used cars, etc.

Relationship between a consumer's demand and market demand

The market demand is the sum of all individual demand for a good as well as the sum of consumers marginal benefits.

Surplus diagram

The producers have tried to raise price to Pi. However, at this price, he quantity demanded will fall to Q1 and the quantity that producers supply rises to Q2 . We now have excess supply of Q1 Q2 . More is being supplied than demanded at the price P1 . In order to eliminate this surplus, producers will need to lower their prices. As they do so, the quantity demanded will increase and the quantity supplied will fall. This process will continue until the quantity demanded once again equals the quantity supplied. This will be back at the equilibrium price and so the situation is self-righting if price is raised for no external reason.

Market demand

The sum of all individual demand for a good that consumers are willing and able to buy. The market demand curve illustrated the law of demand, shown by the negative relationship between price and quantity demanded. The market demand is also the sum of consumers' marginal benefits.

Supply (individual firms)

The supply of an individual firm indicates the quantities of a good or service a firm is willing and able to produce and supply to the market for sale at different possible prices, during a particular period of time, ceteris paribus.

The law of demand

There is a negative causal relationship between the price of a good and its quantity demanded over a particular time period, ceteris paribus: As the price of a good increases, its quantity demanded falls and rise versa.

Market equilibrium

When a market is in equilibrium, quantity demanded equals quantity supplied, and there is no tendency for the price to change.

Normal goods

When demand for it varies directly with income.

Shortage

When the demand of a good is greater than its supply and there is a subsequent excess in demand

Surplus

When the demand of a good is smaller than the quantity demand and there is a subsequent excess in supply.

how changes in the determinants of demand lead to new market equilibrium

a change in a determinant of demand that causes the demand curve to shift to the right from D1 to D2 (for example, an increase in consumer income in the case of a normal good). Given D2, at the initial price, P1, there is a movement to point b, which results in excess demand equal to the horizontal distance between points a and b. Point b represents a disequilibrium, where quantity demanded is larger than quantity supplied, thus exerting an upward pressure on price. The price therefore begins to increase, causing a movement up D2 to point c, where excess demand is eliminated and a new equilibrium is reached. At c, there is a higher equilibrium price, P2, and greater equilibrium quantity, Q2, given by the intersection of D2 with S. A decrease in demand, shown in Figure 2.10(b), leads to a leftward shift in the demand curve from D1 to D3 (for example, due to a decrease in the number of consumers). Given D3, at price P1, there is a move from the initial equilibrium (point a) to point b, where quantity demanded is less than quantity supplied, and therefore a disequilibrium where there is excess supply equal to the horizontal difference between a and b. This exerts a downward pressure on price, which falls, causing a movement down D3 to point c, where excess supply is eliminated, and a new equilibrium is reached. At c, there is a lower equilibrium price, P3, and a lower equilibrium quantity, Q3, given by the intersection of D3 with S.

consumer surplus on a demand and supply diagram

at a price of $15, there would still be five thingies demanded and at a price of $17, there would be demand for three thingies. However, the consumers do not have to pay $15 or $17, they just have to pay the equilibrium price. This means that all of the consumers who purchase the first nine thingies have made a gain. They have paid a price below the one they were prepared to pay. In this case, one consumer was willing to pay as much as $19 for a thingy, but as he only has to pay $10, he is gaining. The total consumer surplus is usually shown by the area under the demand curve and above the equilibrium price.

Producer surplus on demand and supply diagram

at a price of $5, there would still be five thingies supplied and at a price of $3, there would be a supply of three thingies. However, the producer does not have to sell for $5 or $3, she can sell her thingies at the equilibrium price. This means that she will have made a gain on each of the first nine thingies in terms of what she would have accepted for them. She has received a price higher than the one she was prepared to accept.In this case, the producer was willing to supply a thingy for as little as $1, but as she receives $10 for each thingy, she is gaining. The total producer surplus is usually shown by the area under the equilibrium price and above the supply curve.

Consumer surplus

the extra satisfaction (or utility) gained by consumers from paying a price that is lower than that which they are prepared to pay. This is measured by the highest price consumers are willing to pay for a good minus the price actually paid.

Shortage diagram

the producers have tried to lower the price to P2. However, at this price, the quantity demanded will rise to Q4 and the quantity that producers supply falls to Q3. We now have excess demand of QQ4. More is being demanded than supplied at the price P2. In order to eliminate this shortage, producers will need to raise their prices. As they do so, the quantity demanded will fall and the quantity supplied will increase. This process will continue until the quantity demanded once again equals the quantity supplied. This will be back at the equilibrium price and so, once again, the situation is self-righting.

Demand (individual consumers)

the quantities of a good or service the consumer is willing and able to buy at different prices during a particular time period.