Supply and Demand by 2aUNb8CA


									                                    Supply and Demand

I.       Markets – a set of rules for the negotiation of exchange between buyers and

Prices communicate market conditions.

II.      Demand

Demand compares the quantity demanded (qd for individuals, Qd for a market) and the
price of a product.

      A. Individual Demand: compare prices and qd for an individual, holding all else

               Demand Schedule
Alice’s desired pounds of chicken per week:

         Price = MB            qd
          $5.00                0
          $3.00                1
          $2.00                2
          $1.50                3
          $1.20                4
          $1.00                5
               Demand Curve






       1                                                                       D

       0             1              2           3            4             5          q

There are actually two ways to interpret what the demand schedule and the demand curve
show us.
       1. They give the quantity of the g/s demanded at each possible price.
       2. They show the maximum that an individual is willing to pay to purchase an
           extra amount.

   B. Market demand: gives the total Qd by all individuals at each price (equals market
      MB). Market demand is simply the sum of all individual demands.

Price Alice’s qd         Bob’s qd       Market Qd
$5.00    0                 1                1
$3.00    1                 1.5             2.5
$2.00    2                 2.3             4.3
$1.50    3                 3.1             6.1

In all cases, as the price of a g/s rises the quantity demanded falls, and vice versa (all else
constant). This is the Law of Demand, and it always holds true (we will discuss the
theoretical possibility of violating the law of demand later in the course).
III.    Shifts in the Demand Curve.
    A. Prices of Related Goods
        1. Substitutes
Example: If the price of Pepsi doubles, then some (not all) people ma switch from
buying Pepsi to buying Coke (Pepsi and Coke are substitutes). Thus, whatever the going
price of Coke, there will be a greater quantity demanded for Coke. Since there is a
greater Qd at each given price of Coke, the entire demand curve shifts – we say that
Demand for Coke rises as the price of Pepsi rises. The demand for a substitute will
always move in the same direction as the price of its substitute.

                Pepsi market (the price increases from P1 to P2 and Qd decreases).




        0                     Q1           Q2                           Q

                Coke market (Qd increases for any given price).


            0                                                               Q
The distinction between quantity demanded and demand is an important one – demand
only changes when a variable besides the price of the g/s in question changes. When the
good or service’s own price changes only quantity demanded changes, not demand!

         2. Complements – two g/s that are typically consumed together (e.g. milk and
             cereal, peanut butter and jelly, shoes and shoe laces).
Example: If the price of peanut butter rises, then Qd for peanut butter will fall. Since
jelly is often used with peanut butter, the Qd for jelly will also fall at whatever the current
price of jelly may be. Therefore, demand for jelly decreases.

              Peanut butter market (the price increases from P1 to P2 and Qd decreases).




      0                     Q1           Q2                            Q

              Jelly market (Qd decreases for any given price).


          0                                                                Q
      B. Income
         1. Normal goods – when an individual’s income rises, we typically see that the
            person will demand more of a g/s, all else held constant. It depends on the
            individual, but market-wide this is the case for most g/s.
         2. Inferior goods – for some g/s as our incomes rise we will want to buy less at a
            given price (as in each of the other cases we hold other demand determinant,
            including the price, constant to focus on the specific effect of a change in
            income). An example might be Ramen Noodles, which are often consumed
            by college students on a tight budget, but when they graduate and see an
            increase in their income, they switch away to other food items.

      C. Tastes – obviously people’s tastes and trends in preferences can have an effect on
         demand. Advertising may have some role to play here, but as the famous
         economist Frederic Hayek noted:
                Many preferences are created by the social environment. Literature, art,
                and music are all acquired tastes. A person’s demand for hearing a Mozart
                concerto may have

      D. Expectations
      Example: If everyone expects there to be a dearth of champagne and high prices in
      late December then many people will start buying champagne in early December or
      late November at whatever the given price (all else constant). Note that this will
      drive the price up making the expectation self-fulfilling.

IV.      Supply

Supply compares the quantity supplied (qs for individuals, Qs for a market) and the price
of a product.

      A. Individual Supply: compare prices and qs for an individual, holding all else

              Supply Schedule
Fanta Corps supply of 20oz. bottles of orange soda per week:
       Price                    qs
       $5.00                 100,000
       $3.00                  95,000
       $2.00                  85,000
       $1.50                  70,000
       $1.20                  50,000
       $1.00                  25,000
There are two ways to interpret what the supply schedule and the supply curve show us.
      1. They give the quantity of the g/s supplied at each possible price.
      2. They show the minimum amount that a firm must be compensated to produce
           a given quantity.

     B. Market Supply: gives the total Qs by all individuals at each price. Market supply
        is simply the sum of all individual firms’ supplies.

V.      Shifts in the supply curve.

     A. Input Prices
      Example: Suppose the price of oats decreases, and that oats are a major input in
      production of granola. Then a granola producer will not need to be compensated as
      much (because its costs are lower), to produce the same amount of granola.
      Thus, all else equal, the supply of a g/s (at every price) will increase if input prices
      decrease (and vice versa).

               Granola market (Qs increases for any given price).

                                 S1            S2

           0                                                                 Q

      B. Technology: the term “technology” is used to indicate the way factors of
         production (inputs) are used to produce g/s. Technology is a broad term and
         includes items such as changes in the weather or natural disasters.

      C. Expectations.

      D. The Number of Suppliers (affects market supply): as more firms enter an industry,
         the total supply of that industries product can increase.

VI.      Market Equilibrium
      Example: Suppose the market demand and supply for beach towels are given below.







        0        10     20      30   40      50      60       70     80          Q (mil.)

   Here, equilibrium quantity (Q*) is 50 million at an equilibrium price (P*) of $15.

   At the equilibrium price, consumers get exactly the quantity they are willing to buy at
   that price and producers can sell exactly the amount they are willing to sell at that
   price (Qd = Qs).

VII.        Changes in Equilibrium
If both supply and demand change, then we can be certain of a change in either the
equilibrium quantity or price, but the direction of change in one of the two will be
uncertain unless we have more information. The resulting equilibrium will depend on the
amount of the shifts and the amounts Qd and Qs change as price changes. The measure of
these changes is called “elasticity”.

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