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The Fundamentals of

VIEWS: 39 PAGES: 4

									                          The Fundamentals of
                  “Shifts In” and “Movements Along”
                     Supply and Demand Curves

General Specifications

        Demand Curve: Qd = f(Px; T&P, N, I, Py … Pz, E, D)

        Supply Curve: Qs = f(Px; w … r, Θ, N, T, N&P)

Ceteris Paribus Assumptions behind the Demand and Supply Curves

   I.      THE DETERMINANTS OF DEMAND – LOCATION OF THE
           DEMAND CURVE

           A. T&P – Tastes and Preferences

                  1. Value in Use

                  2. Innate attitudes toward commodities. Generally change slowly, but
                     can change abruptly when new information about health or safety
                     of the product is made available. Can also change rapidly in
                     response to changes in style or fads.

           B. N – Number of Buyers

                  1. Size of the market

                         i. Limited by transportation / communication costs

                         ii. Limited by national borders and trade policy

           C. I – Income of Buyers

                  1. Normal Goods

                         i. Increase in income leads to an increase in consumption

                         ii. Most goods are normal




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       2. Inferior Goods

               i. Increase in income leads to a decrease in consumption

               ii. Examples: Rot gut whiskey, cheap cigars, etc.

               iii. Points: narrowly defined, must have more highly valued
                    substitutes.

D. Py … Pz – Prices of Related Goods

       1. Substitutes

               i. Goods that the consumer views as being more or less
                  interchangeable in consumption
                      a. Examples: Tea / Coffee

               ii. Increase in the price of one leads to an increase in the
                   demand for its substitute.

       2. Complements

               i. Goods that are typically consumed together
                     a. Examples: Coffee / Cream, Tires / automobiles

               ii. Increase in the price of one leads to a decrease in the
                   demand for its substitute.

E. E – Expectations

       1. Typically about prices or availability

               i. Examples: Futures markets, stock market, demand for
                  bottled water before a hurricane arrives, etc.

F. D – Demographics

       1. Change in the age structure of the population will cause the
          demand curves for some goods to shift out. In an aging population,
          demand for homes in retirement communities shifts out while the
          demand for punk rock CDs shifts in.

G. Additional factors which aren’t mentioned in the book but which you
   might want to consider include government regulation, legality /illegality,
   and seasonality.




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II.   THE DETERMINANTS OF SUPPLY – LOCATION OF THE SUPPLY
      CURVE

      A. r …w – Resource prices
            1. Essential determinants of the cost of production, the higher the cost
               of production, the less firms will wish to supply at each Px

      B. Θ (or Theta) – Technology

             1. The current state of knowledge about how to produce the good or
                service. May be embodied in labor (skills, techniques, knowledge,
                etc.) or in capital (the “latest” machine) or in both.

             2. Technical progress usually results in lower costs – hence a
                willingness to supply more of the good at each price.

      C. N – Number of Sellers (Firms)

             1. The market supply curve is the supply curve for the industry so the
                location of the supply curve depends on the number of firms in the
                industry. An increase in firms shifts the supply curve outward and
                a decrease shifts it in.

             2. When the number of firms in an industry is held constant the
                industry is said to be in the short run. When the number changes,
                the industry is adjusting toward long run equilibrium.

      D. T – Taxes

             1. An excise tax on a product raises its price in much the same way
                that an increase in the price of any other input. Increasing the tax
                shifts the supply curve inward. Decreasing the tax shifts the supply
                curve outward.

      E. N & P – Elements of nature and political disruptions

             1. Idea here is that good or bad weather may shift the supply curve
                for some products while political disruptions are likely to shift
                most supply curves to the left.

      F. Other possible ceteris paribus assumptions behind the Supply Curve:
         governmental regulation, legality or illegality of the product and
         seasonality. These are not identified explicitly by the text, but you might
         want to keep them in mind.



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KEYS:           1.     A shift in either a supply curve or a demand curve occurs
                       whenever one of the underlying ceteris paribus assumptions
                       changes.

                2.     A movement along one of the curves is the result of a shift in the
                       other curve. For example, if income changes, that will cause a
                       shift in the demand curve (because income is one of the ceteris
                       paribas assumptions behind the demand curve). This shift in the
                       demand causes a movement along the supply curve.

HINT:       A change in the price of good comes about because one of the curves in the
            supply and demand diagram has shifted, causing a movement along the other.
            A change in the price of the good never causes either the supply curve or
            demand curve in the market for the good to shift. It will, however, cause a
            shift in the demand curves of goods that are substitutes or complements to the
            original good.


SAMPLE QUESTIONS:

        Which of the following would produce a shift in the demand curve in the market
        for beer? Which would produce a movement along the demand curve in the
        market for beer?

        S   M    1.    An Increase in the price of wine.

        S   M    2.    A decrease in income.

        S   M     3.   A drought in Oregon that reduces the hop crop by fifty
                       percent. (Hops are used to make beer – it’s what gives beer
                       its bitter taste.)

        S   M    4.    A technical improvement in the production of beer that
                       allows brewers to produce the same amount of beer for half
                       the cost (Long run effect.)

Answers: S S M M




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