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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 1 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. 2 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. 3 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 4
"The Fundamentals of"