demand and supply basics

1. Demand and Supply: Basics
September 9, 2009

2. Demand
 Ceteris Paribus
 “all else remaining the same” or “other things being equal”
 Relative prices and Money Prices
 Money Price is the price that is observed in terms of today’s
dollars.
 Relative price is the price of good or service in terms of
another. It is the money price of one commodity divided by
the money price of another; the number of units of one
commodity that must be sacrificed to purchase one unit of
another commodity.

3. Demand

4. Demand
 The money prices of both commodities has fallen from
last year to this year.
 The relative price of 4-Gigabite flash memory drives has
fallen, whereas the relative price of rewritable DVDs has
risen.
 When evaluating the effects of price changes, we
must always compare price per constant-quality
unit.

5. Demand
 In a market economy, the price of a good is
determined by the interaction of demand and
supply.
 All the analysis about demand and supply in this
chapter will be in the competitive market.
 Competitive Market: a market that has many
buyers and many sellers so no single buyer or seller
can influence the price.

6. Demand
 Demand is the relationship between the price of a
good and the quantity of the good demanded at each
price.
 The various combinations of price and quantity
demanded can be reported in a demand schedule.
 Each individual in a market has a demand schedule since
each person has different preference over the products.

7. Demand
 The law of demand: The greater the price the
lower the quantity demanded, other things being
equal.
 This is the result of two effects:
 Substitution Effect: The tendency for people to
substitute in favor of cheaper goods and away from more
expensive ones.
 Income Effect: The change in people’s purchasing
power when the price of one of the goods they buy
changes.

8. Demand
 The good with an upward demand curve is called
“Giffen Good”, but it rarely exits in the real world.
Discussion:
Whether luxury goods are Giffen Goods? Some
people say that in certain circumstances, only when
the prices of some goods, such as luxury goods, are
high, they tend to be willing to buy it. When the
prices are low, they will not buy it.

9. Demand
 Market Demand: the total quantity demanded in the
market equals the sum of the quantities demanded
by each person in the market at a given price.
 The law of demand also holds for market demand.

10. Demand
Demand schedules in the Market for Chewing Gum
Price
Quantity Demanded by Total Quantity
Demanded
Person 1 Person 2 Person 3 Person 4
$0.01 10 17 13 20 60
$0.10 7 16 10 17 50
$0.20 5 15 5 15 40
$0.30 4 8 4 14 30
$0.40 2 6 3 9 20
$0.50 1 3 1 5 10

11. Demand
A simple demand curve

12. Demand
 Distinction between Quantity Demanded and
Demand
 Demand: The overall relationship between price and
quantity demanded.
 Quantity Demanded: The amount that would be
purchased at a given price.
 A change in demand is not the same as a change in
the quantity demanded.

13. Demand
 A change in demand indicates a shift of the demand
curve.
 A change in the quantity demanded is represented
by the movement long the demand curve, when
there is a change of the own price.

14. Demand
A change in the quantity demanded versus a change in demand
A change in demand – shift
of demand curve
A change in demand – shift
of demand curve
A change in the quantity changed
– movement along the same
demand curve
A change in the quantity changed
– movement along the same
demand curve

15. Demand
 Determinants of Demand ( other than own price)
 Changes in the prices of related goods
 The disposable income of consumers
 Expected future prices and future income
 The number of demanders in the market(market size)
 Tastes and Preferences

16. Demand
 Changes in the prices of related goods
 Substitutes: Goods that can replace each other in
consumption.
 Complements: Goods that are used in conjunction with
each other.
 When the price of a substitute increases, ceteris paribus,
the demand for the good in focus will increase. When the
price of a complement increases, the demand for the
product in focus will decline.

17. Demand
 The disposable income of consumers
 Normal goods: Demand increases after an increase in
income.
 Inferior goods: Demand decreases after an increase in
income.

18. Demand
 Expected future prices and future income
 If a sufficient number of demanders expect the price of the
good to increase in the future, these people will increase
their demand for the product today in order to stock up on
the good and avoid the higher price in the future. If a
sufficient number of demanders think the price will decline
tomorrow, the demand today will decrease.
 Expectation of a rise in income may cause consumers to
purchase more of normal goods today at current prices.

19. Demand
 The number of demanders in the market(market size)
 As the number of demanders in the market or population
increases, the demand for the good increases.
 Tastes and Preferences
 If the taste or preference increases, then the demand for
that product will increase, and vice versa.
 Economists tend to think that preferences change slowly
over time and therefore this influence on demand is
relatively minor.

20. Supply
 Supply is the relationship between the price of a
good and the quantity supplied by producers.
 A market supply is found by adding up individual
producer supply schedules. Summing the quantity
supplied at each price by each producer (horizontal
summing of the individual supply curves) derives
the market supply curve.

21. Supply
 The law of supply: The higher the price of a good,
the greater the quantity supplied, other things being
equal.
 The law of supply is the result of the law of
increasing cost.
 As the quantity of a good rises, the marginal opportunity
cost rises.
 Sellers will only produce and sell additional unit of a
good if the price rises above the marginal opportunity
cost of producing additional unit.

22. Supply
Supply Schedules in the Market for Chewing Gum
Price
Quantity Supplied by Total Quantity
SuppliedFirm 1 Firm 2 Firm 3
$0.01 10 15 0 25
$0.10 20 25 5 50
$0.20 30 35 10 75
$0.30 40 45 15 100
$0.40 50 55 20 125
$0.50 60 65 25 150

23. Supply
A simple supply curve

24. Supply
 A change in supply indicates a shift of the supply
curve.
 A change in the quantity supplied is represented by
the movement long the supply curve, when there is
a change of the own price.

25. Supply
 Determinants of Supply (other than own price)
 The prices of factors of production
 The price of related goods: substitutes and complements
in the production process.
 Expected future prices
 Number of suppliers
 Technology
 Taxes and subsidies
 The state of nature

26. Demand and Supply
 Market Equilibrium
 Equilibrium is a situation in which opposing
forces balance each other.
 In the supply and demand model, the equilibrium
occurs when there is neither a shortage nor a
surplus in the market.

27. Demand and Supply
Supply and demand diagram
SurplusSurplus
ShortageShortage

28. Demand and Supply
 Equilibrium Price is the price at which the
quantity demanded equals the quantity supplied.
 Equilibrium Quantity is the quantity bought and
sold at the equilibrium price.

29. Demand and Supply
 Changes in demand and Supply does not change
 Increase in demand leads to a rise in the equilibrium
price and quantity.
 Decrease in demand leads to a fall in the equilibrium
price and quantity.

30. Demand and Supply
Changes in demand

31. Demand and Supply
 Changes in supply and demand does not change
 Increase in supply leads to a fall of equilibrium price and
quantity.
 Decrease in supply leads to a rise of equilibrium price
and quantity.

32. Demand and Supply
Changes in supply

33. Demand and Supply
 Changes in supply and demand(in the same direction)
 If both the demand and the supply of a good or service
increase, both the demand and supply curves shift
rightward. The quantity unambiguously increases but the
effect on the price is ambiguous.
 If the increase in demand is greater than the increase in supply, the
price rises.
 If the increase in demand is the same size as the increase in supply,
the price does not change.
 If the increase in demand is less than the increase in supply, the price
falls.

34. Demand and Supply
 If both the demand and the supply of a good or service
decrease, both the demand and supply curves shift
leftward. The quantity unambiguously decreases but the
effect on the price is ambiguous.
 If the decrease in demand is greater than the decrease in
supply, the price falls.
 If the decrease in demand is the same size as the decrease in
supply, the price does not change.
 If the decrease in demand is less than the decrease in supply,
the price rises.

35. Demand and Supply
Increase in both demand and supply

36. Demand and Supply
 Changes in supply and demand(in the opposite
direction)
 If the demand increases and the supply decreases, the
demand curve shifts rightward and the supply curve shifts
leftward. The price unambiguously rises but the effect on the
quantity is ambiguous.
 If the increase in demand is greater than the decrease in supply, the
quantity increases.
 If the increase in demand is the same size as the decrease in supply,
the quantity does not change.
 If the increase in demand is less than the decrease in supply, the
quantity decreases.

37. Demand and Supply
 If the demand decreases and the supply increases, the
demand curve shifts leftward and the supply curves shifts
rightward. The price unambiguously falls but the effect
on the quantity is ambiguous.
 If the decrease in demand is greater than the increase in
supply, the quantity decreases.
 If the decrease in demand is the same size as the increase in
supply, the quantity does not change.
 If the decrease in demand is less than the increase in supply,
the quantity increases.

38. Demand and Supply
Increase in supply and a decrease in demand