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1
A Close Examination ofSupply & Demand Principles of
Microeconomic Theory, ECO 284
John Eastwood CBA 247 523-7353 e-mail address:
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The Market
Any arrangement by which people exchange goods (or services).
These exchanges have two sides -- those who wish to buy (demand) and those who wish to sell (supply).
Prices are signals that direct the behavior of both sides.
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Demand
the inverse relationship between the price of a good (or service) and the quantity consumers are willing and able to buy (during a given period of time, ceteris paribus).
A demand price is the greatest amount ($) that a buyer would pay to buy one more unit. (a.k.a. subjective price)
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Representing Demand
The Demand Schedule lists the quantity people plan to buy at each price.
The Demand Curve plots the quantity people plan to buy at each price.
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Eastwood’s Demand Schedule for White Dress Shirts
Price($/unit)
QuantityDemanded(units/time)
$15/shirt 6 shirts per year$18/shirt 5 shirts per year$21/shirt 4 shirts per year$24/shirt 3 shirts per year$27/shirt 2 shirts per year$30/shirt 1 shirt per year$33/shirt 0 shirts per year
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Demand “Curve” (Step Function)
0
5
10
15
20
25
30
35
0 1 2 3 4 5 6
Quantity (shirts/year)
Pri
ce (
$/sh
irt)
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Continuous Demand Curve
0
5
10
15
20
25
30
35
0 1 2 3 4 5 6
Quantity (shirts/year)
Pri
ce (
$/sh
irt)
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Determinants of Demand
Prices of other related goods -- Po Income -- I Number of People -- N Tastes -- T Expectations -- E Subsidies or Taxes -- S
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An Important Difference:
Change in Demand -- The entire curve shifts when one of the PoINTES changes.
Change in Quantity Demanded -- When a good's own price changes, this causes a movement along a single demand curve.
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Prices of other related goods
Substitutes -- goods that satisfy similar needs or desires. Suppose X and Y are substitute goods. (Let X= ___, Y= ____) If the price of Y rises, then the demand for X will rise (shift right).
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Prices of other related goods
Complements -- goods that are consumed jointly. (e.g., hot dogs & buns).
Suppose X and Z are Complements and that the price of Z rises. Then the demand for X will fall (shift left).
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Income
As a person's income rises, his or her ability to purchase any given good also rises.
Willingness to buy is also important, hence we have two classes of goods . . .
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Normal Good
a good that is consumed voluntarily and for which demand will rise as income rises, and fall as income falls.
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Inferior Good
An inferior good is one that is consumed due to economic circumstances.
Demand for an inferior good will fall as income rises . . .
and will rise as income falls.
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Number of People
People are potential buyers. If the number of people increases, demand
will increase (shift right). If the number of people decreases, demand
will decrease (shift left).
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Tastes (or preferences)
People's tastes affect their willingness to buy a good at any given price.
An increase in consumers' taste for a good X will shift the demand curve for X to the right.
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Expectations (of price changes)
If the price of a good X is expected to rise, current demand will increase (if the good can be stored).
If prices are expected to fall, current demand will decrease.
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Subsidies and/or Taxes
From a seller’s viewpoint. . . A subsidy increases demand A tax decreases demand
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Three Demand Curves White Dress Shirts
0
5
10
15
20
25
30
35
0 10 20 30 40 50
Quantity (shirts/year)
Pri
ce (
$/sh
irt)
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Supply the relationship between the quantity of a
good producers are willing and able to offer (during a given period of time), and the price, ceteris paribus.
A supply price is the least amount ($) that will induce a seller to produce one more unit.
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Representing Supply as a Schedule or as a Curve. The supply curve is usually upward sloping
to the right. When the supply is fixed regardless of
price, supply is vertical. When an industry can expand output at a
constant cost per unit, supply is horizontal.
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Tailor’s Supply Schedule for White Dress Shirts
Price($/unit)
QuantitySupplied
(units/time)
$15/shirt 0 shirts per year$18/shirt 1 shirt per year$21/shirt 2 shirts per year$24/shirt 3 shirts per year$27/shirt 4 shirts per year$30/shirt 5 shirts per year$33/shirt 6 shirts per year
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Supply “Curve” (Step Function)
0
5
10
15
20
25
30
35
0 1 2 3 4 5 6
Quantity (shirts/year)
Pri
ce (
$/sh
irt)
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Continuous Supply Curve
0
5
10
15
20
25
30
35
0 1 2 3 4 5 6
Quantity (shirts/year)
Pri
ce (
$/sh
irt)
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Change in Supply VersusChange in Quantity Supplied A change in Supply refers to a shift in the
curve.– A shift to the right is an increase
larger quantity at a given price
– A shift to the left is a decrease smaller quantity at a given price
A change in price causes only a change in quantity supplied, not a shift in the curve.
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Determinants of Supply -- PEST
Prices of other goods– Substitutes in production.– Complements in production (by-products)
Expectations (concerning the good's price in the future)
Supplier's Input Prices Technology (process technology)
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More Non-Price Determinants PESTS WIN
Subsidies and/or Taxes Weather Import Quotas Number of Sellers
Short Run -- Capital fixed;
Long Run -- All factors may vary.
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Prices of other producible goods
Substitutes in production (corn,x; alfalfa,y) If the price of Y rises, then the supply for X will decrease (shift left).
Complements in production (by-products) (cornstalks,z) If the price of X rises, then the quantity supplied of X will increase and the supply of Z will increase (shift right).
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Expectations (of price changes)
If the price of a good X is expected to rise, current supply will decrease (if the good can be stored).
If prices are expected to fall, current supply will increase.
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Suppliers’ Input Prices
aka resource costs Higher input prices,
such as wages or raw materials prices, squeeze profits, and decrease supply.
Higher supply price for any quantity
Lower q for any p.
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Technology
An improvement in process technology reduces the costs of production.
Lower supply price for any given quantity
Larger Qs at a given P
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Subsidies or Taxes
From a buyer’s viewpoint. . . A subsidy increases supply A tax decreases supply
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Weather
Often considered part of Technology Favorable weather increases the supply of
crops Unfavorable weather decreases supply
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Import Quotas
A maximum quantity of a good that may be legally imported during a specified period of time
A quota makes supply vertical above a certain price. 0
5
10
15
20
25
0 20 40 60Quantity (shirts/year)
Pri
ce (
$/sh
irt) Quota=40
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Number of Sellers (Firms)
In the short run, the number of sellers is constant– Short Run -- Capital,K, fixed, Labor, L, may vary;– Long Run -- All factors may vary.
If the number of sellers rises, supply will increase (shift right).
If the number of firms decreases, supply will decrease (shift left).
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Three Supply CurvesWhite Dress Shirts
0
5
10
15
20
25
30
35
0 10 20 30 40 50
Quantity (shirts/year)
Pri
ce (
$/sh
irt)
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Marshall’s Analytical Time Market Period -- Firms cannot change
quantity, S is vertical Short Run -- Firms may vary output, but
not plant size Long Run -- All inputs are variable Secular Period (Very Long Run) --
population and technology vary
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Demand does NOT influence SSR
PESTS WIN -- Demand not on list! Demand and supply are independent in
the short-run. In the short run, capital (K) is fixed New firms cannot enter. Established firms cannot exit.
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The Individual and Market Demand Curves. The market demand curve for a good X is a
(horizontal) summation of the quantity each individual in the market area is willing and able to buy at each price.
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Equilibrium -- where the forces of supply and demand balance.
The equilibrium price (Pe) is where . . .
Qs = Qd. Who sets Pe?
No one! It’s spontaneously established. Equilibrium is stable.
Once reached, it persists until . . .
one of the PoINTES or PESTS change.
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Balancing Supply and Demand: Shortage Buyers wish to buy at a low price,
but also seek to obtain the good. When quantity demanded (Qd) exceeds
quantity supplied (Qs), buyers may . . .
"bid-up" the price.
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Balancing Supply and Demand: Surplus Sellers wish to sell at a high price,
but also desire to sell their goods. When Qs > Qd, sellers may
"bid-down" the price.
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Marshall’s Cross
0
5
10
15
20
25
30
35
0 1 2 3 4 5 6
Quantity (shirts/year)
Pri
ce (
$/sh
irt)
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Changes in Supply (Demand curve unchanging)
Increase in supply implies . . . Pe falls and Qe rises. Decrease in supply implies . . . Pe rises and Qe falls.
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Changes in Demand(Supply curve unchanging)
Increase in demand implies . . . Pe rises and Qe rises. Decrease in demand implies . . . Pe falls and Qe falls.
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Both Supply and Demand Change in the Same Direction
Demand increase; Supply increase;
Qe rises. Pe ? Demand decrease; Supply decrease;
Qe falls. Pe ?;
Pe? implies that Pe could rise, fall or stay the same
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Supply and Demand Change in Opposite Directions
Demand increase; Supply decrease;
Pe rises; Qe? Demand decrease; Supply increase;
Pe falls; Qe?
Qe? implies that Qe could rise, fall or stay the same
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Undercutting the Consumers Arizona Daily Sun, Tuesday, January 16, 1996, page 10.
AUSTIN, Texas (AP) - Bruce Springsteen's latest album features songs about life on the streets. But you won't find a song about this: 100 homeless people who camped out for tickets to his concert. The homeless were shuttled to nine locations around Austin Friday night to buy the $30 tickets for companies that resold them for as much as $400. The homeless people were offered as much as $50 each to stay in line overnight and buy the tickets in the morning. "I think it's wrong because I don't think the homeless people understand how bad they're being used," attorney Steve Boney, who waited for tickets Friday, told the Austin-American Statesman.Jay Hill, who works for Ticket City, said his company paid about five homeless people to stand in line for tickets. "It's free enterprise. That's what America is based on," he said.
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Is the Market too Radical?
"If there's a buck in it, do it."
Market equilibrium results in the greatest possible quantity produced and sold that is agreeable to both buyers and sellers.
Which determines price, demand or supply?
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Rationing
Goods must be allocated to consumers. Thus rationing is a task that every economic
system must carry out.
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Price as a Rationing Device
One of the prime functions of the market is to determine who shall be allowed to acquire goods and who shall not.
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The market excludes...
certain people from economic activity the customers with too little money or too
weak desires, and suppliers unwilling or unable to operate
at a certain price.
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Rationing through Price
Advantages:
Highly dynamic, unlike rigid tradition.
Self-enforcing, unlike command.
Disadvantage:
The market recognizes no claims to outputexcept those of wealth and income.
