Chapter 3

Supply and Demand: In Introduction

Basic Economic Questions to Answer

What: variety and quantity How: technology For whom: distribution

To answer the questions:

Economic Systems:– Centrally Planned Economy– Free Market Economy– Mixed Economy

Market Economy

the allocation for resources is determined by supply and demand

Demand: the buying force Supply: the selling force

Demand: the definition

The quantity of a good or service consumers’ are willing and able to buy at various prices

willingness and ability to buy – willingness: need - necessity– want – desire– ability: purchasing power

Demand: the model

Variables: prices, quantity demanded Assumption: other things equal Hypothesis: (the law of demand)

– Other things equal, a higher price leads to a smaller quantity demanded and a lower price results in a larger quantity demanded

Forecast / test / accept – the law

Demand: key points

Demand is a relationship between quantity demanded and product price

Qd = f (P) – quantity demanded is a function of price – quantity demanded is determined by price

The law of demand: – Qd and P are negatively related

Demand Curve: downward sloping Market demand: the sum of individual

demand

Demand Curve:Change in Qd and The Law of Demand

Other things equal, higher price for a good leads people to demand a smaller quantity of the good.

Assumption: Other Things Equal

the other things: factors affecting D

– --price of related goods • complements vs. substitutes

– --income: normal vs. inferior– --preference– --expectations (prices, income, …)– --population– --others

Qd vs. D

Qd: a number, a corresponding point on the curve

Change in Qd: movement along a curve, caused by change in price only

D: a relationship, a curve Change in D: a shift of the entire curve,

caused by change in other things

An Increase in Demand

Movement Along the Demand Curve

vs. Shift of the Demand Curve

Shifts of the Demand Curve

Supply: the definition

The quantity of a good or service producers are willing and able to sell at various prices

willingness and ability to sell

willingness: profitability

ability: production capacity

Supply: the model

Variables: prices, quantity supplied Assumption: other things equal Hypothesis: (the law of supply)

– Other things equal, a higher price leads to a larger quantity supplied and a lower price results in a smaller quantity supplied

Forecast / test / accept the law

Supply: Key Points

Supply is a relationship between price and quantity supplied

Qs = f (P) – Quantity supplied is a function of price– quantity supplied is determined by price

The Law of Supply: Qs and P are positively related

Supply Curve: upward sloping Market supply: the sum of individual supply

The Supply Curve: change in Qs and the law of supply

Assumption: Other Things Equal

the other things:

factors affecting S

--prices of inputs

goods used to produce other goods

--price of related goods

goods that use the same resources

--technology

--expectations

--others

Qs vs. S

Qs: a number, a corresponding point on the curve

Change in Qs: movement along a curve, caused by change in price only

S: a relationship, a curve

Change in S: a shift of the entire curve, caused by change in other things

Movement Along the Supply Curve vs.

Shift of the Supply Curve

A Decrease in Supply

Shifts of the Supply Curve

The Market:

Equilibrium Change in D and impacts on Pe and Qe

Change in S and impacts on Pe and Qe

Market Equilibrium

Surplus

Shortage

Equilibrium and Shifts of the Demand Curve

Equilibrium and Shifts of the Supply Curve

Simultaneous Shifts of the Demand and Supply Curves

Effects of the “War on Drugs”

Change in D & S--price of related goods

complements vs. substitutes

--income: normal vs. inferior

--preference--expectations (prices,

income, …)--population--others

--prices of inputs (goods used to produce other goods)

--price of related goods (goods that use the same resources)

--technology

--expectations

--others