Chapter 4

Demand and Supply

The Market

• can be a location, network of buyers and sellers for a product, demand for a product or a price-determination process

• the interaction of buyers and sellers determines what the price will be for a good or service

Demand

• the quantity of a good or service buyers will purchase at various prices during a given period of time

• the law of demand states the quantity demanded varies inversely with price (Ceteris Paribus – all other things remain the same)

Demand

Reasons supporting the law of demand:

• Substitution Effect – we buy different goods when prices rise or fall

• Income Effect – we can buy more if price falls or less if it rises

Demand

• the demand schedule is the entire relationship between each price and quantity demanded

• the demand is downward-sloping

Demand

• the sum of all individual consumer demand curves for a good is the market demand curve

• “demand” is the entire set of price and quantity relationships while “quantity demanded” is the amount demanded at one price

Supply

• the quantities sellers will offer for sale at various prices during a given period of time

• law of supply states the quantity supplied will increase if price increases and fall if price falls

• “supply” is the entire set of price and quantity relationships while “quantity supplied” is the amount offered at one price

Supply

• Supply curve is upward sloping to the right

Market Equilibrium

• the interaction of buyers and sellers, of demand and supply

• equilibrium price is the result of supply and demand forces

• a price above the equilibrium leads to a surplus which can only be cleared by a drop in price

• a price below equilibrium leads to a shortage and can only be cleared with a price increase

Market Equilibrium

• The intersection of demand and supply

Demand Determinants(changes in Demand)

• Non-price factors shifting the entire curve (at every price)

1. Income – more leads to increased demand

2. Population – more leads to increased demand

3. Tastes/Preferences – various reasons, reports, advertising

4. Expectations – of a future event may lead to more or less demand now

5. Price of Substitute Goods – if a compliment, demand shifts in the same direction; if substitute the opposite direction; eg. bread price increase, demand for butter decreases (compliment); e.g. steak price increases, hamburger demand increases

Supply Determinants(changes in Supply)

1. Costs – increase/decrease in production costs decrease or increase supply

2. Number of Sellers – new producers increase market supply

3. Technology – usually decreases costs and increases supply

4. Nature – weather or disaster can affect supply 5. Prices of related outputs – if another good has

higher price, producers may shift production

Movement along Demand curve

• Can only be caused by change in price

Movement along Supply Curve

• Can only be caused by price change

Shortage

• decrease in price, away from equilibrium

• Excess will be cleared with an increase in price and shrinking quantity demanded

Surplus

• Increase in price, causing excess quantity supplied

• Cleared by lowering prices and reducing quantity demanded

Change in Demand

• Can only be caused by a demand determinant (no price change)

• The whole demand curve shifts

Change in Supply

• Caused by change in supply determinant (no price change)