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SUPPLY AND DEMAND: MODELING A COMPETITIVE MARKET For a market to be competitive, there has to be several

buyers and sellers – so that the aggregate effect sets prices, not a single player’s actions

The behavior of competitive markets is well described by the supply and demand model

Because we are studying Macroeconomics, we do not look at individualized aspects of the model – but we focus instead on Aggregate Supply and Aggregate Demand

THE DEMAND CURVE Demand is somewhat determined by price.

For the graph, price level is on the vertical axis while quantity demanded is on the horizontal.

Because demand for a product goes down as the price rises, demand curves slope downward.

CHANGES IN DEMAND Change in demand shifts the position of the demand curve.

An increase in demand moves the demand curve to the right, while a decrease in demand moves the demand curve left.

“Change in demand” is different from movements along the original demand curve, which are caused by changes in a good’s price.

SHIFTING THE DEMAND CURVEFive Principal Factors that Shift the Demand Curve

1. Changes in the prices of related goods or services – Demand for substitutes increases when a good’s price rises and demand for complements increase when a good’s price falls.

2. Changes in income – Demand for most goods increase with the rise in income, with the exception of inferior goods.

3. Changes in tastes – When fads and preferences change, this shifts demand curves.

4. Changes in expectations – Expected changes in prices or income impact demand.

5. Changes in the number of consumers – Population changes shift demand curves.

THE SUPPLY CURVE Supply is also somewhat determined by price.

Because supply of a product goes up as the price rises, supply curves slope upward.

“Change in supply” is different from movements along the original supply curve, which are caused by changes in a good’s price.

CHANGES IN SUPPLY Change in supply shifts the position of the supply curve.

“Change in supply” is different from movements along the original supply curve, which are caused by changes in a good’s price.

An increase in supply moves the supply curve to the right, while a decrease in supply moves the supply curve left.

SHIFTING THE SUPPLY CURVEFive Principal Factors that Shift the Supply Curve

1. Changes in input prices – When components of production are more costly, producers make less and supply decreases.

2. Changes in the prices of related goods or services – When producers create complements simultaneously, supply of both products may be driven by the price of only one. Supply of substitutes increases as the price for the other product falls.

3. Changes in technology – New tech tends to decrease cost of production, leading to greater production

4. Changes in expectations – Expectation of increased price can inspire producers to hold out for the “right time” to sell to maximize profit.

5. Changes in the number of producers – The number of producers shifts the supply curve.

THE FIRST TWO “LAWS”1. Law of Demand – Ceteris paribus, higher prices for a

good lead people to demand a smaller quantity of that good.

2. Law of Supply – Ceteris paribus, the higher the price being offered, the more of any good or service producers are willing to sell.