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Demand, supply and market equilibrium
• Basic decision-making units in market (the circular flow)
Household demand in product market
• Household’s decision about quantity demanded (number of
units per period of time) depends on:
- Price of product (p)
- Income of household (normal vs. inferior goods) (y)
- Household’s wealth (w)
- Prices of other products
(substitutes vs. complementary goods) (op)
- Household’s tastes and preferences (pref)
- Expectations about future income, wealth, and prices (exp)
Household demand curve issues
• Household demand curve: A graph illustrating how much of
a product a household would be willing to buy at different
prices.
p
Discussion:
D (y0, w0, op0, pref0, exp0)
0
-Ceteris paribus or all else
equal
- Law of demand
- Dem curve intersects q axis
(time limitations and
diminishing marginal utility)
- Dem curve intersects p axis
(limited income and wealth)
- Change in income
q
From household demand to market demand
• Market demand: The sum of the quantities of a good
demanded per period by all the households buying in that
market.
Firm supply in product markets
• Firms engage in production to maximize profits. Therefore,
firm’s decision about the quantity supplied (number of units
per period of time) depends on:
- Price of product (p)
- Cost of producing the product:
price of inputs (e.g. wage (w) and interest rate (r)),
technology used (tech), short run limitations
- Prices of other products (op)
Firm supply curve issues
• Firm supply curve: A graph illustrating how much of a
product a firm would be willing to sell at different prices.
p
Discussion:
- Law of supply
- Change in wages
- Short run vs. long run supply
curve
S (w0, r0, tech0, op0)
0
q
From firm supply to market supply
• Market supply: The sum of what is supplied each period by
all producers of a single product.
Market equilibrium
• Market equilibrium: The condition that exist when quantity
supplied and quantity demanded are equal. At equilibrium
there is no tendency for price to change.
p
Example:
S
S: qs = -10 + p
D: qd = 20 – p
peq=15 , qeq=5
peq
equilibrium point
D
0
qeq
q
Stability of market equilibrium
• Economists like equilibriums, but we love those that are stable!!!
Stable equilibrium: The system always returns to it after
small disturbances.
Unstable equilibrium: The system moves away from the
equilibrium after small disturbances
Stability of market equilibrium
The inherent forces of the
market move the system to
its equilibrium!!!
p
S
p0
excess supply
equilibrium point
p1
excess demand
D
0
q
Changes in Equilibrium
p
Example: Increase in income
S
eq. point 1
eq. point 0
D0
0
D1
q