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2. Law of Demand and Law of Supply
Essay:
2. Give the laws of supply and demand, as they relate to both consumer goods
and labor. (Must define relative price, ceteris paribus, households and
firms, quantities supplied and demanded.)
The Price System
The market economic system uses private property and the process of
exchange to coordinate the production and consumption of all the firms and
households. But because prices play such an important role in providing for
coordination, the market system is sometimes called the price system. In a
market economic system, prices depend on supply and demand.
The Law of Demand
The law of demand states that, ceteris paribus, if the relative price of
a good increases, the quantity demanded by the market decreases. And, ceteris
paribus, if the relative price of a good decreases, the quantity demanded by
the market increases.
The relative price of a good is the rate at which different goods can be
"exchanged". If all prices change in proportion, relative prices are
unchanged. If the price of one good changes and other prices remain
unchanged, then the good's relative price has also changed.
The quantity of a good demanded is the amount of the good that buyers are
able and willing to buy during a specified period of time, given a specific
price. "Ceteris paribus" means all other things being equal.
Consumer Good
The market demand for a consumer good by adding up the quantity demanded
by all households.
A household is a group of people that together consume
goods and services (usually a family).
Given the price of a consumer good, the demand function can be solved for
the quantity demanded by all households together.
Qd = 2000k – 100k P
k
stands for thousand.
2000k is 2000 thousand or 2,000,000.
The negative coefficient on price is consistent with the law of demand.
(P is multiplied by a negative 100k)
The demand schedule shows a series of prices and the quantity demanded
associated with that price.
P
Qd
0 2000
1 1900
2 1800
3 1700
4 1600
5 1500
6 1400
7 1300
8 1200
9 1100
10 1000
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The law of demand is shown on the demand schedule since the quantity
demanded falls as the price rises.
The demand curve for a consumer good illustrates the demand function.
Price is on the vertical axis and quantity demanded by all households is on
the horizontal axis. Sometimes they are drawn to scale. (In this class,
scale demand curves will be drawn using excel. Other times, the demand curves
are more abstract. The downward slope of the demand curve helps us various
economic events.
Excel Diagram
Demand Curve
11
10
9
8
7
6
5
4
3
2
1
0
Qd
0
500
1000 1500 2000 2500
Diagram drawn by computer graphics (diagrams drawn using pencil and paper
should generally look like this!
p
P-Price
Q-Quantity
D
Q
In both demand diagrams, the demand curve slopes down (looked at from
left to right.) That illustrates the law of demand--lower price, higher
quantity demanded.
Labor
The market demand for labor (or other resource) is found by adding up the
quantity demanded by all the firms. Firms are organizations made up of people
that together produce and exchange goods or services (usually a corporation,
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proprietorship, or partnership).
Given the wage rate offered for a specific type of labor (or price of
other resource), the demand function can be solved for the quantity demanded
by all firms together.
Ld = 1250m – 50m W
(m stands for millions)
The demand schedule for labor shows different wage rates and the associated
quantities of labor demanded.
Ld
W
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
1250
1200
1150
1100
1050
1000
950
900
850
800
750
700
650
600
550
500
The demand curve for labor illustrates the demand function. The wage rate is
on the vertical axis and the quantity of labor demanded is on the horizontal
axis.
Excel Demand Curve
Demand Curve
20
15
Ld
10
5
0
0
W
200
400
600
800 1000 1200 1400
W- Wage
L- Labor
8
D
L
The Law of Supply
The law of supply states that ceteris paribus, if the relative price of a
good increases, the quantity of the good supplied by the market increases.
And if the relative price of a good decreases, the quantity of the good
supplied by the market decreases.
The quantity of a good supplied is the amount of a good all sellers are
able and willing to sell during a specific period of time, given the price.
Consumer Good
The market supply of a consumer (or capital) good is found by adding up
the amount of a good supplied by all the firms. Given the price, the supply
function gives the quantity of supplied by all firms together.
Qs = -500k + 400k P
Since the coefficient on the price is positive (+400k), the law of supply
applies.
The supply schedule for a consumer good has a series of prices and then
gives the quantities supplied associated with each price.
P
Qs
0
1
2
3
4
5
6
7
8
9
10
-500
-100
300
700
1100
1500
1900
2300
2700
3100
3500
L
Since the quantity supplied increases as the price increases, the law of
supply applies.
The supply curve for a consumer good illustrates the supply function.
Price is measured on the vertical axis and quantity supplied is measured on
the horizontal axis.
Excel Supply Curve
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Supply
12
10
8
Qs
6
4
2
0
-1000
-500
0
500
1000
1500
2000
2500
3000
3500
4000
S
P
P - Price
Q - Quantity
Q
Since the supply curve slopes up, the law of supply applies.
Labor
The market supply of labor is found by adding up the amount of labor
supplied by all the households. Given the wage, the supply function gives the
quantity supplied by all households.
Ls = -50m + 80m W
The labor supply schedule has a series of wage rates and gives the
associated quantity of labor supplied.
W
Ls
0
1
2
3
4
5
6
7
8
9
-50
30
110
190
270
350
430
510
590
670
10
10
11
12
13
14
15
750
830
910
990
1070
1150
The supply curve for labor illustrates the supply function. The wage is
measured on the vertical axis and quantity supplied is measured on the
horizontal axis.
The excel labor supply curve is drawn to scale.
Labor Supply
20
15
10
Ls
5
0
-500
0
500
1000
1500
Usually, supply curves simply are shown with the proper “upward” slope.
If you are asked to draw one using pencil and paper, it should look like the
one below.
W
S
W - Wage
L - Labor
L
Discussion topics:
1. Gasoline is a necessity, so the law of demand doesn’t apply.
2. Increased production allows firms to lower costs because of the economies
of mass production. That means that the law of supply doesn’t apply.