Download Quantity demanded

Econ 100
Lecture 4
The determination of prices and quantities of goods
purchased by large numbers of buyers and sold by large
numbers of sellers:
Demand and supply analysis – part 1
We have already seen that in any economy it must be
decided what to produce, how to produce, and for whom
to produce.
These involve the determination of prices and quantities
produced and sold of goods and services.
As quantities are determined, the question of what (which
goods in what quantities) is decided.
As prices are determined, not only the allocation of
resources (the question of how) is directed,
but also, since prices include wages and salaries, rents,
and interest rates, income distribution is determined.
In many economies, except for those that are
ruled by central planning at all levels, markets play
a very important (or, at least some) role in the
determination of quantities and prices.
Markets are where buyers and sellers meet and
interact and it is through this interaction that prices
and quantities take on their values.
Therefore, we have to examine how markets
work, and how buyers and sellers behave. The
behavior of buyers is captured by the concept of
demand and that of the sellers by supply.
Therefore, these are the topics that we will take up
in this lecture:

Markets (competitive markets and others)

Demand (buyer side of a competitive market)

Supply (seller side of a competitive market)


Equilibrium (determination of price and quantity as a
result of the interaction between demand and supply)
Changes in equilibrium (changes in price and quantity)
What is a market?



any medium through which the buyers and
sellers of the same good or service can meet,
bargain or not, agree or disagree on the price
and quantities to be sold of that good in
particular exchanges, and engage in exchanges
A physical market place or highly developed
organization is not necessary for a market to
exist
... although some markets are highly developed,
functioning even with officers acting as auctioneers
Markets can be classified by different criteria, two
of which would be:
• The number of buyers and sellers in the market
Only one seller, many buyers – monopoly
A few sellers, many buyers – oligopoly
Many sellers, many buyers – competitive
• The similarity of the goods sold in the market
All goods exactly the same – homogeneous goods
All goods similar but different – differentiated goods
Competitive markets
If a market with many buyers is characterized by

a large number of sellers
and

all the units of the goods sold in that market being
almost exactly the same regardless of the producer
we talk about a perfectly competitive market.
If the number of sellers is still relatively large but the
goods sold by different sellers are differentiated, that is
a monopolistically competitive market.
The numbers of buyers and sellers in a monopolistically
competitive market are also large, but they are so large
in a perfectly competitive market and the goods sold so
similar, no single buyer or seller has the ability to affect
significantly the market price all by his or her actions
alone.
In particular,


If a seller sets a price higher than his competitors, all buyers will
move to other sellers, so it will not be reasonable to do it.
If a seller sets a price lower than his competitors, all buyers will
rush to him making him unable to meet all the orders selling
what he could sell anyway at an unnecessarily low price and
again it will not be reasonable to charge a different price than
others.
For this reason, the buyers and sellers in a perfectly
competitive market are said to be price-takers (in the
sense that their behavior can be analyzed as if they are
following an auctioneer)
instead of being price-setters (which monopolistic
sellers are).
You see that a perfectly competitive market is a bit of an
imaginary construct, and
the larger the number of buyers and sellers in an actual
market and the more similar the products sold there, the
more closely does that market resemble a perfectly
competitive market.
The demand and supply analysis as we will
discuss it applies as a whole to a perfectly
competitive market
(although parts of this analysis are useful or even
necessary also to understand other markets – for
example, the monopolistic market will have a
demand side because of the large number of
buyers there).
So let us continue by starting to examine the
demand side of a perfectly competitive market.
But, first, a question:
Why do we have to separate the buyers and
sellers sides of the market if we are trying to
understand how the quantity produced and sold in
that market is determined?
Because there is actually not one but two quantities that
are involved here:


Quantity demanded = the number of units of the good
that the buyers are willing (and able with available
means to them, such as their income) to buy over a
given period of time
Quantity supplied = the number of units of the good
that the sellers are willing (and able with available
means to them, such as their inventories or production
capacity) to sell over a given period of time
Demand
The discussion of the demand side of the market deals
with the factors that affect / determine the quantity
demanded.
We can talk about two different quantities demanded:


Individual quantity demanded – quantity demanded
by an individual buyer
Market quantity demanded – quantity demanded by
all buyers in the market which is the sum of all
individual quantities demanded
Either of these are determined by a number of factors.
Quantity demanded of a good
is determined by...

Price of the good itself

Income (the individual QD is affected by the income of the
individual buyer, the market QD is affected by the income of all
buyers)

Tastes or preferences of (all) the individual(s)

Prices of other goods



Expectations (expected future price of the good, expected
future income, …)
Population and the age profile of the population (if it is
the market quantity demanded)
...
The relationship between individual quantity
demanded and the price of the good
For most of the goods (except for those that are called
“Giffen goods” in economics), the quantity demanded
by an individual is negatively related to the price of
the good.
In other words, individual quantity demanded (qD)
•
decreases as the price (P) of the good increases
and
•
increases as the price of the good decreases.
The exact properties of this relationship may be different
depending on the good and the individual in the
sense that...
as P changes, the change in qD may be
• continuous or stepwise
• large or small
but the fact remains that as P goes in one direction, qD
will go in the other direction.
What is the reason behind this negative relationship?
As P increases and the good becomes relatively more
expensive, the individual will switch to other goods that
will fulfill the same need or more or less the same need
or serve similar purposes. We say the individual
substitutes other goods for the one whose price has
increased.
If substitute goods are available or not so available, it will
be easier or more difficult to switch to those and the
change in qD as a result of a change in P will be
relatively larger or smaller.
One can draw the graph of this relationship in general by
• Using the horizontal axis to measure qD
• Using the vertical axis to measure P
• Drawing a negatively sloped curve
This graph will display the relationship in a general way
because for a specific good and a certain individual we
may actually have a continuous curve or a stepwise
function descending like a staircase in the + direction
along the horizontal axis, or a relatively flat or a
relatively steep curve.
Sticking with the general case, we see that if A, B, and C
are three points on this curve, it shows that
as the price of the good is equal to PA, the quantity
demanded by the individual will be equal to qDA,
and if P increases to PB, qD will decrease to qDB,
and if P decreases to PC, qD will increase to qDC.
so that as P changes we move from one point on the
curve onto another one.
The negative relationship between qD and P is called the
demand (for a specific good by a certain individual)
and
the negatively sloped curve which is the graph of the
relationship between qD and P is called the demand
curve (for a ...).
In order that the demand curve really displays the
relationship between qD and P, it has to show the
effect on qD of P only.
In other words, it has to show how qD changes as P and
only P changes without any change in any one of the
other factors that can affect qD.
This means that all factors other than P must
remain constant along the demand curve.
In other words, the demand curve must be drawn
such that, if for example the income of the
individual is equal to 2500 TL per month at one
point on the demand curve, it has to be also
equal to 2500 TL per month at another point on
the demand curve.
So the demand curve shows the effect of P on qD
everything else remaining the same or constant.
Factors that remain constant
along an individual demand curve
Not the price of the good itself, of course, but
•
Income of the individual
•
Tastes or preferences of the individual
•
Prices of other goods
•
Expectations (expected future price of the good,
expected future income, ...) by the individual
•
...
Individual demands and market demand
Consider two individuals A and B and their individual
quantities demanded resulting in the market quantity
demanded (assuming there are only two buyers):
Price
Quantity demanded (no of units)
(TL/unit)
by A
by B
market
5
12
20
32
6
10
17
27
7
9
14
23
Market demand is the horizontal sum of individual
demands.
Compared to the individual demand curves, the
market demand curve is relatively
• flatter
• shifted out more
Almost everything we noticed about individual
demand (curve) applies to market demand
(curve) as well.
The relationship between market quantity
demanded and the price of the good
For most of the goods, the market quantity demanded is
negatively related to the price of the good.
In other words, market quantity demanded (QD)
decreases as the price (P) of the good increases and
increases as the price of the good decreases.
The negative relationship between QD and P is called the
demand (for a specific good by all individuals in the
market) and
the negatively sloped curve which is the graph of the
relationship between QD and P is called the demand
curve (for a ...).
In order that the demand curve really displays the
relationship between QD and P, it has to show the
effect on QD of P only.
This means that all factors other than P must remain
constant along the demand curve.
So the demand curve shows the effect of P on QD
everything else remaining the same or constant.
Factors that remain constant
along a market demand curve
Not the price of the good itself, of course, but
•
Income of all individuals (buyers)
•
Tastes or preferences of all individuals
•
Prices of other goods
•
Expectations (expected future price of the good,
expected future income, …) by all individuals
•
Population and the age profile of the population
•
...
We have seen that as P changes, (individual or market)
quantity demanded changes along the demand curve.
So we can see the effect of a change in P as a
movement along the demand curve.
What if one of the other factors, for example income,
changes?
The relationship between quantity
demanded and income
Changes in income can affect the quantity demanded in
two ways:
•
positively: normal goods (most goods)
•
negatively: inferior goods (some goods)
In other words, for a normal good, the quantity
demanded will
•
increase as income increases and
•
decrease as income decreases.
Again, the graph of this relationship can be drawn. But
how exactly should we do it?
One possibility would be as follows:
• use the horizontal axis to measure quantity demanded
• use the vertical axis to measure income
• draw a positively sloped curve
Along this curve, all factors other than income (including
the price of the good among those other factors) will
remain constant so that the curve shows the effect on
quantity demand of a change in income only.
But what if we prefer to see the effect of a change in
income on the same diagram as the demand curve?
Then we would have to
• use the horizontal axis to measure quantity demanded
as before, but
• use the vertical axis to measure price of the good
instead of income, and
• draw the demand curve.
Now since we are trying to see the effect of a change in
income only, everything else, including the price of the
good, will have to remain the same.
This implies that, if the good is a normal good and the
quantity demanded increases as income increases, it
increases at the same price.
which in turn implies that we move onto a new
demand curve or
the demand curve shifts (and it shifts right if
quantity demanded increases).
We see that the effect of a change in any factor
other than the price of the good is seen as a
shift in the demand curve.
We can summarize that there are two types of
changes:
Either
the price of the good changes
• causing the quantity demanded to change
• which is seen as a movement along the same
demand curve.
or
any factor other than the price changes
• causing the demand to change
• which is seen as a shift in the demand curve.
Notice that the following three are equivalent expressions
(they express the same thing):
• Quantity demanded increases at any price
• Demand increases
• Demand curve shifts out
Also, it is equivalent to say the demand curve shifts
• out
• right
• up
Effects of some of the other factors on
quantity demanded
•
Income
Normal good (+)
(As income increases, QD increases at any P or D increases
or D curve shifts out)
Inferior good (–)
(As income increases, QD decreases at any P or D
decreases or D curve shifts in)
•
Prices of other goods
Price of a substitute good (+)
Price of a complement good (–)
•
Expectations
Expected future price (+)
Expected future income (+)