Download Lecture 1: Demand and Supply

Lecture 1: Demand and Supply
The Use of Models
Any sensible discussion about economics starts with the concepts of demand and supply. Economists take it as given that, the greater the price of any commodity, the less of it
consumers will want to purchase, and the more of it other people will be willing to supply.
- While simplistic in nature -- people continue to deny their validity
ex.: the demand for water
Economic Laws and Economic Models
Law of Supply and Demand was first stated in 1776
– Adam Smith’s The Wealth of Nations.
Economic Theory or Laws – generalizations about the working of an abstract economy
- rules that economists use to predict actual market behavior
- Price up – quantity demanded down
Demand Curve - A demand curve, or demand function shows the quantity of a particular
product that people demand as a function of price.
Law of Demand - The lower the price, the greater the quantity demanded.
A Graphical Interpretation
A possible demand curve for apples as a function of the price of apples.
The Demand Curve for Apples
The demand curve shows combinations of apples consumers want to purchase at different prices. At Po, the quantity demanded is Qo. At P1, Q1.
Demand is downward sloping, indicating that the lower the price, the higher
the quantity demanded.
The movement from A to B is a change in quantity demanded not a change in
demand.
Demand Function
- the relation between price and quantity demanded is more properly stated as a demand function,
- representing a demand function as a demand schedule
Demand Schedule
Price of Apples
Quantity
Demanded
$0.40
100
$0.50
80
$0.60
75
- representing a demand function mathematically or equational demand
Q = 100- 2P
or
P = 50 – (1/2) Q
Determinants of Demand – shift factors of demand
Household Income
Normal good – as income increases, demand increases (other things constant)
Inferior good – as income increases, demand decreases (other things constant)
Prices of Related Goods in Consumption
Substitutes in Consumption – as Psub rises, demand for own good rises
Complements in Consumption – as Pcomp rises, demand for own good falls
The demand function gives the quantity demanded as a function of price. But the demand
function also has determinants such as income and the price of complements and substitutes.
Thus we can write the demand curve as
D = D(p, I, pc, ps)
where
p = price
I = income
pc = price of a complement
ps = price of a substitute
Other Determinants of Demand
Expected Future Prices
Population
Preferences
Impact of a Change in a Determinant of Demand
While a change in price leads to a movement along a demand curve,
a demand shifter causes the demand curve to increase from D to D'.
The quantity demanded at the price Po increases from Qo to Q1.
This shifter could be an increase in income (if the good is a normal
good), an increase in the price of a substitute, or a decrease in the
price of a complement.
Supply
Quantity Supplied – the amount of a commodity a firm plans to sell given the time
period and prices
Law of Supply – as the price increases, quantity supplied increase, other things
constant
- a supply curve can be represented as a supply schedule
Supply Schedule
Price of Apples
Quantity
Supplied
$0.40
75
$0.50
80
$0.60
100
- a supply curve can be represented as a mathematical or equational supply
Q = 10 + 2P
or
P = -5 + (1/10) Q
A Supply Curve
The supply curve gives the quantity supplied to the market at different prices. In general, the higher the price, the greater the quantity
supplied.
Determinants of Supply – supply shifters
Price of the Factors of Production
- changes in production technology
Price of Related Goods in Production
Substitutes in Production – if the Psub rises, production of the own good decreases
Complements in Production – if the Pcomp rises, production of the own good rises
Other Determinants of Supply
Number of Firms on the Market
Expected future Prices
Production Taxes / Subsidies
Disasters
Market Equilibrium
- market price at which quantity supplied and quantity demanded are equal
(true, whether the equilibrium is determined graphically, by a schedules, or mathematically)
Price and Quantity Determined by the Intersection of the
Demand and Supply Curves
While supplies and demands usually take prices as given, it is the
intersection of the demand and supply curves that determine the
equilibrium market price. When the price equals po, both the quantity demanded and the quantity supplied equal q o.
Must the Quantities Demanded and Supplied be equal?
It is not uncommon to hear or read of
- demand outstripping supply
- a need to assure the consumer of an adequate supply of _______
Surplus – if P > PE then the Qs > Qd
Shortage - if P < PE then the Qd > Qs
It is possible for Supply and Demand to not intercept at all.
The process of adjustment can take time
- in macro it is common to distinguish between short term and long-term supply and
demand curves.
Example of freshly cut flowers
An Illustration of Long Run and
Short Run Supply Curves
The initial adjustment to a shift in the demand curve is a movement
along the short run supply curve so that the price drops from P e to
Ps. Over time, the price rises part way back to P' as the quantity falls
to Q'
Two Extreme Cases
- vertical supply curve indicate a fixed quantity supplied
- horizontal supply curve indicate that supply is as much as one might wants at one
price.
A Vertical Supply Curve
A Horizontal Supply Curve
This figure illustrates a vertical
supply curve. No matter what
the price, only a fixed quantity is
available. The supply curve for
land, for instance, is vertical.
The other special case is that of
a horizontal supply curve, where
there is an infinite amount available at a given price.