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Principles of Micro economics-Armah
Hand out for Supply and Demand
Key Points from Chapter 4
Key points to take away from this chapter
-Economists use the model of supply and demand to analyze competitive markets.
-Competitive market  Many buyers/sellers. Each has little/no influence on Market price
Demand curve/schedule illustrates dependence of quantity of good demanded on price
Law of Demand: As the price of a good falls, quantity demanded rises. Demand has (-) slope
Apart from price other determinants of Consumer willingness to buy include
-Income, Price of substitutes and Complements, Tastes, Expectations, and the Number of buyers
-If one of these (other factors-exogenous) changes, the demand curve shifts
-Supply Curve shows how quantity supplied of a good depends on the price
-Law of supply- As the price of a good rises, the quantity supplied of the good rises
The supply curve therefore slopes upward
-In addition to price, other determinants of how much producers want to sell include:
Input prices, technology, expectations, and the number of sellers. If one of these
(other/exogenous) factors change, the supply curve shifts
- The market equilibrium is determined by the intersection of the supply and the demand
curves
-At the equilibrium price, the quantity demanded, exactly equals the quantity supplied
-The behavior of buyers and sellers in the market naturally drives the market to its equilibrium
THE MARKET EQUILIBRIUM
-Suppose the market price is above the equilibrium price: Sellers try to sell all they can
so they supply too much->there is a surplus of goodsThis causes the market price to fall back
-Suppose the market price is below the equilibrium price: Consumers want to buy as
much as they can for cheapThis causes a shortage of the good or too much demandthis
causes the market price to rise
-We always use the supply and demand curves to see how an event affects prices and quantity
when we want to see how this event affects the market
Steps
1) Does the event affect supply curve or the demand curve or both?
2) What direction does the affected curve (s) shift?
3) Compare the new equilibrium with the old equilibrium
Prices are the main signals that guide decisions in market economies and thereby
allocate scarce resources
For every good in the economy, prices ensure that supply and demand are exactly balanced
The equilibrium price then determines how much of the good buyers wish to purchase and
how much sellers choose to produce.
Examples of Markets Classified Ad section of a Newspaper, college careers services, market
for weed on college campus
Can you tell me who is buying and who is selling?
The demand Curve: Relationship between quantity demanded and price holding all other things
constant: ceteris paribus
A change in price leads to: Movement along the demand curve
By convention (historical occurrence)-> Price is graphed on the Vertical Axis. Q on horizontal Axis
Demand Schedule: A Table showing the relationship between price of a good and quantity demanded
Price of ice-Cream
Quantity of cones Demanded
$0.00
12
$0.5
10
$1.00
8
$1.50
6
$2.00
4
$2.50
2
$3.00
0
EXERCISE: Plot the Demand curve
The graph just drawn is the demand curve
An increase in price  leads to decreased quantity demanded
A decrease in price leads to increased quantity demanded
Market Demand Vrs Individual Demand
1. The market Demand is the Sum of all individual demands for a particular good or service
2. The Demand curves are summed horizontally (not vertically): That means for each price
level the quantity demanded by different individuals are added up
3. The market Demand Curve shows the total quantity of a good varies with the price of the
good, holding all other factors that affect how consumers want to buy constant
Shifts in the Demand Curve
Change in Price: Causes a movement along the demand curves-> Change in quantity
demanded
Change in a determinant of demand (other factors that we usually hold
constant): Causes a shift of the demand curve - > A change in demand
-Remember that that the demand curve shows how much consumers wants to buy at any
price, holding constant the many factors that influence buying decisions
If any of these factors change, the demand curve will shift
-Give me some examples of other factors that might change (Income, preferences, price of related
goods, expectations: future incomes, prices, Number of buyers)
An increase in demand causes the demand curve to shift right
A decrease in demand causes the demand curve to shift left
INCOME
The relationship between Income and quantity demanded depends on the type of good
Normal good: A good for which other things equal, an increase in income, leads to
an increase in the demand for the normal good
Inferior good: A good for which other things equal, an increase in income, leads to n
decrease in the demand for the inferior good
Giffen good: An increase in the price of a Giffen good leads to increased quantity
demanded
QN What is the law of demand?
Giffen goods contradict the law of demand. They have positive not
negative slopes
There are however some exceptions (to downward sloping demand). For
instance, as Sir R. Giffen has pointed out, a rise in the price of bread makes so
large a drain on the resources of the poorer labouring families and raises so
much the marginal utility of money to them, that they are forced to curtail their
consumption of meat and the more expensive farinaceous foods: and, bread
being still the cheapest food which they can get and will take, they consume
more, and not less of it. But such cases are rare; when they are met with, each
must be treated on its own merits ( Marshall, 1890)
Price of related goods
Substitutes: Two goods for which an increase in the price of one leads to
an increase in the demand for the other. Example Levy’s and Tommy
Hilfiger jeans
Complements: Two goods for which an increase in the price of one leads to a
decrease in the demand for the other. Example fingers and fries. Plantain and Banana
(Kofi Brokeman)
Case Study: Two Ways to Reduce the Quantity of Smoking Demanded
1. Cause a shift in the demand curve to the left: Public health announcements,
mandatory health warnings, prohibition of cigarette ads on TV are policies intended to
reduce the demand for cigarettes
2. Cause a movement along the demand curve
Raise the price of cigarettes and lower the quantity of cigarettes demanded (Law of
demand)
-The demand curve does not shift
- Studies have shown that a 10% increase in the price of cigarettes causes a 4 %
reduction in the quantity of cigarettes demanded.
- -For teens 10% increase in the price of cigarettes causes 12% reduction in the quantity
of cigarettes demanded.
- However studies have also shown that a decrease in the price of cigarettes is
associated with greater use of marijuana. Tobacco and marijuana are complements
- If we raise tobacco prices both tobacco smoking and marijuana smoking will go down
On Monday we will tackle supply and the concept and attainment of the
market equilibrium
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