2 - Supply & Demand (Edited)

8/11/2019 2 - Supply & Demand (Edited)

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Supply and Demand Before we can begin interpreting and predicting prices, we need to

develop an understanding of basic economic theory including:

Definitions relating to supply and demand

Supply and demand basics (e.g., increases in demand,

decreases) Factors affecting supply and demand

Substitute goods

Compliment goods


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DefinitionsMarkets For this course 2 main markets:

1) Product Markets

Goods & services

2) Factor Markets Land, Labour, Capital (LLC)

There is a third market (Financial Markets) which we will get tolater


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Assumptions Key Assumptions

1) More is better e.g., 4 cars is better than 3

2) Non-satiation

i.e., never can have too many cars

Equilibrium conditions of the economic model will remain in place unless

something disturbs it

called equilibrium at rest


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Supply and Demand

Q (quantity)

P (price)

0

D (demand)

S (supply)

Q*(Equilibrium quantity)

P*(EquilibriumPrice)


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Supply and Demand

Q (quantity)

P (price)

0

D (demand)

S (supply)

Q*

P*

this graph is the basis of oureconomic model that wehave developed

by analyzing this graph, andchanging the conditions to

supply and demand, we canattempt to predict theresulting price

alternatively, we canattempt to predict the

resulting supply anddemand by affecting price(e.g., government pricecontrols)

Equilibrium


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Demand

for every price along thedemand curve, a certainquantity will be demanded

e.g., at Price (P 1), a quantityof Q 1 goods (apples, cars,

widgets) will be demandedby the market (i.e.,households)

same holds for P 2 and Q 2

basic inferences: as priceof a good decreases, moreof it will be demanded byhouseholds

Q (quantity)

P(price)

0

D

(marketdemand)

Q 1

Demand Curve

Q2

P 2

P 1


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Supply

Q (quantity)

P(price)

0

S (market supply)

for every price along thesupply curve, firms will supplya certain quantity of goods tothe market

e.g., for a Price of P 1, firms willsupply a quantity of Q 1 goods(apples, cars, widgets) tomarket

same holds for P 2 and Q 2

basic inferences: as price of a

certain Good increases, firmsare willing to produce andsupply more of it to market

P 2

P 1

Q2 Q1

Supply Curve


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Supply and Demand

Q (quantity)

P(price)

0

D (demand)

S (supply)

Q*

P*

Equilibrium

at equilibrium, the amountof a good demanded byhouseholds equals theamount of a good that firmsare willing to supply for thatprice

however, the market istypically not static andchanges in the market cancause changes to thesupply and demand

Equilibrium


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Shifts in Supply and Demand Shifts in supply and demand

changes to the underlying forces of the market can cause shiftsin the demand and supply curves

the effect is for a increase/decrease in the amount demanded orsupplied at every price along the curve

Underlying Market forces:

DEMAND SIDE

1) Income

2) Population

3) Tastes, etc.

4) Substitutes & Compliments

SUPPLY SIDE

1) Costs

2) Technological Improvementsor technological backtracking

3) Number of Firms(Competition)

4) Substitutes & Compliments


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Increase in Demand an increase in demand will be

caused by a change in theunderlying forces that affectthe market

e.g., an increase in thepopulation will cause the

demand curve to shiftoutwards from D 1 to D 2

at any given price, more goodswill now be demanded

this is explained by moregoods are purchased at thesame price as there are morepeople buying goods

Equilibrium changes to P** andQ**

S

0 Q

P

D1

Q*

P*

D2

Q**

P**

shift in demand (increase)


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Decrease in Demand

0

similarly, a change to theunderlying forces of themarket can cause adecrease in demand

e.g., a recession causesincomes to fall and sohouseholds have less tospend on goods (e.g. TVs)

Demand for TVs falls fromfrom D 1 to D 2

For the TV market the totalTVs demanded andsupplied will decrease fromQ* to Q**

Q

P

D1

S

Q*

P*

D2Q**

P**

shift in demand (decrease)


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Increase in Supply

0

alternatively, the changes inthe underlying forces canaffect the supply curve byaltering the willingness offirms to supply goods for acertain price

e.g., a new type oftechnology decreases thecosts to manufacture flatpanel computer screens

For every price along thedemand curve, firms will nowbe willing to supply more(i.e., the supply curve shiftsfrom S 1 to S 2)

Q

P

D1

Q*

P*

S 2

Q**

P**

shift in supply (increase)

S 1


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Decrease in Supply

0

e.g., increasing oil pricesincrease shipping costs forsteel producers and causean increase in the costs toproduce cars

car manufacturers will nowonly be willing to supply thequantities of S 2 for everyprice along P

the market equilibrium forcar prices under the new oilprice increases from P* toP**, and the quantity ofcars demanded decreasesfrom Q* to Q**

Q

P

D1

Q*

P*

S 2

Q**

P**

shift in supply (decrease)

S 1


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Substitutes Substitute Goods

two goods which are different, yet satisfy the same needs of theconsumer and therefore can be substituted for the original good

e.g., 1) margarine and butter; 2) plasma TVs and regular TVs

Market Effects (Demand Side)

a decrease in the price of a substitute good will cause a decreasein demand for the other good

e.g., a decrease in the price of margarine, will cause an decrease inthe demand for butter

vice versa, an increase in the price of a substitute good will cause

an increase in demand for the other good e.g., an increase in the price of margarine, will cause an increase in

the demand for butter


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Substitutes

0

e.g., an increase in

demand for butter isobserved from an increasein the price of margarine(substitute good)

consumers switch out of

margarine and into butter demand for butter shifts

from D 1 to D 2 Note: the graph is

analyzing the price andquantity effects on themarket for butter notmargarine Q

P

D1

S

Q*

P*

D2

Q**

P**

Increase in demand from an

increase in price of a substitutegood


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Compliments Compliment Goods

two goods which are needed together to satisfy one need, or theysatisfy that need better if they are together

e.g., 1) beer and pizza; 2) vehicles & gasoline

Market Effects (Demand Side)

a decrease in the price of a compliment good will cause anincrease in demand for the other good

e.g., a decrease in the price of beer, will cause an increase in thedemand for pizza

vice versa, an increase in the price of a compliment good will

cause a decrease in demand for the other good e.g., an increase in the price of coffee, will cause a decrease in the

demand for donuts


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Compliments

0

e.g., an increase in theprice for coffee causes adecrease in the demand fordonuts

consumers purchase less

donuts and demand fordonuts shifts from D 1 to D 2

Note: the graph isanalyzing the price andquantity effects on themarket for donuts, notcoffee

Q

P

D1

S

Q*

P*

D2

Q**

P**

Decrease in demand from anincrease in price of a complimentgood


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Notes on Substitutes & Compliments Whether goods are substitutes or not depends on the level of the

market being analyzed i.e., plasma TVs and regular TVs are still TVs, hence if I was

analyzing the TV market they would be included as the samegoods in the quantity demanded/supplied

however, if I was a firm that only produced regular TVs, I would

likely want to analyze the market for regular TVs here I would consider plasma TVs as a substitute good

Substitutes & Compliments affect the supply side of a market too,

but mainly in the way that they affect input costs


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Important DistinctionShifts in Demand Curve

a change to the underlying market(demand) forces can cause anincrease or decrease in demand

This is demonstrated by a shift to thedemand curve

changes caused by changes inunderlying forces:

Change in Quantity Supplied As a result of the shift in demand, the

market equilibrium changes and therewill ultimately be a change in theQuantity Supplied

This is not a shift in the supply curve,but rather a move along the supplycurve

Underlying Forces (Demand)

Income Population Tastes, etc. Substitutes & Compliments

0 Q

P

D1

Q*

P*

D2

Q**

P**

S


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Important DistinctionShifts in Supply Curve

a change to the underlying market(supply) forces can cause an increaseor decrease in supply

This is demonstrated by a shift to thesupply curve

changes caused by changes inunderlying forces:

Change in Quantity Demanded As a result of the shift in supply, the

market equilibrium changes and therewill ultimately be a change in theQuantity Demanded

This is not a shift in the demand curve,but rather a move along the demandcurve

Underlying Forces (Supply)

Costs Technology Number of Firms Substitutes & Compliments

0 Q

P

D1

Q*

P*

S 2

Q**

P**

S 1

2 - Supply & Demand (Edited)

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