Understanding Supply and Demand in Economics

1. Economics 1 Paul Samuelson

2. Basic Elements of Supply and Demand • Demand- refers to the quantity of goods and services that consumers are willing and able to buy at different levels of price

3. Law of Demand • When price increases, quantity demanded decreases. When price decreases, quantity demanded increases, ceteris paribus • All other factors held constant • All thing things are equal.

4. Quantity demanded tends to fall when price rises because: • 1. Substitution effect • 2. Income effect

5. Factors Affecting Demand • 1. Consumer Income • 2. Price of related goods • 3. Population • 4. Tastes and Preferences • 5. Special Influences

6. Note that: • Models are simplified theories that show the key relationships among variables. • Often, these relationships are expressed in functions. • - a mathematical concept that shows how • one variable depends on a set of other variables.

7. Demand Equation: Movement Along the Demand Curve • Q = 100- 1p

8. Economists when graphing demand curves, always put price on the vertical axis and quantity on the horizontal axis.

9. Alfred Marshall, conceived of the demand function with a market price as a function of quantity available for sale. • He observed English country markets with numerous sellers bringing their quantities to the marketplace. The demand function specified what price consumers, taken together, would pay for a given quantity.

10. Today, we assume that consumers take market prices as given and choose quantities that maximize their utilities. • However, Marshall’s influence is so strong that we continue to draw our graphs with price on the vertical axis. Marshall did this because to him, the dependent variable was price and the independent variable was quantity.

11. However • The modern theory generally conceives of the demand function with the quantity as the dependent variable and price as independent variable.

12. Shift in the Demand Curve • Q= 8-P+2Y • Suppose: Y=1 • Y=2

13. Movement along the demand Curve Shift in the Demand Curve • Q = f(P) • Illustrate the law of Demand • Pb, Y, Pop,TP, and SI are held constant • Q= f( Pb, Y, PoP, TP, SI) • Pb, Y, PoP, TP, and SI can change

14. Supply Quantity of a good and service that producers are willing to sell in a given price.

15. Law of Supply • When price increases, quantity supplied increases. when price decreases, quantity supplied decreases

16. Factors Affecting the Supply Curve • 1. Technology • -Computerized manufacturing lowers costs and increases supply • 2. Input Prices • -A reduction in the wage paid to autoworkers lowers production costs • 3. Price of Related goods- If truck prices fall, the supply of cars rises.

17. 4. Government Policy • -Removing quotas and tariffs on imported automobiles increases total automobile supply. • 5. Special Influences • -Internet shopping and auctions allow consumers t0 compare the prices of different dealers more easily and drives high-cost sellers out of business.

18. Movement in the Supply curve • Qs= 50+3P

19. Shift in the supply curve • Suppose that there is an improvement in technology • Qs= 5+P+2TC, TC=2

20. Market Equilibrium • Equilibrium condition: Qd= Qs, is known as the equilibrium condition equation. The result is equilibrium price (Pe) and equilibrium qunatity (Qe). • Algebraic computation • Given: Qd= 10-P Qs = 5+ P Req. • Equilibrium Price (Pe) • Equilibrium Quantity (Qe)

21. Solution: Qd = 10-P • Qs = 5+P • 10-P = 5+P • -P+P= 5-10 • 2p= -5 • Pe = 2.5

22. 10- (2.5) = 5 + (2.5) Therefore, Qd = Qs = 7.5

24. Surplus- a situation in which Qs is greater than Qd. • Shortage-a situation in which the Qd is greater than Qs.

25. The equilibrium price and quantity depend on the position of the supply and demand curves. When some event shifts one of these curves, the equilibrium in the market changes. • The analysis of such change is called comparative statics because it involves comparing two unchanging situations- an intial and a new equilibrium.

26. Example: A Change in demand • Suppose that one summer the weather is very hot. How does this event affect the market for ice cream? • 1. The hot weather affects the demand curve by changing people’s taste for ice cream. That is, the weather changes the amount of ice cream that people want to buy at any given price.

27. The supply curve is unchanged because the weather does not directly affect the firms that sell ice cream. • Because hot weather makes people want more ice cream, the demand curve shifts to the right. This shift indicates that the quantity of ice cream demanded is higher at every price.

28. 3. The increase in demand for ice cream raises the equilibrium price from $2.00 to $2.50 and the equilibrium quantity from 7- 10. In other words, the hot weather increases the price of ice cream and the quantity of ice cream sold.

29. Example: A Change in Supply • Suppose that , during another summer, a hurricane destroys part of the sugar cane crop and drives up the price of sugar, How does this event affect the market price for ice cream?

30. 1. The change in the price of sugar, an input into making an ice cream, affects the supply curve. By raising the costs of production, it reduces the amount of ice cream that firms produce and sell at any given price. The demand curve does not change because the higher cost of inputs does not directly affect the amount of ice cream that households wish to buy.

31. The supply curve shifts to the left because, at every given price, the total amount that firms are willing and able to sell is reduced. • The shift of the supply curve raises the equilibrium price from $2.00-$2.50 and lowes the equilibrium quantity from 7-4.

32. A Change in Both Supply and Demand • Now suppose that the heat wave and hurricane occur during the same summer.

33. 1. The hot weather affects the demand curve because it alters the amount of ice cream that household want to buy at any given price. At the same time, when the hurricane drives up sugar prices, it alters the amount of ice cream that firms want to sell at any given price.