Chapter 3 notes

Chapter 3

SUPPLY & DEMAND IN INDIVIDUAL MARKETS

Determinants, Sensitivity & Equilibrium

MARKETS
! Buyers and sellers exchange/trade goods and services
! Quantity supplied or demanded mainly depends the market Price of that item, ceteris paribus.
Quantity Demanded = Dx(Px) - amount people are willing to buy at different prices
Quantity Supplied = Sx(Px) - amount people are willing to sell at different prices
where Px is the price of item x

Perfect Competition:

a market with a sufficiently high number of buyers and sellers where No Single Buyer or Seller
Can Impact Price

LAW OF DEMAND - when an item's price rises, the quantity demanded falls (and vise versa).
E.g.
A Single Consumer's Demand Schedule:
Price
$5
$4
$3
$2
$1

Individual Demand Curve:

Quantity Demanded per Week

10
20
35
55
80

Why do Demand Curves Slope Downward?

Law of Diminishing Marginal Utility:

Each additional unit consumed brings less additional satisfaction (utility [U]) than prior units
consumed, Marginal Utility [MU] falls as more [Q = Quantity] is consumed, MU = )U/)Q,
)MU/)Q = )()U/)Q)/)Q < 0 where ) = change.
Therefore, the price consumers are willing to pay per additional item falls as quantity consumed
rises since added utility falls.

MARKET DEMAND:
The Market Demand Curve is the Sum of Individual Demand Curves.

Chapter 3 notes

CHANGES SHIFTING THE DEMAND CURVE (left/right)

things other than price of that item causing a shift, as opposed to movement along the same curve
1.)
2.)
3.)
4.)
5.)

Consumer Tastes
Number of Consumers in the Market
Money Incomes of Consumers
Prices of Related Goods
Consumer Expectations

An increase or decrease or shift in Demand

(or Supply) does NOT refer to the actual
equilibrium quantity consumed/produced
changing, but more to the entire relationship
between quantity and price changing, i.e. the
curve shifts.
1.) CONSUMER TASTES
change in subjective valuation, expected utility, popularity, social norms, advertizing
e.g. 1.) Demand Curve Shifts Right (higher utility): sushi
2.) Demand Curve Shifts Left (lower utility): fur coats, typewriters
2.) NUMBER OF CONSUMERS IN MARKET : more buyers Y more market demand, e.g. allow free trade
3.) CONSUMER MONEY INCOMES
Impact (or direction of shift of Demand Curve) varies by type of Good or Service:
Normal Goods : Income Up (Down) Y Demand Curve Shifts Right (Left) or More (Less) Demanded at
same Price, e.g. new cars, jewelry, furniture, consumer durables
Inferior Goods: Income Up (Down) Y Demand Curve Shifts Left (Right), or Less (More) Demanded at
same Price, e.g. margarine, used clothing, generic food (has nothing to due with quality,
bankruptcy services by a quality $500 an hour attorney could be an inferior good)
4.) PRICES OF RELATED GOODS
Two Goods are ...
Complements if the Price of one Rises, Demand Curve Shifts Left for the other
usually bought/consumed together
e.g. CDs & CD players, hotdogs and hotdog buns, college tuition and college textbooks
Substitutes if the Price of one Rises, Demand Curve Shifts Right for the other
similar items, alternative purchases
e.g. airplane & train tickets, romaine versus iceberg lettuce
5.) CONSUMER EXPECTATIONS
i.) Prices Future and current goods can be Substitutes.
Expect Future Prices to Rise Y Demand for Current goods shifts Right
ii.) Income Current or future current income can be used to buy goods, consumers can borrow or save.
Expect future Income to Rise (Fall) Y same impact as current Income Rise (Fall)
Also, Changes in actual or expected WEALTH have the same impact as changes in actual or expected income.

Chapter 3 notes

SUPPLY
Supply Curve - Relationship between the price of an item and the quantity sellers will supply.
Law of Supply - When a products price rises, the quantity sellers are willing to supply rises.
Why? Rising product prices Y Higher Profits for existing businesses, plus attracts new entrants,
incentive to produce more when price rises

CHANGES SHIFTING THE SUPPLY CURVE

1.)
2.)
3.)
4.)
5.)
6.)

Number of Sellers
Resource Prices
Taxes & Subsidies
Production Technology
Prices of Alternative Production Items
Expectations

A shift right would mean at a given output price which

does not change, an event causes producers to supply a
higher quantity of output at that same market price.

1.) NUMBER OF SELLERS

Market supply is the sum of individual sellers' supply curves.

Additional sellers entering a market shifts the market Supply Curve Right at given prices
(similar to Demand Curve and number of buyers), Supply Curve shifts left if firms exit.

2.) RESOURCE PRICES = input prices, or costs for the factors of production (land, labor, capital).
Production Costs Fall (Rise) Y Profits Increase (Fall) Y Supply Curve Shifts Right (Left)
3.) TAXES & SUBSIDIES
Rising business taxes have the same impact as rising resource prices, a cost reducing profits
inasmuch as higher input prices Shifting the Supply Curve Left.
Subsidy is a negative tax Shifting Supply Right.
4.) PRODUCTION TECHNOLOGY
improved technology has the same impact as falling resource prices
Y Lower Production Costs Y Profits Rise Y Supply Curve Shifts Right
5.) PRICES OF ALTERNATIVE PRODUCTION ITEMS
Relative profits from producing an item are less attractive if the market price of alternative
outputs rise Shifting Supply Curve Left.
6.) EXPECTATIONS
future output prices

Chapter 3 notes

SUPPLY AND DEMAND

SURPLUSES AND SHORTAGES Surplus:
Shortage:

Quantity Supplied exceeds Demand

Quantity Demanded exceeds Supply

EQUILIBRIUM PRICE AND QUANTITY

the Market Clearing Price and Quantity where there is no surplus or shortage
intersection of the Supply and Demand curves
Markets naturally self-adjust via the price mechanism eliminating shortages and surpluses, prices rise or
fall until supply = demand. (Invisible Hand - no command needed)

SUPPLY & DEMAND SHIFTS AND CHANGES IN EQUILIBRIUM PRICE & QUANTITY
Change or Shift:
Demand shifts Right
Demand shifts Left
Supply shifts Right
Supply shifts Left

... Result ...

Price Quantity
Rises
Rises
Falls
Falls
Falls
Rises
Rises
Falls

Actual change in Price and Quantity depends on curve slopes (or elasticity).

Chapter 3 notes

Government imposed Price Controls cause Surpluses and Shortages:

1.) Ceilings (maximum legal price),
e.g. rent controls Y shortage of low income housing
e.g. $0 for organs Y shortage of organs for transplants
Attempt to help buyers with lower legal price may not help.

2.) Floors (minimal legal price),

e.g. minimum wage Y surplus of labor, i.e. unemployment
(some work for higher legal wage, others lose jobs)
Attempt to help sellers with higher legal price may not help.

Price Controls Cause Inefficiency, MC MB,

Prevents mutually beneficial voluntary exchange.

Equilibrium in Competitive Markets is ...

Production Efficient ...

Least Costly Mix of Resources Used

Why? - Profit Incentive to Minimize Costs

Allocative Efficient (or Optimality)...

Output Mix Produced Best Satisfies Societal Wants

Why?
Demand and Supply Signal Value of Outputs and Inputs
At Market Equilibrium Level of Output...
Marginal Cost = Marginal Benefit
Since Supply = MC, and Demand = MB
Markets Generally Efficiently Transform Lower Valued
Resources into Higher Valued Outputs Most Valued by Society (making both consumers and
producers better off)..