Lecture 4: Demand and Supply
Outline:
1. Introduction
2. Theory of Demand
i. Quantity demanded (Qd)
ii. Determinants of Qd
iii. Demand
a. Demand schedule
b. Demand curve (D)
iv. Distinction between D and Qd
v. Movements along versus shifts of the demand curve
3. Theory of Supply
i. Quantity supplied (Qs)
ii. Determinants of Qs
iii. Supply
a. Supply schedule
b. Supply curve (S)
iv. Distinction between S and Qs
v. Movements along versus shifts of the Supply curve
4. A glimpse of the market - supply and demand together.
1. Introduction:
* The theory of demand and the theory of supply are tools which are used to analyze markets.
* These theories are constructed independently of one another - one set of determinants explains the demand for a product and another set of determinants explains the supply of a product.
* The one determinant that both demand and supply have in common is the price (P) of the product.
2. Theory of Demand:
Definition:
The Quantity Demanded (Qd) is the total amount of a given product that an economy's consumers wish to purchase in some time period.
Some notes:
* the Qd is the quantity of a product that consumers wish to purchase and it may differ from the quantity actually purchased (quantity exchanged).
* the Qd is the quantity of a product that people wish to purchase knowing what the price of the product is.
* the Qd is a flow of purchases over some time period, such as, units per week.
Question: What determines how much of a product consumers wish to purchase in some period?
Determinants of Qd = Price of the product
Average household income
Distribution of income
Tastes of consumers
Prices of related products (complements and substitutes)
Size of population
Other factors
Note:
The ceteris paribus assumption in economics allows us to look at the relationship between two variables holding all other influencing variables constant.
Quantity demanded (Qd) and Price (P):
* A basic economic hypothesis is that there is a negative relationship between the Qd of a product and its P.
* As the price of a product increases, some consumers buy less of it and some consumers stop buying it at all.
Demand:
* One way to show the relationship between Qd and P is to construct a demand schedule - for every price observe how much of a product consumers purchase, all other things constant (ceteris paribus).
* The demand schedule can then be represented graphically - which is what we refer to as the demand curve.
Definition:
The demand curve represents the relationship between the Qd of a good and its P, all other things constant.
An important note on terminology:
* When we use the term DEMAND we are referring to the entire DEMAND CURVE
*When we use the term QUANTITY DEMANDED we are referring to A SINGLE POINT on the demand curve.
Movements along the demand curve:
* When the price of the product changes, all other things constant, there is a movement along the demand curve.
Shifts of the demand curve:
* The demand curve is drawn on the assumption that all the determinants of Qd except the products own price are held constant.
* If any of the ceteris paribus determinants of Qd change the entire demand curve shifts to a new position.
Ceteris paribus determinants of Qd:
Average Income - For normal goods an increase in AI will increase demand
For inferior goods an increase in AI will decrease demand
Distribution of income - A change in the DI will increase demand for goods that most people whose incomes rise, purchase.
A change in the DI will decrease demand for goods that most people whose incomes fall, purchase.
Tastes - A change in T in favor of a product will increase demand for the product
A change in T against a product will decrease demand for the product
Price of a substitute product - An increase in Ps will increase demand for the product
A decrease in Ps will decrease demand for the product
Price of a complement product - An increase in Pc will decrease demand for the product.
A decrease in Pc will increase demand for the product.
Size of the population - An increase in the size of the population will increase demand for the product.
A decrease in the size of the population will decrease demand for the product.
3.Theory of Supply:
Definition:
The Quantity Supplied (Qs) is the total amount of a given product that firms wish to sell in some time period.
Some notes:
* the Qs is the quantity of a product that firms wish to sell and it may differ from the quantity actually sold (quantity exchanged).
* the Qs is the quantity of a product that firms wish to sell knowing what the price of the product is.
* the Qs is a flow of sales over some time period, such as, units per week.
Question: What determines how much of a product firms wish to sell in some period?
Determinants of Qs = Price of the product
Price of inputs
Goals of the firm
State of technology
Government regulations
Other factors
Quantity supplied (Qs) and Price (P):
* A basic economic hypothesis is that there is a positive relationship between the Qs of a product and its P.
* As the price of a product increases, while a firms's costs remain unchanged, the firm's profits will increase and it will want to sell more of the product.
Supply
* One way to show the relationship between Qs and P is to construct a supply schedule - for every price observe how much of a product firms sell, all other things constant (ceteris paribus).
* The supply schedule can then be represented graphically - which is what we refer to as the supply curve.
Definition:
The supply curve represents the relationship between the Qs of a good and its P, all other things constant.
An important note on terminology:
* When we use the term SUPPLY we are referring to the entire SUPPLY CURVE
* When we use the term QUANTITY SUPPLIED we are referring to A SINGLE POINT on the supply curve.
Movements along the supply curve:
* When the price of the product changes, all other things constant, there is a movement along the supply curve.
Shifts of the supply curve:
* The supply curve is drawn on the assumption that all the determinants of Qs except the products own price are held constant.
* If any of the ceteris paribus determinants of Qs change the entire supply curve shifts to a new position.
Ceteris paribus determinants of Qs:
Price of inputs - An increase in input prices will decrease supply of the product
A decrease in input prices will increase supply of the product
Goals of the firm - The firm may have goals that lead supply of the product to increase.
The firm may have goals that lead supply of the product to decrease.
State of technology - Improvements in technology decrease production costs and increase supply.
Government regulations - Government regulations or taxes imposed on firms increase production costs and decrease supply of the product
Government relaxation of regulations or payment of subsidies to firms decrease production costs and increase supply of the product
4. Supply and Demand Together
* Price is on the vertical axis, Quantity is on the horizontal.
* The Demand curve is downward sloping.
* The Supply curve is upward sloping.