Demand , Supply and Equilibrium

Demand & its Determinants

• A general example: The demand for soda
• Demand Schedule & Demand Curve
• Wants vs. Demand
• The Law of Demand
• Reasoning behind the law of Demand
• Substitution Effect
• Income effect
• Movement along vs. a shift of the Demand Curve

• Other determinants of demand
• Prices of related goods
• Substitutes
• Complements
• Expected future prices
• Population

Supply & its Determinants

• A general example: The supply of soda
• Supply Schedule & Supply Curve
• Law of Supply
• Reasoning behind the supply curve

• Other determinants of supply
• Cost of production
• Prices of other goods produced
• Substitutes in production
• Complements in production
• Expected future prices
• Number of suppliers
• Technology

Market Equilibrium

• Equilibrium of the Soda market
• The forces behind equilibrium
• Surplus
• Shortage
• Equilibrium price & equilibrium quantity
• Adjustment time lag
• Summary of Demand & Supply Shifters

Demand Schedule :
A demand schedule lists the quantities demanded at each price ceteris paribus

Demand Curve:
A demand curve shows the relationship between the quantity demanded of a good and its price, ceteris paribus.

• Wants Vs. Demand
  Wants are the unlimited desires or wishes people have for goods and services.
  
• Demand is a want backed by an ability an a willingness to pay.

Law of Demand

A basic economic hypothesis is that the price of a commodity and the quantity that will be demanded are related negatively, ceteris paribus. In other words, other things remaining the same, the lower the price the higher the quantity demanded and the higher the price the lower the quantity demanded.

Reasoning Behind the Law of Demand

• Substitution Effect

Price ­ Þ Opportunity cost ­ Þ Substitute away from the good Þ As Price ­ then quantity ¯

• Income Effect

As Price increases given that income is fixed the number of units purchased decreases because real income has decreased

Movement along the Demand Curve

The change in price is the change in an exogenous variable that is represented on the graph thus it amounts to a movement along the demand curve and not a shift of the curve. A change in any other exogenous variable besides price results in a shift of the demand curve.

Demand Shifters

• Prices of related goods

· Substitutes

As the price of a substitute decreases, the demand for the good decreases (the demand curve shifts to the southwest). As the price of a substitute increases, the demand for the good increases (the demand curve shifts to the northeast).

• Prices of related goods (continued)

· Complements

As the price of a complement decreases, the demand for the good increases (the demand curve shifts to the northeast). As the price of a complement increases, the demand for the good decreases (the demand curve shifts to the southwest).

• Expected Future Prices

If future prices are expected to rise people will stock up on the good now thus leading to a rise in demand (the demand curve shifts to the northeast). If future prices are expected to fall, people will wait to purchase the good, thus leading to a fall in demand (the demand curve shifts to the southwest).

• Population

A rise in population leads to more potential buyers and thus an increase in demand (the demand curve shifts to the northeast).

A supply schedule lists the quantities supplied at each price, ceteris paribus.

Supply Curve:

A supply curve shows the relationship between the quantity supplied and the price of a good ceteris paribus.

Law of Supply

Ceteris paribus, the price of the commodity and the quantity supplied are related positively. Other things remaining the same, the higher the commodity’s price, the more its producers will supply. The lower its price, the less they will supply.

Reasoning Behind the Supply Curve

The supply curve shows the least amount of money that a supplier will accept for a given unit. The supply curve slopes upward because the per unit cost of production (marginal cost) of the firm rises with the quantity produced.

Other Determinants of Supply

• Cost of production

As cost of production increases supply shifts NW otherwise producers will make a loss.

As cost of production decreases supply shifts SE.

• Prices of other goods produced

· Substitutes in production

Two goods are said to be substitutes in production when by producing more of one good you produce less of the other.

As the price of a substitute in production rises the supply curve of the good in question shifts NW. As the price of a substitute in production falls the supply curve of the good in question shifts SE.

· Complements in production

Two goods are said to be complements in production when producing one good automatically yields the other as a by product.

As the price of a complement rises supply shifts SE.
As the price of a complement falls supply shifts NW

• Expected Future Prices

If prices in the future are expected to rise suppliers hoard quantities to sell at the higher price thus resulting in a decline in supply. If prices in the future are expected to fall suppliers sell all they can now before prices drop resulting in an increase in supply.

• Number of Suppliers

In general supply increases with the number of suppliers.

• Technology

New and improved technology reduces the cost of production thereby increasing supply at a given price.

Market Equilibrium

Surplus:

At any given price when the quantity supplied exceeds the quantity demanded at that price, there is said to be a surplus. A surplus usually results in sellers cutting prices in an effort to sell their product. The impact of a surplus in a market is to drive prices down and to increase the quantity traded.

Shortage:

At any given price if the quantity demanded exceeds the quantity supplied at that price there is said to be a shortage. A shortage usually results in buyers trying to outbid each other for the few scarce remaining units. The impact of a shortage in a market is to drive prices up and to increase the quantity traded.

Equilibrium Price:

It is the price at which the quantity demanded equals the quantity supplied. There is no shortage or surplus at this price.

Equilibrium Quantity:

It is the quantity bought & sold at the equilibrium price.

(b) Complements