Notes on Supply and Demand PDF

**The Market Forces of Supply and Demand** Supply and demand are the forces that make market economies work. They determine the quantity of each good produced and the price at which it is sold. If you want to know how any event or policy will affect the economy, you must think first about how it wi...

**The Market Forces of Supply and Demand** Supply and demand are the forces that make market economies work. They determine the quantity of each good produced and the price at which it is sold. If you want to know how any event or policy will affect the economy, you must think first about how it will affect supply and demand. The terms supply and demand refer to the behavior of people as they interact with one another in competitive markets. **What Is a Market?** A market is a group of buyers and sellers of a good or service. The buyers as a group determine the demand for the product, and the sellers as a group determine the supply of the product. Some markets are highly organized, more often, markets are less organized. **What Is Competition?** Economists use the term ***competitive market*** to describe a market in which there are so many buyers and so many sellers that each has a negligible impact on the market price. In this chapter, we assume that markets are perfectly competitive. To reach this highest form of competition, a market must have two characteristics: (1) The goods offered for sale are all the same, and (2) the buyers and sellers are so numerous that no single buyer or seller has any influence over the market price. Because buyers and sellers in perfectly competitive markets must accept the price the market determines, they are said to be price takers. At the market price, buyers can buy all they want, and sellers can sell all they want. Not all goods and services, however, are sold in perfectly competitive markets. Some markets have only one seller, and this seller sets the price. Such a seller is called a ***monopoly.*** **Demand** **The Relationship between Price and Quantity Demanded** The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase. one [determinant] plays a central role in determining the quantity of demand of any good: [the price of the good.] **law of demand** the claim that, other things being equal, the quantity demanded of a good fall when the price of the good rises. Example: the price of ice cream is on the vertical axis, and the quantity of ice cream demanded is on the horizontal axis. The line relating price and quantity demanded is called the demand curve. The demand curve slopes downward because, other things being equal, a lower price means a greater quantity demanded. **Market Demand** market demand, the sum of all the individual demands for a good or service.  **Shifts in the Demand Curve** Any change that increases the quantity demanded at every price, shifts the demand curve to the right and is called an *increase in demand.* Any change that reduces the quantity demanded at every price shifts the demand curve to the left and is called a *decrease in demand.* **Income** What would happen to your demand for ice cream if you lost your job one summer? Most likely, it would fall. A lower income means that you have less to spend in total, so you would have to spend less on some---and probably most---goods. If the demand for a good fall when income falls, the good is called a normal good. Normal goods are the norm, but not all goods are normal goods. If the demand for a good rise when income falls, the good is called an inferior good. An example of an inferior good might be generic products, used cars, pizza, discount clothing, and canned foods. **Prices of Related Goods** When a fall in the price of one good reduces the demand for another good, the two goods are called **substitutes**. Substitutes are often pairing of goods that are used in place of each other, such as hot dogs and hamburgers, sweaters and sweatshirts, and cinema tickets and film streaming services. When a fall in the price of one good raise the demand for another good, the two goods are called **complements.** Complements are often pairing of goods that are used together, such as gasoline and automobiles, computers and software, and peanut butter and jelly. **Other Determinant of Demand** **Tastes**- Economists normally do not try to explain people's tastes because tastes are based on historical and psychological forces that are beyond the realm of economics. Economists do, however, examine what happens when tastes change. **Expectations-** Your expectations about the future may affect your demand for a good or service today. If you expect to earn a higher income next month, you may choose to save less now and spend more of your current income buying ice cream. If you expect the price of ice cream to fall tomorrow, you may be less willing to buy an ice-cream cone at today's price. **Number of Buyers-** market demand depends on the number of these buyers. If Peter were to join Catherine and Nicholas as another consumer of ice cream, the quantity demanded in the market would be higher at every price, and market demand would increase. **Supply** **The Supply Curve: The Relationship between Price and Quantity Supplied** The quantity supplied of any good or service is the amount that sellers are willing and able to sell. There are many determinants of quantity supplied, but once again, price plays a special role in our analysis. **law of supply** the claim that, other things being equal, the quantity supplied of a good rises when the price of the good rises  **Market Supply** market supply is the sum of the supplies of all sellers. The market supply curve shows how the total quantity supplied varies as the price of the good varies, holding constant all other factors that influence producers' decisions about how much to sell  **Shifts in the Supply Curve** Any change that raises quantity supplied at every price, shifts the supply curve to the right and is called an *increase in supply* Any change that reduces the quantity supplied at every price shifts the supply curve to the left and is called a *decrease in supply.* There are many variables that can shift the supply curve: **Input Prices-** To produce their output of ice cream, sellers use various inputs: cream, sugar, flavoring, ice-cream machines, the buildings in which the ice cream is made, and the labor of workers who mix the ingredients and operate the machines. When the price of one or more of these inputs rises, producing ice cream is less profitable, and firms supply less ice cream. If input prices rise substantially, a firm might shut down and supply no ice cream at all. Thus, the supply of a good is negatively related to the price of the inputs used to make the good. **Technology**-The technology for turning inputs into ice cream is another determinant of supply. The invention of the mechanized ice-cream machine, for example, reduced the amount of labor necessary to make ice cream. By reducing firms' costs, the advance in technology raised the supply of ice cream. **Expectations**-The amount of ice cream a firm supplies today may depend on its expectations about the future. For example, if a firm expects the price of ice cream to rise in the future, it will put some of its current production into storage and supply less to the market today. **Number of Sellers**-In addition to the preceding factors, which influence the behavior of individual sellers, market supply depends on the number of these sellers. If Ben or Jerry were to retire from the ice-cream business, the supply in the market would fall. **Supply and Demand Together** **Equilibrium** a situation in which the market price has reached the level at which quantity supplied equals quantity demanded the market supply curve and market demand curve together. Notice that there is one point at which the supply and demand curves intersect. This point is called the market's *equilibrium*. The price at this intersection is called the *equilibrium price*, and the quantity is called the *equilibrium quantity*.  *At the equilibrium price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell.* **surplus** a situation in which quantity supplied is greater than quantity demanded There is a surplus of the good: Suppliers are unable to sell all they want at the going price. A surplus is sometimes called a situation of excess supply. They respond to the surplus by cutting their prices. Falling prices, in turn, increase the quantity demanded and decrease the quantity supplied. These changes represent movements along the supply and demand curves, not shifts in the curves. Prices continue to fall until the market reaches the equilibrium. **shortage** a situation in which quantity demanded is greater than quantity supplied There is a shortage of the good: Demanders are unable to buy all they want at the going price. A shortage is sometimes called a situation of excess demand. sellers can respond to the shortage by raising their prices without losing sales. These price increases cause the quantity demanded to fall and the quantity supplied to rise. regardless of whether the price starts off too high or too low, the activities of the many buyers and sellers automatically push the market price toward the equilibrium price. Once the market reaches its equilibrium, all buyers and sellers are satisfied, and there is no upward or downward pressure on the price. How quickly equilibrium is reached varies from market to market depending on how quickly prices adjust. In most free markets, surpluses and shortages are only temporary because prices eventually move toward their equilibrium levels. Indeed, this phenomenon is so pervasive that it is called the **law of supply and demand**: The price of any good adjusts to bring the quantity supplied and quantity demanded for that good into balance.