Chapter 4: The Market Forces of Supply and Demand PDF

Chapter 4: The Market Forces of Supply and Demand Shuo Xu September 26, 2024 Introduction I The role of supply and demand in economics. I How markets determine prices. I Importance of understanding shifts in supply and demand. Demand vs...

Chapter 4: The Market Forces of Supply and Demand Shuo Xu September 26, 2024 Introduction I The role of supply and demand in economics. I How markets determine prices. I Importance of understanding shifts in supply and demand. Demand vs. Quantity Demanded I Demand: The relationship between the price of a good or service, and the quantities consumers are willing and able to buy over a fixed time period, all else held constant (ceteris paribus). I Quantity Demanded: The quantity of a good or service, that consumers are willing and able to buy at a given price. Law of Demand Law of demand states that as the price of a good or service increases, the quantity demanded will decrease, ceteris paribus. Law of Demand Three reasons behind law of demand: 1. Income Effect: As the price increases, the purchasing power decreases. 2. Substitution Effect: Lower opportunity costs in terms of substitutes. 3. Diminishing Marginal Utility: The benefit of consuming additional units decreases. Market Demand Market demand represents the horizontal summation of the quantities demanded by individuals, at each price over a fixed time period, ceteris paribus. Change in Demand I Movement along a demand curve: A change in the quantity demanded of a good or service due to a change in its price I Shift in demand: A change in the quantity demanded of a good or service at every price. Demand Shifters Change in Income: I For normal Good: As income increases, demand increases. I For inferior Good: As income increases, demand decreases. Tastes and Preferences: I As the perceived desirability rises, the demand increases. Number of Buyers: More buyers, more market demand. Expectations I Expect higher price tomorrow? Buy it today! Price of Related Goods I Substitute: Cheaper substitutes negatively affects the demand. I Complement: Cheaper complements positively affects the demand. Supply vs. Quantity Supplied I Supply: The relationship between the price of a good or service, and the quantities producers are willing and able to sell over a fixed time period, all else held constant (ceteris paribus). I Quantity supplied: The quantity of a good or service, that producers are willing and able to sell at a given price. Law of Supply Law of Supply states that as the price of a good or service increases, the quantity supplied will increase, ceteris paribus. Law of supply A reason behind law of supply: 1. Diminishing Marginal Productivity: If at least one input of production is fixed, the marginal productivity of additional variable resources will eventually fall, all else constant. Market supply Market supply represents the horizontal summation of the quantities supplied by individuals, at each price over a fixed time period, ceteris paribus. Change in supply I Movement along a supply curve: A change in the quantity supplied of a good or service due to a change in its price I Shift in supply: A change in the quantity supplied of a good or service at every price. Supply Shifters Subsidies and Taxes to producers: I Subsidies: Subsidies provided, supply increases. I Taxes: Taxes imposed, supply decreases. Resource Costs and Technology: I Resource Costs: Resource costs increased, supply decreases. I Technology: Positive changes in technology increases supply. Number of sellers: More sellers, more market supply. Expectations I Expect higher price tomorrow? sell it tomorrow! Market Equilibrium Equilibrium Price (Pe ): The price at which the quantity supplied equals the quantity demanded. Equilibrium Quantity (Qe ): The quantity traded when the quantity supplied equals the quantity demanded. Shortage Shortage: The quantity demanded is greater than the quantity supplied. Surplus Surplus: The quantity supplied is greater than the quantity demanded. Price Ceiling Price Ceiling: A maximum legal price at which a good or service can be sold. Nonbinding Price Ceiling > Pe > Binding Price Ceiling Price Floor Price Floor: A minimum legal price at which a good or service can be sold. Binding Price Floor > Pe > Nonbinding Price Floor Tax on Producers Excise Tax: A tax based on the number of units purchased, not on the price paid for a good or service. I Producers receive Ps per unit after Pb per unit from consumers and tax paid to the government. I Consumers receive Pb per unit. I Government gets Qt (Pb − Ps ). Tax on Consumers