These are my notes and thoughts on demand, supply, and equilibrium in economics.
In a perfectly competitive market, sellers all sell an identical good or service. Any individual buyer or seller isn’t powerful enough on his own to affect the market price of that good or service. The demand curve plots the relationship between the market price and the quantity of a good demanded by buyers. The supply curve plots the relationship between the market price and the quantity of a good supplied by sellers. The competitive equilibrium price equates the quantity demanded and the quantity supplied. When prices are not free to fluctuate, markets fail to equate quantity demanded and quantity supplied.
A market is a group of economic agents who are trading a good or service plus the rules and arrangements for trading.
If all sellers and all buyers face the same price, that price is referred to as the market price. This implies that buyers and sellers are all price-takers. They accept the market price and can’t bargain for a better price.
At a given price, the amount of the good or service that buyers are willing to purchase is called the quantity demanded. A table that reports the quantity demanded at different prices is called a demand schedule. Plotting a demand schedule is called a demand curve. The demand curve has an important property which is that the price of gasoline and the quantity demanded are negatively related. They move in opposite directions. When one goes up, the other goes down.
Almost all goods have demand curves that exhibit this fundamental negative relationship, which economists call the law of demand. The law of demand says that the quantity demanded rises when the prices fall. Diminishing marginal benefit is when you consume more of a good, your willingness to pay for an additional unit declines.
Though almost all individual demand curves are downward sloping, that is all they have in common. The demand of all buyers in a market is the market demand curve. It is the sum of the individual demand curves of all potential buyers. The market demand curve plots the relationship between the total quantity demanded and the market price.
The demand curve shifts when these 5 major factors change:
- Tastes and preferences
- Income and wealth
- Availability and prices of related goods
- Number and scale of buyers
- Buyer’s beliefs about the future
A change in tastes or preferences is simply a change in what we personally like or value. This would be a leftward shift in demand because a lower quantity demanded for a given price of oil corresponds to a leftward movement on the x-axis.
The demand curve shifts only when the quantity demanded changes at a given price. If a good’s own price changes and its demand curve hasn’t shifted, the own price change produces a movement along the demand curve. It helps to remember that if the quantity demanded changes at a given price, then the demand curve has shifted.
A change in income or wealth affects your ability to pay for goods and services. For a normal good, an increase in income shifts the demand curve to the right, causing buyers to purchase more of the good. If rising income shifts the demand curve for a good to the left, then the good is called an inferior good.
Even if the price of oil hasn’t changed, a change in the availability and prices of related goods will also influence demand for oil products, thereby shifting the demand curve for oil. Two goods are said to be substitutes when a rise in the price of one leads to a rightward shift in the demand curve for the other. Two goods are said to be complements when a fall in the price of one good leads to a rightward shift in the demand curve for the other good.
When the number of buyers increases, the demand curve shifts right. When the number of buyers decreases, the demand curve shifts left. The scale of the buyers’ purchasing behavior also matters.
Changes in buyer’s beliefs about the future also influence the demand curve.
The interaction of buyers and sellers in a marketplace determines the market price. We want to analyze the relationship between the price of a good and the amount of the good that sellers are willing to sell or supply. At a given price, the amount of that good or service that sellers are willing to supply is called the quantity supplied.
A supply schedule is a table that reports the quantity supplied at different prices. The supply schedule shows that Exxon increases the quantity of oil supplied as the price of oil increases. So, a supply curve plots the supply schedule table. The supply curve of oil shows that the price of oil and the quantity supplied are positively related. This means that the variables move in the same direction. When one variable goes up, the other goes up too. In almost all cases, quantity supplied and price are positively related, which economists call the law of supply.
For an optimizing firm, the height of the supply curve is the firm’s marginal cost. A firm;s willingness to accept is the lowest price that a seller is willing to get paid to sell an extra unit of a good. For an optimizing firm, willingness to accept is the same as the marginal cost of production.
When we studied buyers, we summed up their individual demand curves to obtain a market demand curve. We do the same thing for sellers. Adding up the quantity supplied world the same way as adding up the quantity demanded. We add up quantities at a particular price. We then repeat this at every possible price to plot the market supply curve. The market supply curve plots the relationship between the total quantity supplied and the market price.
Aggregating the individual supply curves of thousands of oil producers yields a market supply curve. Recall that the supply curve describes the relationship between price and quantity supplied. There are four major types of variables that are held fixed when a supply curve is constructed. The supply curve shifts when these variables change:
- Prince inputs used to produce a good
- Technology used to produce the good
- Number and scale of buyers
- Sellers’ beliefs about the future
Changes in the prices of inputs shift the supply curve. An input is a good or service used to produce another good or service. The supply curve shifts only when the quantity supplied changes at a given price. If a good’s own price changes and its supply curve hasn’t shifted, the own price change produces a movement along the supply curve.
Changes in technology also shift the supply curve.
Changes in the number of sellers also shift the supply curve. Finally, changes in seller’s beliefs about the future shift the supply curve.
Competitive markets converge to the price at which quantity supplied and quantity demanded are the same.
Demand curves slope down and supply curves slope up.
Economists refer to the crossing point of the two curves as the competitive equilibrium. This is also called the market clearing price.
The price at the crossing point is the competitive equilibrium price.
The quantity at the crossing point is the competitive equilibrium quantity.
At the competitive equilibrium price, the quantity demanded is equal to the quantity supplied.
In a perfectly competitive market, sellers:
- Cannot charge more than the market price and buyers cannot pay less than the market price
In a perfectly competitive market, if one seller chooses to charge a price for its good that is slightly higher than the market price, then it will:
- Lose all or almost all of its customers
Market demand is derived by:
- Fixing the price and adding up the quantities that each buyer demands
Does the shape of the market demand curve differ from the shape of the individual demand curve:
- No, they both tend to be downward sloping curves
There is an inverse relationship between the quantity demanded of books and their price.
The law of demand states that as the price of a good increases, the quantity demanded decreases. This can be shown with a downward sloping demand curve or numerically in a table using a demand schedule. The relationship that exists between these two variables can be described as negatively related.
Which of the following is not one of the five major factors that shifts the demand curve when it changes?
- Prices of inputs used to produce the good
When one of the five major factors changes, causing an increase in demand, the demands curve shifts rightward
If the price of a complementary good increases, how would the demand for a normal good be impacted?
- This is a left shift line parallel but left of the original
The law of supply states that as the price of a good increases, the quantity supplied of that good increases. This can be shown graphically with an upward sloping supply curve or numerically in a table using a supply schedule.
The relationship that exists between these two variables can be described as positively related.
As a firm produces more of a good, the cost of producing each additional unit increases. This implies that the marginal cost of producing a good increases as you make more of that good.
The supply curve represents:
- The minimum price sellers are willing to accept to sell an extra unit of a good
Which of the following is not one of the four major factors that shifts the supply curve when it changes?
- Price of the good itself
When one of the four major factors changes, causing an increase in supply, the supply curve shifts rightward.
If firms expected future price increases. How would the supply of smartphones be impacted?
- Supply would contract. Draw a line parallel but leftward of the original line.
Land in Sonoma, CA, can be used to either grow grapes for pinot noir wine or to grow apples. Given this information, what is the relationship between pinot noir and apples?
- They share a common input
If the demand for pinot noir suddenly shifts sharply to the right, we would expect to see an increase in the demand for land in Sonoma, which would increase the equilibrium price of land.
Since both pinot noir wine and apples use the same land in Sonoma, CA, a sharp increase in demand for pinot noir wine will result in a higher price for apples and a lower price equilibrium quantity.
Lobsters are plentiful and easy to catch in August but scarce and difficult to catch in November. Given this information:
- Both supply and demand are higher in August than in other months
When comparing the equilibriums in the lobster market for August and November, the equilibrium quantity is:
- Lower, higher, lower, or unchanged
Given the supply and demand curves on the right, when the price of the goods is $20, we say that the market is in competitive equilibrium. At this price, we know that the quantity supplied is equal to the quantity demanded.
If the only change in the market was that the price increases to $20, then we know that the quantity sup[plied will be greater than the quantity demanded, resulting in an excess supply, which is known as a surplus.
Suppose instead that the price of the good dropped below the competitive equilibrium price to a price of $15 per unit. If this were to occur, then the quantity supplied would be less than the quantity demanded, resulting in an excess demand, which is also known as s shortage.
Suppose conditions arise in the sugar market that would lead to a competitive equilibrium price that is below 18.75 cents per pound. In this situation, sugar mills:
- Not sell to private buyers at this lower price and will sell to the government instead, which will drive up the domestic price until it reaches 18.75 cents per pound.
Suppose a new off campus university apartment complex could rent its rooms on the open market for 900 a month. If instead, the university chooses to cap the price of rooms to 500 a month for students, the result would be that:
- Quantity demanded would exceed the quantity demanded, resulting in a shortage
Suppose the university is trying to determine the most efficient way to allocate the rooms such that those who value the rooms the most get them. Which of the following would you suggest as the most efficient?
- Auctioning the rooms to the highest bidders