CECN 104 – Introduction to Microeconomics

CHAPTER 3: Supply and Demand

MARKET
 Institution or mechanism that brings together buyers (demand) and sellers (suppliers) of
particular good and service
o Many forms
 Physical ie. Gas station
 Moving ie. Roadside stand
 Online ie E-commerce
Competitive Markets
- A large number of independent buyers and sellers
- Standardized goods
- No individual can dictate the market price
 everyone is a price-taker (a buyer or seller is one of millions)
Examples: wheat market, currencies market

DEMAND
 A schedule or a curve that shows the various amounts consumers are willing and able to
purchase at each of a series of possible prices, during some specified period of time.
 RELATION BETWEEN PRICE AND QUANTITY
NOTE: price is put on the y-axis

LAW OF DEMAND
- ALL else equal, as price falls, the quantity demanded rises (&vice-versa)

o Diminishing marginal utility

 As one consumes additional units of a good, the added satisfaction
decreases
 Example: buying a second pizza yields less extra satisfaction than the first
o Substitution effect
 A lower price gives incentive to substitute the lower-priced good for now
relatively higher—priced goods
 Example: Beef is now cheaper than chicken
 A consumer will buy more beef and less chicken
 o Income effect
 A lower price increases the purchasing power of money income enabling
consumer to buy more at a lower price (or less at a higher price) without
having to reduce consumption of other goods NOT INCREASING BUDGET
 Example: PAPER SALE! 50% OFF! Consumer who has the money to buy
one pack can now buy two
Market Demand
- horizontal summation of the individual demand curves of all the consumers in the
market

- At $3, the individual curves yield a total quantity demanded of 100 bushels

The Veblen Effect

- When a product’s high price is seen as a “status symbol”  conspicuous consumption
- EXAMPLE: luxury goods such as brand name watches
- When the price increases the demand also increases ** EXCEPTION TO THE LAW OF
DEMAND”

Changes in Demand
- Change in one or more of the (non-price) determinants of demand changes, there is a
shift in the demand curve
- When the price of the product changes, there is movement along the demand curve
- When any other (non-price) determinant of the demand changes, there is a shift
FACTORS (non-price determinant)
- Tastes (preferences)
o New products: affect consumer tastes
 Example: big touch screen phones, fuel-efficient hybrid vehicles
o Positive change shifts curve to the right
o More will be demanded at each price

- Number of buyers
o Decrease in the number of buyers will shift the curve left
o Less will be demanded at each price

- Population
o Positive change shifts curve to the right
o More will be demanded at each price
o Aging baby boomers
 Increase demand for some products and reduce for others
 Demand for health care will rise
 Demand for new hosing will fall
- Income
o When income increases
demand for NORMAL goods increases
demand for INFERIOR goods decreases
(goods can be normal in one place and inferior in another)
- Prices of related goods
o When two products (say a and b) are SUBSTITUES, the price of one and demand
for the other move in the same direction
 If the price of A increases then the demand for B increases
 o When two products are COMPLEMENTS (say a and c), the price of one and the
demand for the other move in opposite direction
o If the price of A increases then the demand for C decreases
o When products are unrelated  no effect
- Expectations
o Expectation on future prices
 Higher future prices may cause consumers to buy now

o Expectation on future incomes

 Lower future income will cause consumers to buy less now

SUPPLY
 Schedule or a curve showing the amounts that producers are willing and able to make
available for sale at each of a series of possible prices, during some specified period of
time
Law of Supply
 All else being constant, as the price rises the quantity supplied rises (and vice-versa
Why?
- Price is revenue to suppliers
- Higher price  higher revenue higher profit (if cost remains the same)
- Higher price is necessary to cover higher cost associated with more production and
supply

Market Supply Curve

 A change in supply is a shift of the entire curve
 A change in quantity supplied is a movement from one point to another on a fixed
supply curve
FACTORS
- Factor prices
o If factor prices decrease  increase supply

o More will be supplied at each price : shift supply curve to the right
- Technology
o New and better technology improve productivity or lover costs
 If a machine can replace 100 workers and do it more efficiently then
productivity will improve
o More will be supplied at each price: supply shifts right
- Taxes and subsidies
o Increases in taxes will reduce supply
o Less will be supplied at each price : supply shifts left

- Prices of other goods

o Higher prices of substitutes in production
o Soccer balls vs basketballs  if the price of soccer balls increases less resources
are available to produce basket balls
o Less will be supplied at each price: supply shifts left
- Producer expectations
o Expectation of the future price of a product is difficult to generalize
 depends on type of production
o Corn farmers anticipating higher future corn price might withhold some of their
current production from the market  current supply decreases
o Manufacturers expecting higher price (demand) for its good will add another
shift of workers or expand production facilities
 current supply of the manufactured good increases
- Number of sellers
o Number of sellers increase  more will be supplied at each price: supply shifts
right
- “nature” factors
o Natural disaster  less will be supplied at each price: supply shifts left
 CHAPTER 3: Market Equilibrium and Price Controls
MARKET EQUILIBRIUM
 Equilibrium price and quantity (P*, Q*)  established where supply decisions of
producers and demand decisions of buyers are mutually consistent

o Quantity Demand < Quantity Supply  Surplus drives price down

 Quantity supply – quantity demand= positive
o Quantity Demand > Quantity Supply  Shortage drives price up
 Quantity supply – quantity demand = negative
- Change in price brings back equilibrium
- EQUILIBRIUM is where there is no gap in demand or supply
o When QD=QS

 Changes in demand or supply will affect the equilibrium price and quantity
Increase in Demand
- An increase in demand will cause a shortage at the original price P1
- Equilibrium price and quantity move in the same direction as the demand
- SUPPLY CURVE DOES NOT MOVE

- Consumers will bid price up to P2

- QS will increase (NOT increase in supply) QD will decrease
- New equilibrium reached
 Decrease in Demand
- Decrease in demand will cause surplus at original price P1
- Producers will drop price to P2
- Equilibrium price and quantity move in the same direction as the demand
- QS will decrease, QD will increase

Increase in Supply
- Supply line moves to the right  movement along the supply
- Increase in supply will cause surplus at the original price P1

- Producers will drop price to P2

- QD will increase QS will decrease
- A new equilibrium will be reached at P2, Q2
- EQUILIBRIUM WILL MOVE IN THE OPPOSITE DIRECTION
Decrease in Supply
- Decrease in supply will cause shortage at the original price P1

- Consumers will bid price up to P2

- Q2 will increase QD will decrease
- A new equilibrium will be reached at P2, Q2
- EQUILIBRIUM WILL MOVE IN THE OPPOSITE DIRECTION
COMPLEX CASES
 When both supply and demand change, the effect is a combination of the individual
effects
 If both demand and supply shift, one of either price or quantity cannot be predicted- the
result is indeterminate

 The effect on P* will depend on the relative strength of the demand and supply shifts `

 The effect on Q* will depend on the relative strength of the demand and supply shifts

- Demand shifts to the right

- Supply shifts to the left
- Equilibrium
 price and quantity increase
 - Equilibrium price is higher but Q* is
much lower
- P* and Q* move in opposite
directions

INCONCLUSION

- Demand and supply both shifted to the right by the SAME MAGNITUDE
- Price stable (no change) while quantity increased

Example: MARKET FOR PINK SALMON

 Improved technology in catching salmons (larger, more efficient fishing boats)
 Costs decrease Profits increasing  more new fisherman enter the industry
o Supply of pink salmons increases
 Change in consumer income: shifted to higher quality fresh fish  becomes an inferior
good
 Lower prices of substitute products
o demand of pink salmon decreases
WE CAN CONCLUDE supply shift > demand shift

Example: MARKET FOR GASOLINE

 Political factors in the Middle East: conflicts disrupted supply and drive prices up
 Oil is used as an input to produce gasoline
o Cost increases and supply decrease
  Increase in income
 Increased popularity of SUV
o Demand for gasoline will increase
WE CAN CONCLUDE Demand shift > supply shift

- Less buyers searching : lower demand (shift to the left)

- Less construction: lower supply (shift left)

EQUILIBRIUM PRICE AND QUANTITY

 Rationing function of prices
o Combination of freely made individual decisions results in market-clearing price
 Efficient Allocation
o Productive efficiency
 The production of any particular good in the least costly way
o Allocative efficiency
 Particular mix of goods and services most highly valued by society
Demand reflects the marginal benefit (MB)
Supply reflects the marginal cost (MC)
- At market equilibrium QD=QS, MB=MC=P
GOVERNMENT SET PRICES
PRICE CEILINGS
- Government set max price for a good/service
- Set BELOW the market equilibrium price (they feel that price is too high)
o This can create a shortage
 - Enable consumers to obtain some essential goods/services that they could not afford at
the equilibrium price
- Example: rent control
Rationing Problem
- First-come, first-served basis
- Favouritism
- Ration coupons
Black Markets
- Illegal buying and selling
- Landlords might switch from long-term to short-term rentals in order to avoid rent-
controls (Airbnb)
PRICE FLOOR
- A legally established minimum price
- Set ABOVE an equilibrium
- Example: minimum wages for unskilled labour market (so that it doesn’t look like they
are exploited)
- Example: supported prices for some agricultural products (eg. Wheat)

- Distort resource allocation

- Causes surpluses
- Produce negative side effects
o Consumers pay higher prices
o Taxpayers pay higher taxes
o Environmental damages (clear cutting to make space for agriculture or factories)
o Trade conflicts