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Chapter 3: Demand, Supply and Price
Demand in More Detail
(From textbook) Demand is the entire relationship between the quantity of a
commodity that buyers want to purchase and the price of that commodity, other things equal.
Quantity Demanded: The amount of a good or service that a consumer or group of consumers is willing and able to purchase during a particular period of time at a particular price.
The demand for a good is affected by many factors which are collectively referred to as the determinants of demand (these are addressed below in these notes)
The “All-Else Equal” Assumption
This is a critical (if somewhat confusing at first, but not after awhile) part of using the supply-demand model (as well as other models).
All-else-equal is used interchangeably with the term “ceteris paribus”
This assumption means that everything is held constant except one variable – this is a simplification, but allows us to think more slowly and clearly about changes within a model.
o E.g. the price of ketchup falls, but everything else affecting the demand for ketchup stays the same.
What else affects the demand for ketchup?
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The Effect of Price on Quantity Demanded Prediction of the model….
All else equal, when the price of a good or service changes, the quantity demanded of that good changes.
The demand relationship – price and quantity demanded are negatively (or inversely) related E.g. if the price of ketchup increases, all else equal, the quantity demanded of ketchup will decrease.
What explains this inverse relationship?
o Real income effect (income effect)
o Substitution effect
Movements Along a Demand Curve
A movement along a given demand curve results from a change in that good’s price, ceteris paribus (remember the discussion of relative price above?)
The language of the model is that a change in the price of a good will result in a change in the quantity demanded of that good (NOT a “change in Demand”)
E.g. All else equal, an increase in the price of airline tickets will decrease the quantity demanded of airline tickets. (THE DEMAND FOR AIRLINE TICKETS DOES NOT CHANGE AS A RESULT OF A CHANGE IN THE PRICE OF AIRLINE TICKETS).
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Shifts in the Demand Curve
A change in demand is represented in the model by a shift in the entire demand curve
In this model, a “change in demand” for a good results from a change in a determinant of demand other than the good’s price.
o The change can be an increase or a decrease
Increase in Demand: Decrease in Demand:
So we know what an increase/decrease in demand looks like, but how do we interpret it?
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What causes an increase/decrease in demand? A change in a determinant of demand other than a change in the goods “own-price”.
Major Determinants of Demand (other than its own-price)
Consumer’s Income (distinction between normal & inferior goods)
Prices of other goods (distinction between substitutes & complements)
Tastes
Population
Expectations about the future
You should be able to illustrate how changes to the above determinants affect Demand and how they are represented in the Demand and Supply model.
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Supply in More Detail
Supply – the various quantities of a good or service that a seller or group of sellers are willing and able to offer for sale at various prices during a specific time period.
o The term quantity supplied is different than supply
The supply of something is affected by many factors which are collectively referred to as the determinants of supply (these are addressed below in these notes)
The quantity supplied is positively related to price, ceteris paribus.
o What explains this?
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Movements Along a Supply Curve
A movement along a given supply curve results from a change in price, ceteris paribus (remember when I wrote to remember the discussion of relative price above?)
The language of the model is that a change in the price of a good will result in a change in the quantity supplied of that good (NOT a “change in Supply”)
E.g. All else equal, an increase in the price of airline tickets will increase the quantity supplied of airline tickets.
Shifts of the Supply Curve
• A shift in the supply curve is a representation of a change to a determinant of supply other than the good’s own price.
• A change in supply is the language referring to a shift in the entire supply curve.
– Change can be an increase or a decrease
Increase in Supply: Decrease in Supply:
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What is the cause of a “change in supply”
A change to a determinant of supply, other that the price of the good or service being supplied, will result in a change in supply.
Major Determinants of Supply (other than own-price)
These are the major influencers of supply that are held at some fixed level when a given supply curve is drawn…..
Prices of inputs (factors of production)
Technology
Government Taxes or Subsidies
Prices of other products
Number of suppliers
You should be able to illustrate how changes to the above determinants affect supply and are represented in the Demand and Supply Model.
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A Final Point on Language
In this model a change in demand can also result in a change in quantity demanded.
o The opposite is not true.
In this model a change in supply can also result in a change in quantity supplied o The opposite is not true.
The Determination of Price – applying the supply-demand model
The price of a good is determined by the interaction between sellers and buyers.
Prices are an important part of the market system as they act as signals to buyers and sellers as well as having a rationing function.
All determinants of demand and supply influence prices and the behaviour of prices.
Prices adjust to close shortages and surpluses caused by changes in supply and changes in demand.
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The supply-demand model can be used to predict and analyse changing market conditions.
Comparative Statics – how do equilibrium price and equilibrium quantity change as a result of changes to non-own-price determinants of demand and supply?
o Comparative statics will allow us to do quick predictions or provide explanations for changing market conditions.
o For “comparative” think compare and for “statics” think equilibria. We are comparing equilibria before and after some change to a variable affecting supply and/or demand.
To get a feel for using comparative statics, we have the following exercise:
This exercise tests your understanding on how equilibrium prices and quantities change when there are changes in supply and demand.
P* means equilibrium price, Q* means equilibrium quantity, Δ means “change”
Letting a plus sign (+) for an increase, a minus sign (-) for a decrease, a zero (0) for no change and a question mark for no definite conclusion (?) fill in the table with one of these four characters.
Remember that in comparative statics, we are comparing the equilibrium before and after some change to demand or change in supply (resulting from a change to a determinant of supply or demand).
SEE NEXT PAGE FOR EXERCISE
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Situation 2: Situation 3:
Situation 5: Situation 9: