BackDemand and Supply: Foundations of Macroeconomics (Chapter 4 Study Notes)
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Demand and Supply
Introduction
The concepts of demand and supply are fundamental to understanding how markets operate in macroeconomics. This chapter explores how prices and quantities are determined in competitive markets, the factors that influence demand and supply, and the effects of government interventions such as price floors and ceilings.
Competitive Markets
Definition and Characteristics
Market: Any arrangement that brings buyers and sellers together, which can be a physical location or a virtual network.
Competitive Market: A market with many buyers and sellers, none of whom can individually influence the price.
Examples include markets for running shoes, coffee, bagels, and airline travel.
Demand
Quantity Demanded and the Law of Demand
Quantity Demanded: The amount of a good, service, or resource that people are willing and able to buy during a specified period at a specified price.
Law of Demand: Other things remaining the same, as the price of a good rises, the quantity demanded decreases; as the price falls, the quantity demanded increases.
Demand Schedule and Demand Curve
Demand Schedule: A table listing quantities demanded at different prices, holding other factors constant.
Demand Curve: A graph showing the relationship between quantity demanded and price, ceteris paribus.
Price (per bottle) | Quantity Demanded (bottles/day) |
|---|---|
$2.00 | 0 |
$1.50 | 1 |
$1.00 | 2 |
$0.50 | 3 |
Changes in Demand vs. Changes in Quantity Demanded
Change in Quantity Demanded: Movement along the demand curve due to a change in the price of the good.
Change in Demand: Shift of the entire demand curve due to changes in non-price factors.
Determinants of Demand
Prices of Related Goods: Substitutes and complements affect demand.
Expected Future Prices: If future prices are expected to rise, current demand increases.
Income: Demand for normal goods increases with income; demand for inferior goods decreases with income.
Expected Future Income and Credit: Anticipated changes in income or credit availability affect demand, especially for big-ticket items.
Number of Buyers: More buyers increase market demand.
Preferences: Changes in tastes or information can shift demand.
Factor | Effect on Demand |
|---|---|
Price of Substitute rises | Demand increases |
Price of Complement falls | Demand increases |
Income rises (normal good) | Demand increases |
Income rises (inferior good) | Demand decreases |
Number of buyers increases | Demand increases |
Supply
Quantity Supplied and the Law of Supply
Quantity Supplied: The amount of a good, service, or resource that sellers are willing and able to sell during a specified period at a specified price.
Law of Supply: Other things remaining the same, as the price of a good rises, the quantity supplied increases; as the price falls, the quantity supplied decreases.
Supply Schedule and Supply Curve
Supply Schedule: A table listing quantities supplied at different prices, holding other factors constant.
Supply Curve: A graph showing the relationship between quantity supplied and price, ceteris paribus.
Price (per bottle) | Quantity Supplied (bottles/day) |
|---|---|
$2.00 | 8 |
$1.50 | 4 |
$1.00 | 2 |
$0.50 | 0 |
Changes in Supply vs. Changes in Quantity Supplied
Change in Quantity Supplied: Movement along the supply curve due to a change in the price of the good.
Change in Supply: Shift of the entire supply curve due to changes in non-price factors.
Determinants of Supply
Prices of Related Goods: Substitutes and complements in production affect supply.
Prices of Resources and Inputs: Higher input costs decrease supply.
Expected Future Prices: Anticipated changes in prices can affect current supply.
Number of Sellers: More sellers increase market supply.
Productivity: Technological advances or disasters can increase or decrease supply.
Factor | Effect on Supply |
|---|---|
Price of Substitute in production rises | Supply decreases |
Price of Complement in production rises | Supply increases |
Input prices rise | Supply decreases |
Number of sellers increases | Supply increases |
Productivity increases | Supply increases |
Market Equilibrium
Equilibrium Price and Quantity
Market Equilibrium: Occurs when quantity demanded equals quantity supplied.
Equilibrium Price (): The price at which the market clears.
Equilibrium Quantity (): The quantity bought and sold at equilibrium price.
Example: If the equilibrium price of bottled water is $1.00 per bottle and the equilibrium quantity is 10 million bottles per day, the market is in balance.
Shortages and Surpluses
Shortage: Quantity demanded exceeds quantity supplied; price tends to rise.
Surplus: Quantity supplied exceeds quantity demanded; price tends to fall.
Predicting Price Changes
To analyze market changes, ask:
Does the event change demand or supply?
Does it increase or decrease demand or supply?
What are the new equilibrium price and quantity?
Effects of Changes in Demand and Supply
Increase in Demand: Price rises, quantity increases.
Decrease in Demand: Price falls, quantity decreases.
Increase in Supply: Price falls, quantity increases.
Decrease in Supply: Price rises, quantity decreases.
Simultaneous Changes: If both demand and supply change, the effect on price or quantity may be ambiguous and depends on the magnitude of each shift.
Price Rigidities
Price Floors
Price Floor: A government regulation setting a lower limit on price (e.g., minimum wage).
If set above equilibrium, creates a surplus (e.g., unemployment in labor markets).
Price Ceilings
Price Ceiling: A government regulation setting an upper limit on price (e.g., rent control).
If set below equilibrium, creates a shortage (e.g., shortage of parking spaces).
Sticky Prices
Sticky Price: Prices that do not adjust quickly due to contracts or infrequent changes, leading to temporary shortages or surpluses.
Application: The Price of Avocados
Case Study: Seasonal Fluctuations
Each year, the Californian avocado crop winds down and the Mexican crop takes over.
If Mexican production does not fully replace the Californian crop, the price rises due to decreased supply.
Data example: At the end of July 2018, price was $1.03/lb and quantity was 45 million lbs; in September, price rose to $1.29/lb and quantity fell to 36 million lbs.
Conclusion: The price increase was due to a decrease in supply, not an increase in demand.
Date | Quantity (million lbs) | Price ($/lb) |
|---|---|---|
End of July 2018 | 45 | 1.03 |
September 2018 | 36 | 1.29 |
Key Formulas
Demand Function:
Supply Function:
Equilibrium Condition:
Summary Table: Effects of Shifts
Event | Price | Quantity |
|---|---|---|
Increase in Demand | Rises | Increases |
Decrease in Demand | Falls | Decreases |
Increase in Supply | Falls | Increases |
Decrease in Supply | Rises | Decreases |
Both Demand and Supply Increase | Ambiguous | Increases |
Both Demand and Supply Decrease | Ambiguous | Decreases |
Additional info: These notes expand on the brief points in the original slides, providing full definitions, examples, and context for each concept. All tables are reconstructed and some entries inferred for completeness.
