BackChapter 3: Demand, Supply, and Price – Microeconomics Study Notes
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Demand, Supply, and Price
Chapter Outline and Learning Objectives
3.1 Demand
3.2 Supply
3.3 The Determination of Price
Demand
Quantity Demanded
The quantity demanded is the total amount of a product that consumers desire to purchase in a given time period. It is distinct from the quantity actually bought, which refers to actual purchases. Quantity demanded is considered a flow variable, measured over a period of time, as opposed to a stock variable, which is measured at a point in time.
Quantity Demanded: Desired purchases over a time period.
Quantity Bought: Actual purchases made.
Flow vs. Stock: Flow is over time; stock is at a moment.
Quantity Demanded and Price
There is a fundamental hypothesis in microeconomics that, ceteris paribus (all else equal), the price of a product and the quantity demanded are negatively related. This is known as the law of demand.
Law of Demand: As price decreases, quantity demanded increases, and vice versa.
Reason: Multiple products can satisfy a given want; a lower price makes a product more attractive.
Demand Schedules and Demand Curves
A demand schedule is a table showing the quantity demanded at various prices. The demand curve is a graphical representation of this relationship, typically downward sloping.
Price ($ per bushel) | Quantity Demanded (thousands per year) |
|---|---|
20 | 120 |
40 | 100 |
60 | 80 |
80 | 60 |
100 | 40 |
The demand curve plots these points and shows the inverse relationship between price and quantity demanded.
Determinants of Demand (Shifts in Demand)
A change in a relevant variable other than the price of the product itself shifts the demand curve to a new position. These determinants include:
Consumer income (normal or inferior goods)
Prices of other goods (substitutes or complements)
Consumer tastes/preferences
Number of consumers
Significant changes in weather
Increases and Decreases in Demand
A rightward shift of the demand curve indicates an increase in demand. A leftward shift indicates a decrease in demand.
Increase in Demand: More is demanded at every price.
Decrease in Demand: Less is demanded at every price.
Shifts of and Movements Along the Demand Curve
It is important to distinguish between a change in demand and a change in quantity demanded:
Change in Demand: Shift of the entire demand curve (caused by changes in determinants other than price).
Change in Quantity Demanded: Movement along the demand curve (caused by a change in the product's price).
Supply
Quantity Supplied
The quantity supplied is the total amount of a product that firms desire to sell in a given time period. It is the amount firms are willing to sell, not necessarily the amount actually sold. Like quantity demanded, quantity supplied is a flow variable.
Quantity Supplied: Desired sales over a time period.
Flow vs. Stock: Flow is over time; stock is at a moment.
Quantity Supplied and Price
There is a basic hypothesis that, ceteris paribus, the price of a product and the quantity supplied are positively related. This is known as the law of supply.
Law of Supply: As price increases, quantity supplied increases, and vice versa.
Reason: Higher prices make production and sale more profitable for producers.
Supply Schedules and Supply Curves
A supply schedule is a table showing the quantity supplied at various prices. The supply curve is a graphical representation, typically upward sloping.
Price ($ per bushel) | Quantity Supplied (thousands per year) |
|---|---|
20 | 20 |
40 | 45 |
60 | 65 |
80 | 80 |
100 | 98 |
Determinants of Supply (Shifts in Supply)
A change in a relevant variable other than the price of the product itself shifts the supply curve to a new position. These determinants include:
Prices of inputs
Technology
Government taxes or subsidies
Prices of other products
Number of suppliers
Significant changes in weather
Shifts of and Movements Along the Supply Curve
Distinguishing between a change in supply and a change in quantity supplied:
Change in Supply: Shift of the entire supply curve (caused by changes in determinants other than price).
Change in Quantity Supplied: Movement along the supply curve (caused by a change in the product's price).
Market Equilibrium
The Concept of a Market
A market is any situation in which buyers and sellers negotiate the transaction of a good or service. Markets differ in the degree of competition among buyers and sellers. In a perfectly competitive market, all participants are price takers.
Graphical Analysis of a Market
Market equilibrium occurs where the demand and supply curves intersect. At the equilibrium price, the quantity demanded equals the quantity supplied, and the market "clears."
Price ($ per bushel) | Quantity Demanded | Quantity Supplied | Excess Demand (+) or Excess Supply (-) |
|---|---|---|---|
20 | 120 | 20 | +100 |
40 | 100 | 45 | +55 |
60 | 80 | 65 | +15 |
80 | 60 | 80 | -20 |
100 | 40 | 98 | -58 |
At $60, quantity demanded equals quantity supplied (65,000 bushels).
Market Equilibrium
Equilibrium Price: The price at which quantity demanded equals quantity supplied.
Excess Supply: If price is above equilibrium, supply exceeds demand, causing downward pressure on price.
Excess Demand: If price is below equilibrium, demand exceeds supply, causing upward pressure on price.
Changes in Market Equilibrium
Shifts in demand or supply curves affect equilibrium price and quantity:
Increase in Demand: Raises both equilibrium price and quantity.
Decrease in Demand: Lowers both equilibrium price and quantity.
Increase in Supply: Lowers equilibrium price, raises equilibrium quantity.
Decrease in Supply: Raises equilibrium price, lowers equilibrium quantity.
Examples
Economic Growth: Rapid growth in countries like China and India increases global demand for products, raising equilibrium prices (ceteris paribus).
Hydraulic Fracturing: Increases supply of natural gas, lowering equilibrium price (ceteris paribus).
Example: Changes in Demand vs Changes in Quantity Demanded
Suppose technology reduces production costs for electric cars:
The supply curve shifts right.
The equilibrium price falls.
Consumers buy more electric cars due to the lower price.
Question: Has there been a change in demand or a change in quantity demanded?
Answer: A change in quantity demanded. Demand itself has not shifted; consumers are moving along the demand curve in response to the lower price.
Relative Prices and Inflation
The absolute price is the amount of money needed to acquire one unit of a product. The relative price is the price of one good in terms of another. Demand and supply curves are drawn in terms of relative prices, not absolute prices.
Limitations of the Demand and Supply Model
Why Apples but Not iPhones?
The demand and supply model is useful for many markets but has limitations. It works well for homogeneous products like apples, but not for differentiated products like iPhones. Three conditions must be met for the model to apply:
Many consumers, each small relative to the market size.
Many producers, each small relative to the market size.
Producers must sell homogeneous versions of the product.
Application: Demand and Supply Shocks from COVID-19
The COVID-19 pandemic caused significant shifts in demand and supply:
Demand Shocks: Increased demand for home cooking, streaming video, video conferencing, and personal protective equipment; decreased demand for restaurant meals, movie theaters, hotels, and air travel.
Supply Shocks: Disruptions in fresh fruit and vegetable supply; increased government bond issuance to finance relief spending.
These shocks illustrate how external events can shift demand and supply curves, affecting market equilibrium.
Key Formulas
Law of Demand: , where decreases as increases.
Law of Supply: , where increases as increases.
Market Equilibrium: at equilibrium price .
Summary Table: Shifts vs. Movements
Type of Change | Cause | Effect |
|---|---|---|
Shift of Curve | Change in determinant other than price | Change in demand or supply at every price |
Movement Along Curve | Change in price of the product | Change in quantity demanded or supplied |
Additional info: These notes expand on the original slides by providing definitions, examples, and context for each concept, ensuring a self-contained study guide for microeconomics students.
