chapter 3

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Demand and Supply

Introduction to Markets and Prices

Markets are fundamental to microeconomics, serving as arrangements that enable buyers and sellers to exchange information and conduct business. In a competitive market, many buyers and sellers interact such that no single participant can influence the market price. Prices in these markets are determined by the forces of demand and supply.

Money Price: The amount of money required to purchase a good.
Relative Price: The ratio of the money price of one good to the money price of the next best alternative; represents the opportunity cost.

Demand

Definition and Determinants

Demand refers to the relationship between the price of a good and the quantity consumers are willing and able to purchase at each price, given their preferences and income.

To demand a good: You must want it, be able to afford it, and have a definite plan to buy it.
Quantity Demanded: The amount consumers plan to buy during a specific time period at a particular price.

Law of Demand

The law of demand states that, other things remaining equal, as the price of a good rises, the quantity demanded falls; as the price falls, the quantity demanded rises.

Substitution Effect: When the price of a good rises, consumers seek substitutes, decreasing quantity demanded.
Income Effect: A higher price reduces consumers' purchasing power, decreasing quantity demanded.

Demand Curve and Demand Schedule

The demand curve graphically represents the relationship between price and quantity demanded, holding other factors constant. The demand schedule is a table showing quantities demanded at various prices.

Movement Along the Demand Curve: Caused by a change in the price of the good itself.
Shift of the Demand Curve: Caused by changes in non-price determinants (e.g., income, preferences).

Willingness and Ability to Pay

The demand curve also reflects consumers' willingness and ability to pay for additional units, measuring the marginal benefit of consumption.

Changes in Demand

A change in demand occurs when a non-price determinant of demand changes, shifting the entire demand curve.

Increase in Demand: Demand curve shifts rightward.
Decrease in Demand: Demand curve shifts leftward.

Main Factors Affecting Demand

Prices of Related Goods: Substitutes (goods used in place of each other) and complements (goods used together).
Expected Future Prices: If prices are expected to rise, current demand increases.
Income: Demand for normal goods increases with income; demand for inferior goods decreases.
Expected Future Income and Credit: Anticipated increases can boost current demand.
Population: Larger population increases demand.
Preferences: Differences in tastes affect demand.

Supply

Definition and Determinants

Supply refers to the relationship between the price of a good and the quantity producers are willing and able to sell at each price, given their resources and technology.

To supply a good: Firms must have resources and technology, expect profit, and have a plan to sell.
Quantity Supplied: The amount producers plan to sell during a specific time period at a particular price.

Law of Supply

The law of supply states that, other things remaining equal, as the price of a good rises, the quantity supplied increases; as the price falls, the quantity supplied decreases.

Driven by increasing marginal cost as output rises.

Supply Curve and Supply Schedule

The supply curve shows the relationship between price and quantity supplied, holding other factors constant. The supply schedule is a table showing quantities supplied at various prices.

Movement Along the Supply Curve: Caused by a change in the price of the good itself.
Shift of the Supply Curve: Caused by changes in non-price determinants (e.g., technology, input prices).

Minimum Supply Price

The supply curve also represents the minimum price at which producers are willing to sell each unit, reflecting the marginal cost of production.

Changes in Supply

A change in supply occurs when a non-price determinant of supply changes, shifting the entire supply curve.

Increase in Supply: Supply curve shifts rightward.
Decrease in Supply: Supply curve shifts leftward.

Main Factors Affecting Supply

Prices of Factors of Production: Higher input prices decrease supply.
Prices of Related Goods Produced: Substitutes and complements in production affect supply.
Expected Future Prices: If prices are expected to rise, current supply decreases.
Number of Suppliers: More suppliers increase market supply.
Technology: Advances increase supply.
State of Nature: Natural events (e.g., weather) can affect supply.

Market Equilibrium

Definition and Determination

Market equilibrium occurs when the quantity demanded equals the quantity supplied at a particular price. This price is called the equilibrium price, and the corresponding quantity is the equilibrium quantity.

Surplus: If price is above equilibrium, quantity supplied exceeds quantity demanded; price falls.
Shortage: If price is below equilibrium, quantity demanded exceeds quantity supplied; price rises.
Adjustment: Price moves toward equilibrium where plans of buyers and sellers match.

Predicting Changes in Price and Quantity

Effects of Shifts in Demand and Supply

Changes in demand or supply shift the respective curves, affecting equilibrium price and quantity.

Increase in Demand: Price and quantity both rise.
Decrease in Demand: Price and quantity both fall.
Increase in Supply: Price falls, quantity rises.
Decrease in Supply: Price rises, quantity falls.

Simultaneous Changes in Demand and Supply

When both demand and supply change, the effect on equilibrium price and quantity depends on the direction and magnitude of the shifts.

Change	Equilibrium Price	Equilibrium Quantity
Increase in Demand & Increase in Supply	Uncertain	Increases
Decrease in Demand & Decrease in Supply	Uncertain	Decreases
Increase in Demand & Decrease in Supply	Increases	Uncertain
Decrease in Demand & Increase in Supply	Decreases	Uncertain

Key Formulas

Relative Price:
Equilibrium Condition:

Examples

Substitute Goods: If the price of tea rises, demand for coffee (a substitute) increases.
Complement Goods: If the price of printers falls, demand for ink cartridges (a complement) increases.
Market Adjustment: If a surplus of energy bars exists at $2.00, price will fall until equilibrium is reached.

Additional info: Some content and examples have been expanded for clarity and completeness based on standard microeconomics curriculum.