• The model of demand and supply explains how a perfectly competitive market operates

• A perfectly competitive market has many buyers and sellers for a product, so no single buyer or seller can affect the market price.

4.1 The Demand Curve

• How much of a particular product are consumers willing to buy during a particular period?

• List of variables that affect an individual consumer’s decision:

  • The price of the product

  • The consumer’s income

  • The price of substitute goods

  • The price of complementary goods

  • The consumer’s preferences or tastes and advertising that may influence preferences

  • The consumer’s expectations about future prices

• Together, these variables determine how much of a particular product an individual consumer is willing and able to buy, the quantity of demanded.

The Individual Demand Curve and the Law of Demand

• The starting point for a discussion of individual demand is a demand schedule, which is a table of numbers showing the relationship between the price of a particular product and the quantity that an individual consumer is willing to buy.

• The individual demand curve is a graphical representation of the demand schedule. It shows the relationship between the price and the quantity demanded by an individual consumer, ceteris paribus.

• Law of demand: There is a negative relationship between price and quantity demanded, ceteris paribus.

• A movement along a single demand curve is called a change in quantity demanded, a change in the quantity a consumer is willing to buy when the price changes.

From Individual Demand to Market Demand

• The market demand curve shows the relationship between the price of the good and the quantity demanded by all consumers, ceteris paribus.

4.2 The Supply Curve

• On the supply side of a market, firms sell their products to consumers.

• The manager’s decision about how much to produce depends on many variables:

  • The price of the product

  • The wage paid to workers

  • The price of materials

  • The cost of capital

  • The state of production technology

  • Producers’ expectations about future prices

  • Taxes paid to the government or subsides (payments from the government to firms to produce a product).

• Together, these variables determine how much product firms are willing to produce and sell, the quantity supplied.

The Individual Supply Curve and the Law of Supply

• The starting point for a discussion of individual supply is a supply schedule, a table that shows the relationship between the price of a particular product and the quantity that an individual producer is willing to sell.

• The individual supply curve is a graphical representation of the supply schedule.

• Law of supply ( pattern of behavior that we observe in producers): There is a positive relationship between price and quantity supplied, ceteris paribus.

• A movement along a single supply curve is called a change in quantity supplied, a change in the quantity a producer is willing and able to sell when the price changes.

• The minimum single price is the lowest price at which a product is supplied.

Why is the Individual Supply Curve Positively Sloped?

• A higher price encourages a firm to increase its output by purchasing more materials and hiring more workers.

• The supply curve shows the marginal cost of production for different quantities produced.

• Marginal Principle: Increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level at which the marginal benefit equals the marginal cost.

From Individual Supply to Market Supply

• The market supply curve for particular good shows the relationship between the price of the good and the quantity that all producers together are willing to sell, ceteris paribus.

Why Is the Market Supply Curve Positively Sloped?

• To explain the positive slope, consider the two responses by firms to an increase in price:

  • Individual firm: A higher price encourages a firm to increase its output by purchasing more materials and hiring more workers.

  • New firms: In the long run, new firms can enter the market and existing firms can expand their prediction facilities to produce more output. The new firms may have higher production costs than the original firms, but the higher output prices make it worthwhile to enter the market, even with higher costs.

4.3 Market Equilibrium: Bringing Demand and Supply Together

• When the quantity of a product demanded equals the quantity supplied at the prevailing market price, we have reached a market equilibrium.

Excess Demand Causes the Price to Rise

• Excess demand (sometimes called a shortage) occurs when, at the prevailing market price, the quantity demanded exceeds the quantity supplied, meaning that consumers are willing to buy more than producers are willing to sell.

• As the price increases, the excess demand shrinks for two reasons:

  • The market moves upward along the demand curve, decreasing the quantity demanded

  • The market moves upward along the supply curve, increasing the quantity supplied.

• If the government sets a maximum price that is less than the equilibrium price, the result is a permanent excess demand for the good.

Excess Supply Causes the Price to Drop

• Excess supply (sometimes called a surplus) occurs when the quantity supplied exceeds the quantity demanded, meaning that producers are willing to sell more than consumers are willing to buy.

• As the price drops, the excess supply will shrink for two reasons:

  • The market moves downward along the demand curve, increasing the quantity demand

  • The market moves downward along the supply curve, decreasing the quantity supplied.

4.4 Market Effects of Changes in Demand

Change in Quantity Demanded versus Change in Demand

• To convey the idea that changes in these other variables change the demand schedule and the demand curve, we say that a change in any of these variables causes a change in demand.

Increases in Demand Shift the Demand Curve

• Increase in income: Consumers use their income to buy products, and the more money they have, the more money they spend. For a normal good, there is a positive relationship between consumer income and the quantity consumed.

• Decrease in income. An inferior good is the opposite of a normal good.

• Increase in the piercing of a substitute good. When two goods are substitutes, an increase in the price of the first good causes some consumers to switch to the second good.

• Decrease in price of a complementary good. When two goods are complements, they are consumed together as a package, and a decrease in the price of one good decreases the cost of the entire package.

• Increase in population. An increase in the number of people means there are more individual demand curves to add up to get the market demand curve -so market demand increases.

• Shift in consumer preferences.

• Expectations of higher future prices.

Decreases in Demand Shift the Demand Curve

• Decrease in income. A decrease in income means that consumers have less to spend, so they buy a smaller quantity of each normal good.

• Increase in income. Consumers buy smaller quantities of an inferior product when their income increases.

• Decrease in the price of a substitute good.

• Increase in the price of a complementary good.

• Decrease in population.

• Shift in consumer tastes.

• Expectations of lower future prices.

4.5 Market Effects of Changes in Supply

Change in Quantity Supplied versus Change in Supply

• To convey the idea that changes in these other variables change the supply curve, we say that a change in any of these variables causes a change in supply.

Increase in Supply Shift the Supply Curve

• A decrease in the wage will decrease the cost of the producing good and shift the supply curve:

  • Downward shift

  • Rightward shift

4.6 Predicting and Explaining Market Changes

• If the equilibrium price and quantity move in the same direction, the changes were caused by a change in demand.

• If the equilibrium price and quantity move in opposite directions, the changes were caused by a change in supply.