Microeconomics

Demand and Supply (42-72)

Market

• any kind of arrangement where buyers and sellers of goods, services or resources are linked together to carry out an exchange

Competition

• a process in which rivals compete in order to achieve some objective.

Demand

• The demand of an individual consumer indicates the various quantities of a good or service the consumer is willing and able to buy at different possible prices during a particular time period, ceteris paribus

Law of Demand

• there is a negative relationship between the price of a good and its quantity demanded over a particular time period, ceteris paribus: as the price of the good increases, quantity demanded falls; as the price falls, quantity demanded increases, ceteris paribus

Market Demand

• The sum of all individual demands for a good. The market demand curve illustrates the law of demand, shown by the negative relationship between price and quantity demanded.

Non-Price Determinants of Demand

• Income in the case of normal goods. A good is a normal good when demand for it increases in response to an increase in consumer income.

• Income in the case of inferior goods. A good is an inferior good when demand falls as consumer income increases.

• Preferences and tastes.

• Price of substitute goods. Two goods are substitutes if they satisfy a similar need.

• Prices of complementary goods. Two goods are complements if they tend to be used together.

• The number of consumers.

Assumptions underlying the law of demand

• The law of diminishing marginal utility. As consumption of a good increases, marginal utility decreases with each additional unit consumed. This underlies the law of demand, as it shows that a consumer will be willing to buy an additional unit of a good if its price falls.

• The income and substitution effects. If the price of a good falls, the consumer buys more of the less expensive good instead of the more expensive good. A fall in price can also be considered an increase in the consumer’s real income (or purchasing power), enabling them to purchase more.

Supply

• The supply of an individual firm indicates the various quantities of a good or service a firm is willing and able to produce and supply to the market for sale at different possible prices, during a particular time period, ceteris paribus

Law of Supply

• There is a positive relationship between the quantity of a good supplied over a particular time period and its price, ceteris paribus: as the price of the good increases, the quantity of the good supplies also increases.

Market Supply

• The sum of all individual firms’ supplies for a good. The market supply curve illustrates the law of supply, shown by a positive relationship between price and quantity supplied.

Non-price determinants of supply

• Costs of factors of production. If a factor price rises, production costs increase, production becomes less profitable and the firm produces less.

• Technology. A new improved technology lowers costs of production, thus making production more profitable. Supply increases and the supply curve shifts to the right.

• Competitive supply of two or more products refers to production of one or the other by a firm; the goods compete for the use of the same resources and producing more of one means producing less of the other.

• Joint Supply of two or more goods refers to production of goods that are derived from a single product, so that it is not possible to produce more of one without producing more of the other.

• Producer price expectations. If firms expect the price of their product to rise, they may withhold some of their current supply from the market expecting that they will be able to sell it at the higher price in the future; in this case, there is a fall in supply in the present.

• Taxes. Firms treat taxes as if they were costs of production.

• Subsidies. The introduction of a subsidy or an increase in an existing subsidy is equivalent to a fall in production costs, resulting in a rightward shift in the supply curve.

• The number of firms. An increase in the number of firms producing the goods increases supply.

• Supply shocks. Sudden unpredictable events called ‘shocks’ can affect supply.

Assumptions underlying the law of supply

• Law of diminishing marginal returns.

Elasticities (85-104)