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Supply, Demand, and Equilibrium

Competitive market - many buyers and sellers for the same good or service

  • Behavior is described by the supply and demand model

Six Key Elements of the Supply and Demand Model

  • The demand curve

  • Set factors that cause demand to shift

  • The supply curve

  • Set factors that cause supply to shift

  • Market equilibrium - includes equilibrium price and quantity

  • Way equilibrium curve changes based on supply and demand curve shifts

Demand:

Demand Curve

  • Determined by consumers/buyers

  • Buyers have a desire to purchase a good

  • Quantity demanded and price are inversely related

  • The higher the price of an item, the less of that item people will be willing to purchase, and vice versa

Demand Schedule - table that shows how much of a certain good consumers are willing to buy at different prices

  • Quantity Demanded - actual amount consumers are willing and able to buy at a certain price

  • Demand - how much people want at every pricepoint

Demand Curve - graphical representation of a demand schedule

  • Shows the relationship between quantity demanded and price

Law of Demand - the higher price of a good or service leads to less quantity demanded of that good or service, all other things being equal

  • Demand curves are shifted due to population growth

  • Shift in the demand curve (TRIBE factors, no change in price of THE good) ≠ movement along the demand curve (price change)

  • Increase in demand = rightward shift in the curve

  • Decrease in demand = leftward shift in the curve


Five Principle Factors that shift the demand curve (Determinants) (TRIBE)

  • Changes in:

    • Taste - how people feel about a product

  • Related goods or services

    • Substitutes in consumption - two goods for which a rise in the price of one of the goods leads to an increase in demand for the other good (example: Beef and Pork)

    • Complements in consumption - two goods that are used together. The rise in the price of one good leads to a decrease in demand for the other good (example: Beef and Potatoes)

  • Income

    • Normal goods - a rise in income increases the demand (example: Butcher meat)

    • Inferior goods - a rise in income decreases the demand, mostly due to better, more expensive options (example: Spam, which is lower quality meat)

  • Buyers (number of) (example: More parents = more baby supplies)

  • Expectations (future price) (example: Buying large amounts of gasoline because of expectation of prices rising)


Individual Demand Curve - shows quantity demanded and price for a single customer

Market Demand Curve - combined quantity demanded of all consumers determined by the market price of a good

  • Horizontal sum - individual demand curves of all consumers in a market

  • Demand = is the curve

  • Quantity Demanded = point on the curve

Supply:

Quantity Supplied - amount producers are willing to produce and sell

Supply Schedule - table that shows how much of a good or service produced will affect prices

  • Supply Curve - shows the relationship between quantity supplied and price

  • Price and quantity supplied are directly proportional

  • Up and Down graphical movement

Law of Supply - the price and quantity supplied are directly related

  • Movement along the supply curve is not the same as a shift in the supply curve

  • Increase in supply = downward shift

  • Decrease in supply = upward shift


Five Factors that Shift Supply Curve (IRENT)

  • Input prices

    • Input - any good or service that is used to produce another good or service

    • Examples of input prices for producing donuts: Ingredients, Oven, Labor, Utility, and Rent

    • An increase in input costs leads to a decrease in supply

    • A decrease in input costs leads to an increase in supply

  • Related goods or services

    • Substitutes in production (Example: Coke and BodyArmor)

    • Complements in production (Example: Cow skin and beef)

  • Expectations (future price)

  • Number of sellers (more sellers, more supply)

  • Technology (new and better technology becomes available, leading to increase in supply)

Equilibrium

  • Equilibrium: an economic condition where no individual would be better off with any alternative

  • Achieved in a competitive market when quantity demanded is equal to quantity supplied (This is called the equilibrium price or market price)

  • Equilibrium Quantity - quantity bought and sold at the equilibrium price

  • Equilibrium can be calculated by bringing supply and demand curves together on one graph and finding where they intersect

Surplus - excess supply

Shortage - excess demand

  • Market price always moves toward equilibrium

  • When demand for a good/service increases, the equilibrium price and quantity both rise

  • When supply for a good/service decreases, the equilibrium price rises, but the equilibrium quantity falls

  • When both curves shift, the curve with the greatest magnitude of shift will control the equilibrium price and quantity



Supply

Demand

Equilibrium

decreases

increases

Price rises and quantity is ambiguous

increases

decreases

Price falls, quantity is ambiguous

increases

increases

Quantity rises, price is ambiguous

decreases

decreases

Quantity falls, price is ambiguous






Price Controls - restrictions on how high or low a market price can go

  • Price ceiling - the highest a price can be

    • Price ceilings above the equilibrium will not have any effect

    • This can lead to shortages

    • Wasted Resources - a form of inefficiency where people expend money, effort, and time to cope with the shortcomings experienced by a price ceiling

    • Inefficiently low quality - sellers sell lower quality goods at a lower price

    • Sparks the emergence of black markets

  • Price floor - lowest a price can be

    • Price floors below the equilibrium will not have any effect

    • Includes minimum wage

    • Can lead to surpluses

    • Inefficiently low quantity

    • Inefficiently high quality

Quantity Controls - also known as a quota; an upper limit on the amount of a good that can be bought or sold

  • Government can limit quantity by requiring licenses to produce certain products

  • These create wedges in the graph, where the quantity does not meet the equilibrium point

    • This is called the quota rent

  • The cost of these wedges is known as deadweight loss, or the triangle created between the wedge and equilibrium point

Competitive market - many buyers and sellers for the same good or service

  • Behavior is described by the supply and demand model

Six Key Elements of the Supply and Demand Model

  • The demand curve

  • Set factors that cause demand to shift

  • The supply curve

  • Set factors that cause supply to shift

  • Market equilibrium - includes equilibrium price and quantity

  • Way equilibrium curve changes based on supply and demand curve shifts

Demand:

Demand Curve

  • Determined by consumers/buyers

  • Buyers have a desire to purchase a good

  • Quantity demanded and price are inversely related

  • The higher the price of an item, the less of that item people will be willing to purchase, and vice versa

Demand Schedule - table that shows how much of a certain good consumers are willing to buy at different prices

  • Quantity Demanded - actual amount consumers are willing and able to buy at a certain price

  • Demand - how much people want at every pricepoint

Demand Curve - graphical representation of a demand schedule

  • Shows the relationship between quantity demanded and price

Law of Demand - the higher price of a good or service leads to less quantity demanded of that good or service, all other things being equal

  • Demand curves are shifted due to population growth

  • Shift in the demand curve (TRIBE factors, no change in price of THE good) ≠ movement along the demand curve (price change)

  • Increase in demand = rightward shift in the curve

  • Decrease in demand = leftward shift in the curve


Five Principle Factors that shift the demand curve (Determinants) (TRIBE)

  • Changes in:

    • Taste - how people feel about a product

  • Related goods or services

    • Substitutes in consumption - two goods for which a rise in the price of one of the goods leads to an increase in demand for the other good (example: Beef and Pork)

    • Complements in consumption - two goods that are used together. The rise in the price of one good leads to a decrease in demand for the other good (example: Beef and Potatoes)

  • Income

    • Normal goods - a rise in income increases the demand (example: Butcher meat)

    • Inferior goods - a rise in income decreases the demand, mostly due to better, more expensive options (example: Spam, which is lower quality meat)

  • Buyers (number of) (example: More parents = more baby supplies)

  • Expectations (future price) (example: Buying large amounts of gasoline because of expectation of prices rising)


Individual Demand Curve - shows quantity demanded and price for a single customer

Market Demand Curve - combined quantity demanded of all consumers determined by the market price of a good

  • Horizontal sum - individual demand curves of all consumers in a market

  • Demand = is the curve

  • Quantity Demanded = point on the curve

Supply:

Quantity Supplied - amount producers are willing to produce and sell

Supply Schedule - table that shows how much of a good or service produced will affect prices

  • Supply Curve - shows the relationship between quantity supplied and price

  • Price and quantity supplied are directly proportional

  • Up and Down graphical movement

Law of Supply - the price and quantity supplied are directly related

  • Movement along the supply curve is not the same as a shift in the supply curve

  • Increase in supply = downward shift

  • Decrease in supply = upward shift


Five Factors that Shift Supply Curve (IRENT)

  • Input prices

    • Input - any good or service that is used to produce another good or service

    • Examples of input prices for producing donuts: Ingredients, Oven, Labor, Utility, and Rent

    • An increase in input costs leads to a decrease in supply

    • A decrease in input costs leads to an increase in supply

  • Related goods or services

    • Substitutes in production (Example: Coke and BodyArmor)

    • Complements in production (Example: Cow skin and beef)

  • Expectations (future price)

  • Number of sellers (more sellers, more supply)

  • Technology (new and better technology becomes available, leading to increase in supply)

Equilibrium

  • Equilibrium: an economic condition where no individual would be better off with any alternative

  • Achieved in a competitive market when quantity demanded is equal to quantity supplied (This is called the equilibrium price or market price)

  • Equilibrium Quantity - quantity bought and sold at the equilibrium price

  • Equilibrium can be calculated by bringing supply and demand curves together on one graph and finding where they intersect

Surplus - excess supply

Shortage - excess demand

  • Market price always moves toward equilibrium

  • When demand for a good/service increases, the equilibrium price and quantity both rise

  • When supply for a good/service decreases, the equilibrium price rises, but the equilibrium quantity falls

  • When both curves shift, the curve with the greatest magnitude of shift will control the equilibrium price and quantity



Supply

Demand

Equilibrium

decreases

increases

Price rises and quantity is ambiguous

increases

decreases

Price falls, quantity is ambiguous

increases

increases

Quantity rises, price is ambiguous

decreases

decreases

Quantity falls, price is ambiguous






Price Controls - restrictions on how high or low a market price can go

  • Price ceiling - the highest a price can be

    • Price ceilings above the equilibrium will not have any effect

    • This can lead to shortages

    • Wasted Resources - a form of inefficiency where people expend money, effort, and time to cope with the shortcomings experienced by a price ceiling

    • Inefficiently low quality - sellers sell lower quality goods at a lower price

    • Sparks the emergence of black markets

  • Price floor - lowest a price can be

    • Price floors below the equilibrium will not have any effect

    • Includes minimum wage

    • Can lead to surpluses

    • Inefficiently low quantity

    • Inefficiently high quality

Quantity Controls - also known as a quota; an upper limit on the amount of a good that can be bought or sold

  • Government can limit quantity by requiring licenses to produce certain products

  • These create wedges in the graph, where the quantity does not meet the equilibrium point

    • This is called the quota rent

  • The cost of these wedges is known as deadweight loss, or the triangle created between the wedge and equilibrium point