ECO 104Lct 3

Supply and Demand: TheoryBased on ch.2 of Macroecnomics, Roger A. Arnold

Market

Any place people come together to trade.

People = buyers and sellers

Buyers demand goodsAnd sellers supply the goods…

DEMAND AND SUPPLY

DEMAND1) The willingness and ability of buyers

to purchase different quantities of goods

2) At different prices

3) During a specific period of time

SUPPLY1) The willingness and ability of sellers

to produce and offer to sell different quantities of goods

2) At different prices

3) During a specific period of time

LAW OF DEMAND AND SUPPLY

LAW OF DEMAND1. As the price of a good rises, the quantity demanded ( of the good falls, and as the price of a good falls, quantity demanded of the good rises, ceteris paribus.

2. In symbols: , ceteris paribus

LAW OF SUPPLY1. As price (P) of a good rises, the quantity supplied ( of the good rises, and as the price of the good falls, quantity supplied () of the good falls, ceteris paribus.

2.

LAW OF DEMAND AND SUPPLY

DEMAND3. Demand schedule: The numerical tabulation of the quantity demanded of a good at different prices (numerical representation of the law of DD)

4. Demand curve: The graphical representation of the law of demand. (A downward sloping line or curve)Constructed using the demand schedule.

SUPPLY…numerical tabulation of quantity supplied of a good at different prices

…An upward sloping line or curve (indicating a direct relationship)

Explaining The Upward Sloping SS Curve- Assuming ceteris paribus, higher prices implies higher profits which

acts as an incentive for the producers/sellers/firms to produce more

- Costs rise when more units of a good are produced

CHANGE IN QUANTITY SUPPLIED

Implies movement along the supply curve…

Factor causing this movement: change in it’s own price

CHANGE IN SUPPLY

• Changes in supply (SS) => shift of the supple curve

• Factors that cause this shift- Prices of relevant resources (R)

P(R) ↑, Profit ↓, SS ↓P(R) ↓, Profit ↑ , SS ↑ ceteris paribus

- TechnologyTechnological improvement → cost of production ↓ → profit ↑ and hence, SS ↑

- Prices of other goodsSellers/producers shift to goods with higher prices (more profit), hence SS of the good ↓

• Number of sellersif, # of sellers ↑ then, supply (SS) ↑

• Expectations (E) of future prices E (future prices) ↑, current SS ↓, future SS ↑

• Taxes and subsidiesTaxes result in cost ↑, profit ↓, hence SS ↓

• Government restrictionsGenerally restricts/reduces supply (barriers to entry, compliance with certain criteria)

The Market: DD and SS Together

Equilibrium Price, P(E) : The price at which the Q(D) = Q(S)

Equilibrium Quantity, Q(E): The quantity that corresponds to equilibrium price

Surplus: Q(S) > Q(D) …when?Disequilibrium

Shortage: Q(D) > Q(S)

Moving to Equilibrium

“Free-market” allows the market to adjust itself…in the long run equilibrium is always reached in the following manner.

If, surplus, Q(S) > Q(D), then P falls until Equilibrium price is reached where the market clears i.e. Q(D) = Q(S)

If, shortage, Q(D) > Q(S), then P rises until Equilibrium price is reached where the market clears i.e. Q(D) = Q(S)

Equilibrium and Predictions

Examples…

Housing market (empty flats in Uttara is an indication of surplus in the housing market. In the future we might expect house rents to decline)

Education market (current situation indicates a shortage in this market. Many students can’t get admitted due to limited seats. In the future tuition fees (pvt universities) is expected to increase)

Consumer and Producer Surplus

Consumer Surplus, CS: Max buying price – Price paid

Producer Surplus, PS: Price received – Minimum selling price

Total Surplus = CS + PS

Total surplus is maximized at equilibrium