Demand and Supply (0)

MARKET
Market system is an interrelated set of markets for goods , services and inputs.
A market is defined as the interaction of all potential buyers and sellers of a good or class of goods that are close substitutes .

• The markets provide information to agents that may be used to identify and evaluate alternative choices that might be used to achieve objectives.
  
• Each agent acting in a market has incentives to react to the information provided.
  
• Given the information and incentives, agents within markets can adjust to changes .
  

The process of market adjustment can be visualized as changes in demand and/or supply .

• Markets include all potential buyers and sellers
  
  • geographic boundaries of market
    
  • markets defined by nature of product and characteristics of buyers
    
  • conditions of entry into market
    
  • markets, competition and substitutes
    

Markets include all “potential buyers and sellers”

• behavior of buyers is represented by “ demand ” (benefits side of model)
  
• behavior of sellers is represented by “supply” ( cost side of model)
  

Definition: “A schedule of the quantities of a good that buyers are willing and able to purchase at each possible price during a period of time, other things held constant ”

• Demand can also be perceived as a schedule of the maximum prices buyers are willing and able to pay for each unit of a good.
  

Market demand
The market demand function is the horizontal summation of the individuals' demand functions .
In models of firm behavior, the demand for a firm's product can be constructed
DEMAND DETERMINANTS

• Price is the major determinant of the quantity demanded.
  
• The nonprice determinants of demand are:
  - number of buyers,
  - tastes,
  - income ,
  - price of other goods (either complementary or substitute),and
  - expectations about future prices
  

Demand function

• Is the functional relationship between the price of the good and the quantity of that good purchased in a given time period (UT), income, other prices and preferences being held constant.
  
• A change in income, prices of other goods or preferences will alter (‘ shift ’) the demand function.
  

A Demand Curve
Price of
Widgets
Number of Widgets
People Want to Buy
$1.00
100
$2.00
90
$3.00
70
$4.00
40
Demand function
The nature of the "demand function" depends on the nature of the good
considered and the relationship being modeled .
In most cases the demand relationship is based on an inverse or negative relationship between the price and quantity of a good purchased.
The nature of the "demand function" depends on the nature of the good
considered and the relationship being modeled.
In most cases the demand relationship is based on an inverse or negative relationship between the price and quantity of a good purchased.

• The demand function is a model that "explains“ the change in the dependent variable (quantity of the good X purchased by the buyer ) "caused" by a change in each of the independent variables.
  
• Since all the independent variable may change at the same time it is useful to isolate the effects of a change in each of the independent variables.
  
• To represent the demand relationship graphically, the effects of a change in PX on the QX are shown
  

Change in demand
A change in demand is a "shift" or movement of the demand function.
A shift of the demand function can be caused by a change in:
• incomes
• the prices of related goods
• preferences
• the number of buyers.
If incomes or preferences change, the demand function [relationship between P and Q] will change. These are sometimes called “demand shifters”
Be sure to understand difference between a “change in demand” and a “change in quantity demanded”

• change in demand --- shift of the function
  
• change in quantity demanded --- move on the function
  

Inferior, Normal and Superior Goods
A change in income will usually shift the demand function. When a good is a "normal" good, there is a positive relationship between the change in income and change in demand:

• An increase in income will increase (shift the demand to the right) demand.
  
• A decrease in income will decrease (shift the demand to the left ) demand.
  

Law of demand

• Theory and empirical evidence suggest that the relationship between Price and Quantity is an inverse or negative relationship
  
• At higher prices, quantity purchased is smaller, or at lower prices the quantity purchased is greater .
  

Compliments and substitute

• Compliments:
  

• If the price of a compliment increases , the demand for the good decreases.
  
• If the price of a compliment decreases, the demand for the good increases.
  

• Substitutes:
  

• If the price of a substitute increases, the demand for the good increases.
  
• If the price of a substitute decreases, the demand for the good decreases.
  

Complementary good
Two goods may be complimentary, i.e. The two goods are “used together” ( tennis rackets and tennis balls or CD’s and CD Players)
Demand summary

• “Law of Demand” holds that usually as the price of good increases, individuals will buy less of it.
  
• The nature of this relationship is influenced by a variety of other variables;
  
  • income, preferences, prices of related goods, and other circumstances
    
  • As these circumstances change, the demand relationship changes or “shifts.”
    

Supply

• Supply is defined as a schedule of quantities of a good that will be produced and offered for sale at a schedule of prices during a given time, ceteris paribus.
  
• Generally, producers are willing to offer greater quantities of a good for sale at higher prices; a positive relationship between price and quantity supplied.
  

The relationship between the quantity sellers want to sell during some time period (quantity supplied) and price is what economists call the supply curve.
Though usually the relationship is positive, so that when price increases so does quantity supplied, there are exceptions

• The supply curve can be expressed mathematically in functional form as
  

Qs = f(price, other factors held constant).

• It can also be illustrated in the form of a table or a graph .
  

A Supply Curve
Price of
Widgets
Number of Widgets
Sellers Want to Sell
$1.00
10
$2.00
40
$3.00
70
$4.00
140
Change in quantity supplied

• A change in the price of the good causes a change in the “quantity supplied.”
  

• The change in the price of the good causes a “movement on the supply function,” not a change or “shift of the supply function.”
  

Change in supply
There are many factors that influence the willingness of producers to supply a good.

• technology
  
• prices of inputs
  
• returns in alternative choices
  
• taxes , expectations, weather , number of sellers, . . .
  
• Qs = fs (Pinputs, technology, . . .)
  

• Qs = fs ( Pinputs, technology, number of sellers, taxes, . . .)
  
• A change in the price [P] causes a “change in quantity supplied;”
  
• a change in any other variable causes a “change in supply”
  

Equilibrium
Webster’s Encylopedic Unabridged Dictionary of the English Language defined equilibrium as “a state of rest or balance due to the equal action of opposing forces,” and “ equal balance between any powers, influences, etc.”
The New Palgrave: A Dictionary or Economics identifies 3 concepts of equilibrium:

• Equilibrium as a “balance of forces”
  
• Equilibrium as “a point from which there is no endogenous ‘tendency to change’”
  
• Equilibrium as an “ outcome which any given economic process might be said to be ‘tending towards’, as in the idea that competitive processes tend to produce determinant outcomes.””
  

Buyer and seller equilibrium
To develop this idea, it is useful to take still another view of supply and demand curves, to view demand as points of buyer equilibrium and supply as points of seller equilibrium.
When the market price is below the equilibrium price the quantity demanded exceeds the quantity supplied.
At the price below equilibrium, buyers are willing and able to purchase an amount that is greater than the suppliers produce and offer for sale.

• The buyers will “bid up” the price by offering a higher price to get the quantity they want.
  
• The quantity demanded will fallwhile the quantity supplied rises in response to the higher price.
  

An economic system has many agents who interact in many markets.
General equilibrium is a condition where all agents acting in all markets are in equilibrium at the same time.
Since the markets are all interconnected a change or disequilibrium in one market would cause changes in all markets.
Supply and demand analysis

• Supply and demand is a simplistic model that provides insights into the effects of events that are related to a specific market.
  
• Whether an event will tend to cause the price of a good to increase or decrease is of importance to decision makers .
  
• To estimate the magnitude of price and quantity changes more sophisticated models are needed