LECTURE NOTES

DEMAND AND SUPPLY Demand. Changes in Demand

Demand Curve: Graphical depiction of the relationship between the price of a good and the amount of the good that consumers are both willing and able to buy at that price, holding other factors constant (ceteris paribus). 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. The Law of Demand: A demand curve shows the negative relationship between the price and quantity of a good demanded during a given interval, holding all other influences constant. (Quantity demanded rises as price falls, other things constant). ( Quantity demanded falls as prices rise, other things constant.) Changes in the quantity of a good demanded are movements along a demand curve and are caused by only one thinga change in its price But what happens if influences on the demand for a good other than its own price change? If a determinant of demand other than a good's own price changes, there is a change in demand, and a shift in the demand curve. The most important determinants of the demand are:

The consumers income Number of consumers The price of substitute goods The price of complementary goods The consumers preferences or tastes and advertising that may influence preferences
The consumers expectations about future prices

In summary:
changes in demand reflect changes in influences on purchases

other than a good's own price;

changes in the quantity demanded follow changes in the price of the good.

The Supply. Changes in Supply.

To understand the market we also need to understand supply. Supply Curve: Graphical depiction of the relationship between the price of a good and the amount of the good that producers are both willing and able to sell at that price, holding other factors constant (ceteris paribus). And as on the demand side of the equation, the basic law of supply is common sense: as prices rise, supply increases, as prices fall, supply decreases. In other words, when the price for a good goes up, suppliers of that good will produce more. When the price of a good goes down, suppliers produce less. Supply curves are a lot like demand curves. Economists gather information about the amount of a specific good or service that a provider will supply at various prices and then they plot this information on a graph like this.

Supply is influenced by several factors: production costs, technology, the number of competitors, the expectations of producers.

Factors decreasing supply and shifting the supply curve to the left: Increased production costs Increased government regulation Pessimistic market expectations Withdrawal of market competitors

Factors increasing supply and shifting the supply curve to the right: Decreased production costs Decreased government regulation Optimistic market expectations Entrance of new market competitors New technology

Market Equilibrium Price

Equilibrium means a state of equality or a state of balance between market demand and supply. Without a shift in demand and/or supply there will be no change in market price. In the diagram above, the quantity demanded and supplied at price P1 are equal. At any price above P1, supply exceeds demand and at a

price below P1, demand exceeds supply. In other words, prices where demand and supply are out of balance are termed points of disequilibrium. Changes in the conditions of demand or supply will shift the demand or supply curves. This will cause changes in the equilibrium price and quantity in the market.

Changes in Market Demand and Equilibrium Price

The demand curve may shift to the right (increase) for several reasons:
1. 2. 3. 4. 5. A rise in the price of a substitute or a fall in the price of a complement An increase in consumers income or their wealth Changing consumer tastes and preferences in favour of the product A fall in interest rates (i.e. borrowing rates on bank loans or mortgage interest rates) A general rise in consumer confidence and optimism

The outward shift in the demand curve causes a movement (expansion) along the supply curve and a rise in the equilibrium price and quantity. Firms in the market will sell more at a higher price and therefore receive more in total revenue. The reverse effects will occur when there is an inward shift of demand. A shift in the demand curve does not cause a shift in the supply curve! Demand and supply factors are assumed to be independent of each other although some economists claim this assumption is no longer valid!

Changes in Market Supply and Equilibrium Price

The supply curve may shift outwards if there is 1. A fall in the costs of production (e.g. a fall in labour or raw material costs) 2. A government subsidy to producers that reduces their costs for each unit supplied 3. Favourable climatic conditions causing higher than expected yields for agricultural commodities 4. A fall in the price of a substitute in production 5. An improvement in production technology leading to higher productivity and efficiency in the production process and lower costs for businesses 6. The entry of new suppliers (firms) into the market which leads to an increase in total market supply available to consumers

The outward shift of the supply curve increases the supply available in the market at each price and with a given demand curve, there is a fall in the market equilibrium price from P1 to P3 and a rise in the quantity of output bought and sold from Q1 to Q3. The shift in supply causes an expansion along the demand curve. A shift in the supply curve does not cause a shift in the demand curve. Instead we move along (up or down) the demand curve to the new equilibrium position. A fall in supply might also be caused by the exit of firms from an industry perhaps because they are not making a sufficiently high rate of return by operating in a particular market.