LECTURE NOTES CH 3 DEMAND, SUPPLY AND PRICE

My Lecture Notes are written in summary and point form- they emphasize important concepts, do not regurgitate the book and are consequently not meant to be a replacement of the book- If you want to benefit from these notes you must read the book first (before coming to class).
Learning objectives What determines the demand for a product Understanding movements along the demand curve and shifts in the demand curve How is market supply of a product determined Understanding movements along the supply curve and shifts in supply curve What are the laws of demand and supply

The demand and supply analytical framework can explain answers to questions like what will be the supply of housing if interest rates or taxes changed and would more labor be hired if minimum wages were abolished, and what wages should be paid to university professors etc. The demand and supply analysis is the basic framework on which all economic analysis is based. Using the tools of supply and demand we can then determine a market determined equilibrium price at which the markets clear. Some Terminology (1) Quantity Demanded: the quantity of a commodity or product that individuals wish to purchase in a certain time period. Note here that time period is important because we can wish to purchase nothing in some periods and great amounts in other periods. From an accounting perspective since we measure GDP over a certain period (say annually or quarterly) therefore the demand for goods (which are included in GDP by definition) is measured over a certain time period. Factors which Determine Demand or Determinants of Demand Key Factors Income - could be personal income for one individual or household income of the whole household Price of the product Prices of other products which are either substitutes or complements Other Factors

Tastes Population Expectations of the Future Income Distribution (2) Cetrus paribus

When any of the above factors change the demand for the commodity will change but say one wants to find the effect on demand if only own price changes while all other factors remain the same i.e. do not change this caveat when all other things remain the same is called cetrus paribus in the jargon of economics. (3) Stock vs Flow When we invest in yr 1, yr 2 and with that investment buy machines in yr 3, the first two years of investment is a flow which results in a stock of capital in year 3. Bucket holds water -that is a stock, and water flowing out from there through a tap is an example of flow. Savings held at the bank in the year 2003 or on 31st Dec 2003 is a stock Law of Demand Alfred Marshall (1842-1924) dubbed the observation of the inverse relationship between quantity demanded and price of product to be the law of demand. Well we are assuming that price is the only factor that is changing and all other factors that we alluded to earlier are not changing- thus in this law we are looking at the relationship between the products own price and its quantity demanded. Figure 3-1 For those of you who have never plotted graphs (and I doubt it that you have never drawn a graph before in high school) you can draw the demand curve by plotting price on Y axis (its the vertical axis) and quantity demanded on X axis (horizontal axis) . You will see that as price falls (and assuming that all other determinants of demand do not change), the quantity demanded of this commodity will increase. Note that demand curve has a negative slope showing the inverse relationship between price and quantity. Shifts In Demand Curve Note that we move along a demand curve when price changes but we shift a curve when other factors of demand (other than price) change.

The following factors will shift the demand curve- meaning that if the price remained the same the change in the other factor could either increase or decrease the demand for the product (depending on the direction of change of the factor) INCOME Y Q (although price of product hasnt changed) YQ Normal Goods: Goods whose consumption increases when income increases Inferior Goods: Goods whose consumption decreases when income increases e.g. potatoes, starchy roots, pig products, whole milk, non-cotton fabrics say having polyester. There is no universal definition or classification of Giffen goods, it can depend on individual people. PRICES OF OTHER GOODS Other goods could be of two types: substitutes and compliments Substitutes- goods used instead of the commodity that is being used Complements- goods used jointly in consumption with commodity being used Examples: ??????? U tell me !!!!!!!!!!!!!!!!! What is the effect on demand for good X when good Y which is substitute, its price increases? And if Y is a complement, what happens to Demand for X if its price increases? Fig 3-2 TASTES Demand for a product is naturally taste dependant. Firms are always trying their best to influence tastes through advertising. What happens to demand for cigarettes through heavy cigarette advertising in teens or demand for booze (i.e. more booze more macho u r) DISTRIBUTION OF INCOME Income distribution can change with changes in government tax regulations and welfare schemes. However over the longer run income distribution can change by changes in demography (proportion of old/retired people, immigrants), education levels (due to which the income structure would change), wars etc etc.

Say net income of single parents increases as more deductions are allowed by tax authorities and govt makes up revenue shortage by increasing taxes on business. As Net income of 1st Group has increased and of 2nd group reduced, therefore demand for products mostly used by single parents increases and reduces for 2nd group. POPULATION Immigration, wars, population control methods (or lack of), advances in medical science, provision of healthcare and nutrition can affect population levels. What commodities or products would see an increase in demand with say an increase in immigration? demand for housing demand for schooling demand for healthcare demand for transportation demand for groceries demand for clothes (Gucci watches also) What would happen to overall national demand if immigrants have no money to spend and the govt gives them welfare payments? Would total demand increase? Why? Or why not? EXPECTATION OF FUTURE Through what channel can expectation of future change or affect demand for goods and services? If any future events have any bearing on the determinants of demand then yes demand will change. If P gas is to tomorrow what will happen to demand for gas today? Recall the effect of uncertain electricity and impending darkness on demand for candles! Jargon Change in demand vs change in quantity demanded Change in demand refers to a change in demand given the prices- means shift in demand curve Change in quantity demanded refers to change in demand as prices change while all other factors are held constant (cetrus paribus) SUPPLY CURVE

Derived from the maximization decisions of the firm to supply goods and services given their costs, technology etc. Supply is influenced by: Products own price Prices of Inputs Technology Number of suppliers Figure out what happens to supply of product X when - Px S curve does NOT shift- we simply travel down the curve with fall in price - Pinput S curve shifts up and left - Technology improves S curve shifts down and right - # of Suppliers S curve moves down and right CONCEPT OF MARKET EQUILIBRIUM Refer to pgs 61-63 and Fig 3-7 in L&R Equilibrium is a situation at which the demand in the market equals supply also referred to as the market clears. Naturally market demand cannot equal market supply at each and every price. At very high prices demand would be too low and there would be surplus supply or excess supply of goods (ESG). At low prices there would be excess demand for goods and the market supply at those low prices would not be sufficient to meet demand hence an excess demand for goods (EDG) would develop. Laws of Demand and Supply (See Fig 3-8) These laws trace the effects on price and quantity when demand or supply increases and decreses. 1. An increase in D causes increase in both the equilibrium P and equilibrium Q 2. An decrease in D causes decrease in both the equilibrium P and equilibrium Q 3. An increase in S causes decrease in the equilibrium P and increase in equilibrium Q 4. An decrease in S causes increase in equilibrium P and decrease in equilibrium Q Adjustment to New Equilibrium Once Initial Equilibrium Is Disturbed Say that market clears at P = P0 and Q = Q0. Now assume that demand increases at each and every level of price. This means that D curve shifts out and rightwards. At the initial P of P0 we now have an EDG (more is being demanded than is being supplied at P=P0).

The EDG puts upward pressure on prices and they start rising. With every increase in price we see some decrease in price (see that yourself by increasing the price above P0 and check that the EDG reduces (plot it yourself)

ED G D1 D0

What have you learnt from this Chapter? See Key Concepts at end of Ch 3