Economics - Chapter 4 PDF

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Chapter 4: Demand, Supply and Equilibrium Key Ideas: 1. In a perfectly competitive market, (a) sellers all sell an identical good or service, and any individual buyer or any individual seller isn’t powerful enough on his or her own to affect the market price of that good or service. 2. The demand curve plots the relationship between the market price and the quantity of a good demanded by buyers. 3. The supply curve plots the relationship between the market price and the quantity of a good supplied by sellers. 4. The competitive equilibrium price equates the quantity demanded and the quantity supplied = market clearing price. 5. When prices are not free to fluctuate, markets will fail to equate quantity demanded and quantity supplied. -

The market price is the price at which buyers and sellers conduct transactions. In a perfectly competitive market every buyer pays and every seller charges the same market price, no buyer or seller is big enough to influence that market price, and all sellers sell an identical good or service.

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Quantity Demanded: The amount of a good that buyers are willing to purchase at a given price. Demand Schedule: A table that reports that quantity demanded at different prices, holding all else equal. Demand Curve: Plots the quantity demanded at different prices. Market Demand Curve: The sum of the individual demand curves of all the potential buyers. The market demand curve plots the relationship between the total quantity demanded and the market price, holding all else equal.

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Shifts of the Demand curve: Occur when one of the following changes: 1. 2. 3. 4. 5.

Tastes and preferences Income and wealth Availability and pries of related goods Number and scale of buyers Buyer’s expectations about the future

Demand Schedule: A demand curve is the relationship between quantity demanded and the price.

Supply Schedule: A supply schedule is a table that shows the relationship between the price of a good and the quantity supplied. The supply curve is a graphical depiction of the supply schedule that illustrates that relationship between the price of a good and the quantity supplied.  Quantity Supplied: The amount of a good that sellers are willing to sell at a given price.  Supply Schedule: The table that reports the quantity supplied at different prices.  Supply curve: Plot of supply schedule Shifts of the supply curve: Occur when one of the following changes: 1. Input prices 2. Technology 3. Number and scale of sellers 4. Sellers’ expectations about the future Competitive Equilibrium: The point at which the market comes to an agreement about what the price will be (competitive equilibrium price) and how much will be exchanged (competitive equilibrium quantity) and that place, Excess demand: Occurs when consumers want more than suppliers provide at a given price.

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Textbook Notes: If all sellers and all buyers face the same price, it is referred to as the market price. In a perfectly competitive market, (1) sellers all sell an identical good or service, and (2) any individual buyer or any individual seller isn’t powerful enough on his or her own to affect the market price of that good or service. A price-taker is a buyer or seller who accepts the market price – buyers can’t bargain for a lower price, and sellers can’t bargain for a higher price.

4.2 How Do Buyers Behave?  Quantity demanded is the amount of a good that buyers are willing to purchase at a given price.  A demand schedule is a table that reports the quantity demanded at different prices, holding all else equal.  Holding all else equal implies that everything else in the economy is held constant. The Latin phrase ceteris paribus means “with other things the same” and is sometimes used in economic writing to mean the same thing as ‘holding all else equal’.

Demand Curves: The demand curve plots the quantity demanded at different prices. A demand curve plots the demand schedule. Two variables are negatively related if the variables move in opposite directions, which means that they move in opposite directions. In other words, when one goes up, the other goes down. Almost all goods have demand curves that exhibit this fundamental negative relationship, which economists call the Law of Demand: the quantity demanded rises when the price falls (holding all else equal). Willingness to pay: Is the highest price that a buyer is willing to pay for an extra unit of a good. Diminishing marginal benefit: As you pay more of a good, your willingness to pay for an additional unit declines. Aggregation: To study the behaviour of the worldwide energy market, economists need to study the worldwide demand curve for gasoline, which is equivalent to the sum of all individual demand curves. Economists call this adding-up process the aggregation of the individual demand curves. Building the Market Demand Curve: The market demand curve (total demand curve) is the sum of all the individual demand curves of all potential buyers. It plots the relationship between the total quantity demanded and the market price, holding all else equal. Shifting the Demand Curve: When we introduce the demand curve, we explained that it describes the relationship between price and quantity demanded, holding all else equal. It’s now time to more carefully consider the ‘all else’ that is being held fixed. The demand curve shifts when these five major factors change:  Tastes and preferences  Income and wealth  Availability and prices of related goods  Number and scale of buyers  Buyer’s beliefs about the future. Tastes and preferences: - The demand curve shifts only when the quantity demanded changes at a given price. - Leftward and rightward shifts are illustrated. - If a good’s own price changes and its demand curve hasn’t shifted, the own price change produces a movement along the demand curve.

Changes in Income and Wealth: - For a normal good, an increase in income shifts the demand curve to the right (holding the good’s price fixed), causing buyers to purchase more of the good. - For an inferior good, an increase in income shifts the demand curve to the left (holding the good’s price fixed), causing buyers to purchase less of the good. This seemingly insulting label is on a technical term that describes a relationship between increases in income and leftward shifts in the demand curve. Changes in Availability and Prices of Related Goods: - Even if the price of oil hasn’t changed, a change in the availability and prices of related goods will also influence demand for oil products, thereby shifting the demand curve for oil. For example: if a city raises the price of public transportation, drivers are likely to increase use of their cars. This produces a rightward shift in the demand curve for gasoline. Two goods are said to be substitutes, when a rise in the price of one leads to a rightward shift in the demand curve for the other. Public transportation are gas are substitutes, because a rise in the price of public transportation leads to people to use public transportation less and drive their cars more, producing a rightward shift in the demand curve for gasoline. Two goods are said to be complements when a fall in the price of one leads to a rightward shift in the demand curve for the other. Changes in the number and scale of buyers: When the number of buyers increases, the demand curve shifts right. When the number of buyers decreases, the demand curve shifts left. The scale of the buyer’s purchasing behaviour also matters. Changes in the buyer’s beliefs about the future: Changes in buyer’s beliefs about the future also influence the demand curve. Suppose that some people begin losing their jobs during the first months of an economy-wide slowdown.

4.3 How Do Sellers Behave? Quantity supplied: - Is the amount of good or service that sellers are willing to sell at a given price. A supply schedule: - Is a table that reports that quantity supplied at different prices, holding all else equal. The Supply curve: - Plots the quantity supplied at different prices. A supply curve plots the supply schedule. Willingness to accept: - Is the lowest price that a seller is willing to get paid to sell an extra unit of a good. At a quantity supplied, willingness to accept is the height of the supply curve. Willingness to accept is the same as the marginal cost of production. The Market supply curve: - Sum of the individual supply curves of all the potential sellers. It plots the relationship between the total quantity supplied and the market price, holding all else equal. Shifting the Supply curve: Recall that the supply curve describes the relationship between price and quantity supplied, holding all else equal. There are four major types of variables that are held fixed when a supply curve is constructed. The supply curve shifts when these variables change:  Prices of inputs used to produce the good.  Technology used to produce the good.  Number and scale of sellers.  Seller’s beliefs about the future.

4.4 Supply and Demand in Equilibrium: Perfectly competitive markets converge to the price at which quantity supplied and quantity demanded are the same. To visualise what it means to equate quantity supplied and quantity demanded, we need to plot the demand curve and supply curve on the same figure. Because the demand curve slopes down and the supply curve slopes up, the two curves have only one crossing point. Economists refer to this crossing point as the competitive equilibrium. The price at the crossing point is referred to as the competitive equilibrium price, which is the price at which quantity supplied and quantity demanded are the same. This is sometimes referred to as the ‘market clearing price,’ because at this price there is a buyer for every unit that is supplied in the market. The quantity at the crossing point is referred to as the competitive equilibrium quantity. This is the quantity that corresponds to the competitive equilibrium price. At the competitive equilibrium, the quantity demanded is equal to the quantity supplied.

If the market price is above the equilibrium point, it will make selling desirable and buying undesirable, raising the quantity supplied above its competitive equilibrium level and lowering the quantity demanded below its competitive equilibrium level. When the market price is above the competitive equilibrium price, quantity supplied exceeds quantity demanded, creating excess supply. When the market price is below the equilibrium price, quantity demanded exceeds quantity supplied, creating excess demand. Curve Shifting in Competitive Equilibrium: We are now ready to put this framework into action. We’d like to know how a shock to the world oil market will affect the equilibrium quantity and the equilibrium price of oil. For example; what would happen if a major oil exporter suddenly stopped production as Libya did in 2011? This would cause a leftward shift of the supply curve. Since oil has become more scarce, the price of oil needs to rise from its old level to equate quantity supplied and quantity demanded. The rise in the equilibrium point is associated with a movement along the demand curve (which hasn’t shifted). Because the demand curve is downward-sloping, a rising price causes a reduction in the quantity demanded. In fact, the outbreak of full-scale fighting in Libya and the consequent shutdown of the oil fields increase the entire world’s price of oil. If we had a technological breakthrough we should shift the supply curve to the right. Since oil has become more abundant, the price of oil needs to fall from its old level to equate quantity supplied and quantity demanded. The fall in the equilibrium oil price is associated with a movement along the demand curve. Because the demand curve is down-ward sloping, a falling price causes an increase in the quantity demanded....