02 - Supply and Demand Flashcards
Market Demand Curve
Shows the maximum $ anyone will pay for each unit.
Shows the amount that consumers buy at a certain point price.
Shows the marginal benefit of exchange
Law of Demand
The quantity of a good consumers are willing and able to purchase increases (decreases) as the price falls (rises).
Coefficient ax<0 on demand function
Changes in quantity demanded
vs
Changes in demand
Changing ONLY price leads to changes in quantity demanded. The demand point moves along demand curve.
Changing any factors other than price lead to changes in demand. Since more/less of the good is demanded at any price, the whole demand curve moves. This is called a demand shift or shift in demand.
Demand Shifters
Changes in:
Tastes and preferences Number of buyers Income levels*** Price of substitutes Price of compliments Taxation Forecasted price changes Forecasted income changes Govt. Intervention ***note normal and inferior goods differences
Linear Demand Function
Formula for demand of (X) in light of common demand shifters.
Qx =
ao + axPx + ayPy + amM + ahH
Qx = # units X demanded a.. = coefficients for demand shift factors. Px = $ of X - see law of demand Py = $ of Y - see substitute/complement M = income - see normal/inferior H = other variable affecting demand
Normal vs Inferior goods
Normal good demand drops with reduction in income and increases with greater income. Most goods and especially luxury items are normal goods.
If am>0 on demand function then X is normal
Inferior good demand is inversely related to income. Budget substitute are sometimes inferior goods. SPAM instead of steak.
If am<0 of demand function then X is inferior
Substitutes
When the price of a good increases, the demand for substitutes increase. The demand for substitutes is directly related to the price of a good.
If ay>0 on demand function then Y is a substitute for X. If the cost of Y goes up, the demand for X will go up.
Complements
When the price of a good increase, the demand for complements goes down.The demand for complements is inversely related to price of a good.
If ay<0 on demand function then y is a complement for X. If the cost of Y goes up, the demand for X goes down.
Inverse Demand Function
After entering supplied values for coefficients and known demand shift factors, restate demand function to solve for Px in terms of Qx.
Commonly used to express the equation of the demand curve function.
Use in conjunction with inverse supply curve function to identify optimal market quantity and price - Market Equilibrium.
Consumer Surplus
A measure of consumer well being
The extra value consumers derive from a good but do not pay for. The net benefit from consuming a good.
(total consumer value) - (total expenditure)
Same as total benefit - total cost
As price goes up, consumer surplus goes down. Inverse relationship.
Total Consumer Value
The sum of the maximum amount a consumer is willing to pay at any quantity at and below calculation quantity.
The total benefit.
Marginal benefit is the maximum amount that you would pay for one more good. Total benefit is the sum of marginal benefits for all quantities at and below calculation quantity.
Total Expenditure
The per unit market price times number of units consumed.
The total cost.
Market Supply Curve
The supply curve shows:
Minimum price at which sellers are willing to sell.
The amount sellers are willing to sell at each price.
The marginal cost of production.
Law of Supply
As the price of a good rises (falls), the quantity supplied of the good rises (falls).
Coefficient bx>0 on demand function
Changes in quantity supplied
vs
Changes in supply
Changing ONLY price leads to changes in quantity supplied. The supply point moves along supply curve.
Changing any factors other than price lead to changes in supply. Since more/less of the good is supplied at any price, the whole supply curve moves. This is called a supply shift or shift in supply.
Supply Shifters
Changes in:
Number of sellers - entry/exit Costs of production Technology proficiency Taxes Forecasted price changes Govt. Intervention
Excise vs Ad Valorem Taxes
Excise taxes are a flat tax paid on any qty so the supply curve shifts up uniformly. A consistent lower quantity will be demanded at all prices. Preferred by wealthy.
Ad Valorem taxes are a percentage tax so the supply shifts up but rotates counter-clockwise. A lower quantity will be defended at all prices but the amount of reduced quantity is greater at progressively higher prices. Preferred by poor.
Supply Function
Formula for supply of (X) in light of common supply shifters.
Qx =
bo + bxPx + bwW + brPr + bhH
Qx = # units X demanded b... = coefficients for supply shift factors. Px = $ of X - see law of supply W = $ of an input (bw<0) increases costs Pr = $ of tech (br>0) lowers costs H = other variable affecting supply
Inverse Supply Function
After entering supplied values for coefficients and known supply shift factors, restate supply function to solve for Px in terms of Qx.
Commonly used to express the equation of the supply curve function.
Use in conjunction with inverse demand curve function to identify optimal market quantity and price - Market Equilibrium.
Producer Surplus
The amount producers receive in excess of required amount necessary to induce them to produce the good.
The price of the product minus the marginal cost of producing each unit. The area above the supply curve and below the market price line. Illustrates wealth of companies.
As price goes up so does producer surplus. Positively related.
Market responses to scarcity
- Consumers demand less
- Producers and consumers seek out less costly substitutes.
- Producers and consumers seek out new technologies
- Producers shift to new production techniques
Market Equilibrium
Where the demand and supply function equations are equal.
Price is determined by interaction of supply and demand
Shortages below equilibrium qty cause price to increase and surpluses above equilibrium qty cause price to fall.
Matched price and qty where no surplus or shortage exist.
Forces are in balance and there is no pressure for prices or qty to change.
Single curve shift comparative statics.
Static curve comparisons.
Increase in demand causes an increase in equilibrium P&Q
Decrease in demand causes a decrease in equilibrium P&Q
Increase in supply causes P to fall but Q to increase
Decrease in supply causes P to increase Q to to fall
Simultaneous shifts in both supply and demand.
Depends on magnitude of shifts. Some outcomes are ambiguous without precise data.
S & D down = Q down but P ?
S & D up = Q up but P ?
S up, D down = Q ? but P down
S down, D up = Q ? but P up
Price Ceiling
When price ceilings are below equilibrium, they cause:
Shortages Increased non-pecuniary price Less product produced and sold Product deterioration Discrimination Loss of social welfare
Examples: Rent Control and Oil Markets
Non-pecuniary Price
The additional price a consumer pays in opportunity cost to acquire a good because of a shortage condition.
The price paid for which you receive no additional benefit.
At shortage quantity, the price on demand curve minus price on supply curve.
Lost Social Welfare amount
The net opportunity cost.
(equilibrium qty - shortage qty) times equilibrium price.
Price Floor
Price floors that are above the equilibrium price cause a surplus of the good and less to be bought.
Cost of surplus absorption.
Multiply floor price times quantity on supply curve minus quantity on demand curve.
Effects of Prohibition
Possible lower supply Possible lower demand BUT Increase production costs Black market attracts criminals Violence to enforce contracts of sale Sellers offer more concentrated Buyers demand more concentrated Buyers migrate to legal areas Quality decreases - no social accountability - counterfeiting, less testing, less safe
