Chapter 2 - Supply and demand Flashcards
Definition of Demand
Demand is the consumer’s desire, willingness, and ability to purchase goods and services
Definition of quantity demanded
The quantity demanded is the amount of a good or service a consumer is willing to buy at a given price, holding all other factors constant
Economists primarily focus on how _________ affects the quantity demanded
a good’s own price
What are 3 ways of showing the relationship between demand and price
- Demand schedule
- Demand curve
- Demand function
Describe a demand schedule
This is a chart showing the quantity demanded at difference prices
Empirical evidence suggests that the quantity demanded by consumers follows which law
The law of demand
Define the Law of Demand
Consumers demand a higher quantity of a good or service when the price is lower (and a lower quantity when the price is higher), holding all other factors that influence the amount consumers want to consume constant***
The law of demand can be illustrated using which curve
the demand curve (according to the law of demand, demand curves slope downwards)
The demand curve provides an answer to the question of…
what happens to the quantity demanded as price changes, holding all other factors constant
Changes in the quantity demanded in response to a price change is referred to as
a movement along the demand curve
Shift in the demand curve depends on what factors
- Income
- Price of substitute or compliment
- Tastes
- Government rules/regulations
The demand curve relationship can be expressed mathematically using the
Demand function
Describe the demand function
Q = D(p, Y, X) –> it allows us to think precisely about how the quantity demanded will respond to a change in price, holding income (and all other factors) fixed
- Q is the quantity demanded
- D is the demand function that depends on price (p), income (Y), and other factors (X)
–> we will hold all other factors constant so our demand function will be Q = D(p, Y)
–> A constant in the equation reflects all the other factors
if you have a demand function with the variables Q, p, and Y - how would you obtain the demand function
By substituting for income, Y –> so that Q = p essentially
What is the inverse demand curve
that is when p = Q
In the demand function For a given change in price, the quantity consumed will change by (ex. Q=30-(p/5)+0.1Y)
Delta Q = -1/5 * Delta P
–> so coefficient on the p multiplied by the change in p
In many cases we might have an estimate of the demand from all consumers in a market, but in some scenarios we may only know the demands of individual consumers or groups of consumers - in these cases what do we do
we add up the demand from each consumer (or group)
The total quantity demanded at a given price is equal to…
the sum of individual consumer demands at that price
How do you get the market demand
By adding all the individual consumer demands at that price
Define Horizontal Summation (in regards to market demand)
When summing demand for a private good, we add up the quantity demanded of each individual at each price
(DO NOT look at the graph and add the curves vertically. Just remember if no one person demands gasoline above price P_max, the market doesn’t demand any at prices above P_max either
Define supply
Supply is the producer’s willingness to sell goods and services at a price
Define Quantity Supplied
The amount of a good or service that producers want to sell at a given price, holding other factors that influence supply decisions constant
What 3 ways are there to show the relationship between the price of a good or service and the quantity producers want to sell
- Supply schedule
- Supply curve
- Supply function
Law of supply
Producers will normally offer more for sale at higher prices and less at lower prices when holding other factors constant
Describe the slope of a demand and supply curve
Demand curve has a negative slope and supply curve has a positive slope
Changes in the quantity supplied in response to a price change are referred to as
movements along the supply curve
what factors can cause a shift in the supply curve
- Prices
- Production cost
- Technological change
- Government regulation
What would be the effect of a blending component cost decreases on the supply curve
It would shift right because supply would increase
Describe the supply function
Q = S(p, py, X)
–> Q is quantity supplied, and p is price and py is the price of other possible inputs or outputs, and X is other factors
What happens to the quantity supplied if the price of coffee increases by ∆p ( Q = 9.6 + 0.5p - 0.2pc,
the quantity will increase by 0.5∆p
How do you obtain total market supply
You need to add up the supply from each producer (market supply is adding up the quantities not the prices)
Suppose there are 3 producers in the market for gasoline. Their supply functions are given by: Q1=10+P1; Q2=15+2P2; Q3=35+P3. What is the market supply of gasoline in this case?
You assume that market supply = p and therefore p1 = p2 = p3 –> 60 +4p
Define market equilibrium
The market is in equilibrium when all market participants are able to buy or sell as much as they want; no participant wants to change their behavior given what other market participants are doing
How do you determine market equilibrium
its where the demand and supply curve intersect
Who is an important figure for determining Market equilibrium
John Forbes Nash
Define market price
The equilibrium price is the p at which demand equals supply, consumers can buy as much as they want, and seller can sell as much as they want
Define market quantity
The equilibrium quantity is the q such that the quantity demanded equals the quantity supplied
𝑄D = 40 - (P/5)
Qs = (P/3) - 10
–> How can you solve for market equilibrium knowing these two formulas for quantity supplied and quantity demanded
In equilibrium quantity demanded is equal to quantity supplied, so you set the two formulas equal to each other and solve for the equilibrium price. Once you get the equilibrium price you can substitute it back into Qd or Qs to get the equilibrium quantity
The supply and demand model tells use the price and quantity that will ______ the market ______________
clear, holding all other factors fixed
What are the two sets of factors that can change the market equilibrium by shifting the supply and demand curves or both
- Market fundamentals –> income, inputs, preferences, technology, etc.
- Government intervention –> tax, subsidy, geographical restrictions, price ceilings/price floors
The change in the price of an input leads to a shift in the ______ curve, and a movement along the _____ curve
shift in supply curve, movement along the demand curve
What are concurrent shifts
shifts in both the demand and the supply curve
Concurrent shifts: An increase in demand (shift right) and a decrease in supply (shift left) does what
- this can lead to an increase in price, but the effect on the quantities is ambiguous
Concurrent shifts: If demand and supply both increase then
- equilibrium quantities will increase but the effect on price is ambiguous
Concurrent shifts: If supply decreases and demand increases then
- the price will increase but the effect on quantities is ambiguous
When demand and supply change at the same time, what two things determine the outcome
the size of the shifts and the price elasticities of demand and supply determine the outcome
How do you calculate the price elasticity of demand
It is the percentage change in quantity demanded divided by the percentage change in price
What does being more elastic mean
that means more responsive to changes
Describe the elasticity of the demand curve
- downward sloping linear demand curve (Consider elasticity as p/Q)
–> where the line intersects with the price axis is perfectly elastic demand where there is undefined elasticity
–> perfectly inelastic demand has an elasticity of zero and is where the demand curve intersects with the quantity curve
–> inelastic demand is between 0 and -1 (the percentage change in quantity is smaller than the percentage change in price)
–> At the midpoint of the linear demand curve, a 1% increase in price causes a 1% fall
in quantity, so the elasticity equals -1, which we refer to as unitary elasticity
What elasticity does a horizontal demand curve have
perfectly elastic at p
What elasticity does a vertical demand curve have
Perfectly inelastic at every price
What are the 3 government interventions that can lead to shifts in equilibrium
- Curve shifts
- Price controls
- Taxes/Subsidies
Governments use what 3 main approaches to shift curves:
- Limits on who can buy (Governments can restrict who can buy certain products shifting the demand curve to the left by shrinking the market, and thus decreasing the quantity demanded at any price)
- Restrictions on imports or exports (Import restrictions shift the importing countries supply curve to the left, while restrictions on exports shift the exporting country’s demand curve to the left)
- Government purchases (Governments can buy goods directly, increasing the quantity demanded at each price. This shifts the demand curve to the right)
Governments can intervene by controlling prices in the market: what are the two main forms of doing this
- Price ceiling: Policy in which a government sets a maximum price that can prevail in the market –> these cause a shortage/excess demand
- Price floor: Policy in which a government sets a minimum price that can prevail in the market –> here we have excess supply
In which case does supply not equal demand
In cases where the government intervenes in the market –> in the absence of government intervention, supply equals demand and the market clears, but with government intervention the quantity demanded and the quantity supplied need not equal the actual quantity that is bought and sold
Describe the effects of a specific tax
- the imposition of specific sales tax yields the same equilibrium regardless of who pays the tax
- Tax is shared by both the producer and the consumer - customers pay a higher price and producers receive less because of the tax
How do you figure out how much tax revenue the government receives
you get the area of the rectangle created by the tax. Look at the new equilibrium point due to the tax, and go down and create a rectangle with the original price that should be paid at that equilibrium quantity
How do you fin equilibrium price or quantity when tax is imposed
- if the tax is imposed on the supplier that means the price that they receive decreases, so you would substitute p in quantity supplied with (p-tax)
- if the tax is imposed on the consumer that means that the price they pay increases, so you would substitute p in quantity demanded with (p + tax)
What type of market does the supply and demand model work well for
- a perfectly competitive market
What are the 5 characteristics of a perfectly competitive market
- Many small buyers and sellers
- Consumers believe all firms produce identical products
- All market participants have full information about price and product characteristics
- Transaction costs (expenses over and above the price) are negligible
- Firms can easily enter and exit the market, so competition is high
