Chapter 3 - Where Prices Come From: The Interaction of Demand and Supply Flashcards
Demand schedule
A table that shows the relationship between the price of a product and the quantity of the product demanded.
Quantity demanded
The amount of a good or service that a consumer is willing and able to purchase at a given price.
Demand curve
A curve that shows the relationship between the price of a product and the quantity of the product demanded.
Market demand
The demand by all the consumers of a given good or service.
Law of Demand
While holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase.
And when the price of a product rises, the quantity demanded of the product will decrease.
Substitution effect
The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes.
Income effect
The change in the quantity demanded of a good that results from the effect of a change in the good’s price on consumers’ purchasing power.
Consumer purchasing power
Measures the value in money for which consumers may purchase goods or services. Consumer purchasing power indicates the degree to which inflation (rise in price) affects consumers’ ability to buy.
Ceteris paribus (“all else equal”) condition
The requirement that when analyzing the relationship between two variables—such as price and quantity demanded— other variables must be held constant.
Shift of a demand curve
An increase or decrease in demand
The curve moves entirely
Movement along a demand curve
An increase or decrease in the quantity demanded
Value changes on the current curve
What are the 5 variables that shift market demand?
1) Income
2) Prices of related goods
3) Tastes
4) Population and Demographics
5) Expected Future Prices
How does the 1st variable (Income) shift market demand?
For normal goods, the demand increases as the income increases. And vice versa
Ex. New cars, branded clothes
For inferior goods, the demand decreases as the income increases. And vice versa.
Ex. Used cars, used clothes
Normal good
A good for which the demand increases as income rises and decreases as income falls
Ex. Branded items
Inferior good
A good for which the demand increases as income falls and decreases as income rises
Ex. Used item
How does the 2nd variable (Prices of related goods) shift market demand?
There are two types of related goods, substitutes and complements.
For substitutes, an increase in the price of one increases the demand for the other. For example, if Coca-Cola increases their price, consumers will prefer Pepsi because the price is lower.
For complements, an increase in the price of one decreases the demand for the other. For example, if the price of pens goes up, consumers will purchase fewer pens therefore the demand for paper will decrease as well.
Substitutes
Two goods are called substitutes, if:
- Goods and services that can be used for the same purpose
- Increase in the price of one, increases the demand for other
Ex. An increase in the price of Coca-Cola will increase demand for Pepsi
Complements
Two goods are called complements, if:
- Goods and services that are used together.
- Increase in the price of one, decreases the demand for other
Ex. An increase in the price of pens will decrease the demand for Pepsi
How does the 3rd variable (Tastes) shift market demand?
Tastes include subjective elements such as ad campaigns that can affect a consumer’s decision to buy a product.
Ex. In winter, coffee is preferred but in summer, a smoothie is preferred
How does the 4th variable (Population and Demographics) shift market demand?
Every location will have people of different ages, ethnicities, religions, genders etc. These affect the market demand in that area.
Ex. A growing city will have more demand at every price. A city with more youth will prefer better education over better healthcare.
Demographics
The characteristics of a population with respect to age, race, and gender
How does the 5th variable (Expected future prices) shift market demand?
Consumers choose not only which products to buy but also when to buy them
Ex. Purchasing gas for their vehicle another day when the price is lower
Quantity supplied
The amount of a good or service that a firm is willing and able to supply at a given price
Supply schedule
A table that shows the relationship between the price of a product and the quantity of the product supplied
Supply curve
A curve that shows the relationship between the price of a product and the quantity of the product supplied
Law of Supply
While holding everything else constant, increases in price cause increases in the quantity supplied.
Decreases in price cause a decrease in the quantity supplied
What are the 5 variables that shift market supply?
1) Prices of inputs
2) Technological change
3) Prices of substitutes in production
4) Number of firms in the market
5) Expected future prices
How does the 1st variable (Prices of inputs) shift market supply?
A change in the price of an input—anything used in the production of a good or service—is the most likely factor to cause the supply curve for a product to shift.
If there is an increase in the price of an input, the supply curve shifts to the left because the costs of producing the good increase.
How does the 2nd variable (Technological change) shift market supply?
A positive or negative change in the ability of a firm to produce a given level of output with a given quantity of inputs.
If there is an increase in productivity (technological change), the supply curve shifts to the right as the costs of producing the good decrease.
Ex. Machines improve therefore improved production
How does the 3rd variable (Prices of substitutes in production) shift market supply?
Alternative products that a firm could produce are called substitutes in production.
If the price of a substitute in production increases, the supply curve shifts to the left because more of the substitute is produced and less of the good is produced.
How does the 4th variable (Number of firms in the market) shift market supply?
A change in the number of firms in the market will change supply.
If there is an increase in the number of firms in the market, the supply curve will shift to the right because additional firms result in a greater quantity supplied at every price.
How does the 5th variable (Expected future prices) shift market supply?
If a firm expects that the price of its product will be higher in the future than it is today, it has an incentive to decrease supply now and increase it in the future.
If there is an increase in the expected future prices of a good, the supply curve will shift to the left because less of the good will be offered for sale today to take advantage of the higher prices in the future.
Shift of a supply curve
An increase or decrease in supply
The curve moves entirely
Movement along a supply curve
An increase or decrease in the quantity supplied
Value changes on the current curve
Market equilibrium
Where the demand curve crosses the supply curve. At market equilibrium, quantity demanded (Qd) equals quantity supplied (Qs).
Equilibrium price
The price at market equilibrium
Equilibrium quantity
The quantity at market equilibrium
Competitive market equilibrium
A market equilibrium with many buyers and many sellers
Surplus
A situation in which the quantity supplied is greater than the quantity demanded. Decreasing the price is recommended.
When the market price is above market equilibrium, there will be a surplus.
Shortage
A situation in which the quantity demanded is greater than the quantity supplied. Increasing the price is recommended.
When the market price is below market equilibrium, there will be a shortage
Can anyone dictate what the equilibrium price will be?
No! Neither consumers nor firms can dictate what the equilibrium price will because no firm can sell anything at any price unless it can find a willing buyer. Similarly, no consumer can buy anything at any price without finding a willing seller.
Demand formula
Qd = 50 - 5P
In this case: Qd = Quantity demanded 50 = constant 5 = slope of the demand curve P = price
And there is a negative (-) sign because the relationship between price and quantity demanded is negative as seen by the downward sloping demand curve on graphs.
Supply formula
Qs = 5 + 10P
In this case: Qs = Quantity supplied 5 = constant 10 = slope of the supply curve P = price
And there is a positive (+) sign because the relationship between price and quantity demanded is positive as seen by the upward sloping supply curve on graphs.
