week 1 : demand and supply Flashcards
What is economics ?
the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses (Robbins, 1932, p. 6)
Scarcity: the excess of human wants over what can actually be produced
What is the law of demand ?
when the price of a good increases, the quantity demanded decreases this is because
Income effect: purchasing an equal quantity of the good becomes too expensive for an individual
- Substitution effect: alternative or substitute goods are now cheaper and the individual now purchases these
E.g starbucks drink has become more expensive you’ll then buy less
Starbucks drinks becomes expensive you’ll substitute it to costa coffee
Why does demand change ?
Demand can change as the result of changes in the price. This implies a movement along the demand curve
Demand can also change as the result of external factors e.g. income, taste, price of other goods, expectations of future price changes.
This implies a shift in the demand curve to the left or right.
Complementary goods: are consumed together, a price ↑ of one good will result in a demand ↓ for both goods
Q0-Q2
Substitute goods: are considered to be alternatives, a price ↑ of one good will result in a demand ↑ for the other good
E.g if costa increases you substitute to starbucks Q0-Q1
When the price increases, why does supply decrease ?
The supply curve depicts the quantity of the goods supplied by the firm at each price point. When the price of a good increases, the quantity the firm supplies (or wishes to supply)
Decreases
This is To increase revenue and potentially profits.
What external factors can cause a shift in the supply curve ?
Production costs: input prices, technology, government policy, organization
- Production and profitability of: − alternative goods: production ↑ of good B, supply ↓ of good A − joint goods: production ↑ of good B, supply ↑ of good A
E.g milk can be used for cheese as well as milk, if a firm decides to produce more cheese then more cheese will be needs
Joint good - if the price of leather increases the demand for leather will increase so the demand for cows will increase
- Expectations of future price changes and unpredictable events
What is equilibrium price ?
The equilibrium price represents a price for which the amount that consumers are willing to purchase = the amount that firms are willing to supply. In other words, where demand = supply
The assumption is that this equilibrium will be automatically reached in a free market and under perfect competition
What is partial equilibrium ?
When equilibrium is assessed for a single good and not the whole market of all goods we refer to it as a partial equilibrium
What makes a movement to a new equilibrium ?
- Increase in income → demand curve shifts from D0 to D1 (demand increase)
- At price p0 there would be excess demand (shortage)
- To meet demand, supply will have to increase to Q1 (new intersection with demand curve)
- This occurs if the price is increased from p0 to p1
A technological improvement leads to → supply curve shifts from S0 to S1 (supply increase) * At price p0 there would be excess supply * To meet supply, demand will have to increase to Q2 (new intersection with demand curve) * This occurs if the price is decreased from p0 to p2
Why is there a movement to a new equilibrium ?
Increase in income → demand curve shifts from D0 to D1 (demand increase) * At price p0 there would be excess demand (shortage) * To meet demand, supply will have to increase to Q1 (new intersection with demand curve) * This occurs if the price is increased from p0 to p1
How is the new equilibrium price determined/reached ?
Adam Smith: the invisible hand
The assumption is that when competing and self-interested consumers want to buy more of a good when there’s a shortage, they will cast their desire to buy more at a higher price to the market
The market then feeds this desire or increased willingness to pay to firms who then incorporate this price-signal and subsequently respond by producing more/increasing their supply
