Introduction to Economics

Topic 2: Demand and Supply
Source: LR12, LR 11, LR10 Ch. 3 and LR12, Ch. 5 to pg 97; LR11 to pg 103; LR10 to pg 105.

ECO 100Y

ECO 100 W.G. Wolfson

Topic 2: Demand and Supply

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Demand and Supply
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Analyze in detail the interactions between buyers and sellers Isolate one market in the Circular Flow and focus on it  We start with one of the Output Markets Buyers are the demanders  We develop the Demand Schedule and Demand Curve Sellers are the suppliers  We develop the Supply Schedule and Supply Curve Bring Demand (D) and Supply (S) together  D = S determines an Equilibrium in a single market

ECO 100 W.G. Wolfson

Topic 2: Demand and Supply

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Demand

Quantity demanded (QDX) The amount of a commodity (Good X) that a household (consumer) desires to purchase Time is important Per Day? Per Month? Per Year? We usually leave this as implicit! Note that QDX is “desired”, not actual Actual amount determined by the equilibrium

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Determinants of Demand for Good X (QDX shown as QX below)
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Price of Good X ∆QX /∆PX < 0 (usually) Price of Good Y (a substitute for Good X) ∆QX /∆PY > 0 Price of Good Z (a complement to Good X) ∆QX /∆PZ < 0 Tastes / Preferences Can lead to ∆QX > 0 or ∆QX < 0
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Determinants of Demand for Good X (Cont’d)

Income If X is a normal good  ∆QX /∆I > 0 If X is an inferior good  ∆QX /∆I < 0

Other Factors Price Expectations Population (when considering total demand)
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The Demand Schedule for Good X

To derive the Demand Schedule for Good X, we need to isolate one determinant of quantity demanded  Own price is the strongest driver (PX) When isolating on the Price of X, we are implicitly assuming that all other determinants of demand are being held constant (“ceteris paribus”) We consider later what happens if one of these “constants” changes The Market Demand Schedule is the sum of the demand schedules of each individual consumer

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Demand Schedule

The Demand Schedule for a commodity shows the different quantities demanded when only the price of the commodity is allowed to change To the right are some points on a Demand Schedule that has this linear equation: P = 18 - Q

Price of X

Q Demande d 8 10 12 14 16

$10 $8 $6 $4 $2

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The Demand Curve

A Demand Curve graphs the relationship between the quantity demanded of a commodity and its own price A Demand Curve shows the maximum price that consumers are willing to pay for the last unit bought of the commodity Tradition places Price (P) on the Y-axis and Quantity (Q or sometimes q) on the X-axis Draw the D curve from the data provided

Price of X $10 $8 $6 $4 $2

Q Demanded 8 10 12 14 16

ECO 100 W.G. Wolfson

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The Demand Curve Will Shift If There Is ….
1. 2.

3.

4.

5.

A change in the price of a substitute  If the price of a substitute rises, D will increase A change in the price of a complement  If the price of a complement falls, D will increase A change in income  If income rises and X is normal, D will increase A change in tastes / preferences  If tastes shift favourably, D will increase Other changes in a “constant” are possible

ECO 100 W.G. Wolfson

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Shifts vs. Movements along the Demand Curve

If the price of a good changes but everything else remains the same, then the quantity demanded of that good has changed  This is a movement along the Demand Curve If the price of the good remains constant but the quantity demanded changes, then the Demand for that good has changed  This is a shift in the entire Demand Curve  This occurs when one of the “constants” changes

P

D1 Q

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Supply

Quantity supplied (QSX) The amount of a commodity (Good X) that a firm is willing to produce and sell Time is important Per Day? Per Month? Per Year? We usually leave this as implicit! Note that QSX is “desired”, not actual Actual amount determined by the equilibrium

ECO 100 W.G. Wolfson

Topic 2: Demand and Supply

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Determinants of Supply for Good X (QSX shown as QX below)

Price of Good X  ∆QX /∆PX > 0 (usually) Price of Inputs  ∆QX /∆Pinput < 0 State of technology  A technological improvement leads to ∆QX >0 Price of other good (Y) which could be produced by the firm (with the same inputs)  ∆QX /∆PY < 0 Other determinants
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The Supply Schedule

To derive the Supply Schedule for Good X, we need to isolate one determinant of quantity supplied  Own price is the strongest driver (PX) When isolating on the Price of X, we are implicitly assuming that all other determinants of supply are being held constant (“ceteris paribus”) We consider later what happens if one of these “constants” changes The Market (Industry) Supply Schedule is the sum of the supply schedules of individual firms

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ECO 100 W.G. Wolfson

Topic 2: Demand and Supply

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The Supply Schedule

The Supply Schedule for a commodity shows the different quantities supplied when only the price of the commodity is allowed to change To the right are some points on a Supply Schedule that has this linear equation: P = 0.5Q

Price of X $10 $8 $6 $4 $2

Q Supplied 20 16 12 8 4

ECO 100 W.G. Wolfson

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The Supply Curve

The Supply Curve graphs the relationship between the quantity supplied of a commodity and its price, holding all other variables constant The Supply Curve of a commodity shows the minimum price that firms are willing to accept for the last unit sold of the commodity Draw the S curve from the data provided

Price of X $10 $8 $6 $4 $2

Q Supplied 20 16 12 8 4

ECO 100 W.G. Wolfson

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The Supply Curve Will Shift If There Is ….
1.

A change in an input price
 If the wage rate for Labour increases, S will decrease

2.

A change in technology
 If technology improves, S will increase

3.

Other changes in a “constant” are possible

ECO 100 W.G. Wolfson

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Shifts vs. Movements along the Supply Curve

If the price of a good changes but everything else remains the same, the quantity supplied of that good has changed  This is a movement along the Supply Curve If at every price level the quantity supplied changes, the Supply for that good has changed  This is a shift in the Supply Curve  This occurs when one of the “constants” changes

P

S1

Q

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The Market Equilibrium
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The price of a good regulates the quantity demanded and the quantity supplied of that good There is only one price at which the quantity demanded and the quantity supplied are equal: the equilibrium price At any price below the equilibrium price the quantity demanded exceeds the quantity supplied − this is called a situation of excess demand, which pushes the price up At any price above the equilibrium price the quantity supplied exceeds the quantity demanded − this is called a situation of excess supply, which drives the price down

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Equilibrium, Excess Demand (ED) and Excess Supply (ES)
Price $10 $8 $6 $4 $2 Q Demanded 8 10 12 14 16 Q Supplied 20 16 12 8 4 ED or ES ES = 12 ES = 6 ES=ED=0 ED = 6 ED = 12

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Seen on a Bumper Sticker
“Talk is cheap because Supply exceeds Demand!”

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Solving For The Equilibrium
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Demand:  P = 18 – Q Supply:  P = 0.5Q D = S determines the equilibrium Solve for P* = $6 and Q* = 12

ECO 100 W.G. Wolfson

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The “Laws” of Demand and Supply (- sloped D and +sloped S)
1. 2. 3. 4.

An increase in demand causes an increase in both the equilibrium price and the equilibrium quantity A decrease in demand causes a decrease in both the equilibrium price and the equilibrium quantity An increase in supply causes a decrease in the equilibrium price and an increase in the equilibrium quantity A decrease in supply causes an increase in the equilibrium price and a decrease in the equilibrium quantity
Note: The Algebra of Market Equilibrium (LR12, pages 64-65 and LR11, page 68) is interesting and helpful, but you do not need to memorize the formulae!

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The Functioning of the Market - Examples
1.

Good X: Conventional Television Sets
 As Canadians become wealthier, they switch to plasma TVs There is a rise in the price of sand, an essential ingredient in cement The price of computer memory chips falls

2.

Good X: Cement

3.

Good X: Computers

4.

Good X: Bubblegum baseball cards of the 1950 season, produced in 1950 (No counterfeits allowed!!)
 The first World Convention of Baseball Buffs creates new interest in collecting cards.

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The Functioning of the Market (Cont’d)
5.

 Good X: Hockey Skates
 Canadians get even more hooked on playing hockey. Simultaneously, there is a revolutionary change in skate construction, lowering unit costs of production.

6.

Good X: Software engineers
  An increase in the demand for software products price = wage rate

7.

Good X in an “open economy”: Soybeans (imported at a fixed “world price”)
 An increase in domestic demand for soybeans

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Two Puzzles About D & S
Demand Puzzle  Are these two statements contradictory?
 “The quantity demanded varies inversely with the price”  “A rise in demand causes a rise in price”

Supply Puzzle  Are these two statements contradictory?
 “The quantity supplied varies directly with the price”  “A rise in supply causes price to fall”

ECO 100 W.G. Wolfson

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Interrelationships Between Markets
Source: LR 12, Chapter 5 to page 97; LR11, Chapter 5, to page 103; LR10, Chapter 5, to page 105.
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So far, we have analyzed one market in isolation (“partial equilibrium” analysis) But markets are inter-related, and in theory we should try to figure out the impact of an event on all markets (“general equilibrium” analysis) The best we can do in ECO100 is to analyze 2 markets, in a sequential manner:
 Consider the impact of a change in market one on market one and then “the second order” impact on market two  We stop before considering the impact of the change in market two back on market one!

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Interrelationships: Example 1
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Widgets are sold in both the South and the North, and are easily transported between the two (by producers only!) There is an increase in demand for widgets in the North (the shock in Market One). Suppliers of widgets in the South see an opportunity to sell more widgets in the North by redirecting to the North some widgets originally destined for the South (the “second order” impact in Market Two).

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Interrelationships:Example 2
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Tea and coffee are substitutes. A poor coffee crop is the shock in the coffee market (Market One). There is also an impact on the tea market (the “second order” impact on Market Two).

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Interrelationships:Example 3
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There has been a technological improvement in the production of computer chips (Market One). Computer chips are used as an input for both gadgets (Market Two) and gizmoes (Market Three). [This example pushes the analysis to three markets, to
illustrate the pervasive “second order” impacts of shocks across the economy.] Note: In most cases in ECO 100, we will use partial equilibrium analysis (i.e., the impact in “Market One” only). But watch carefully for questions that are explicitly asking for the impacts beyond the original market.

ECO 100 W.G. Wolfson

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