Supply and Demand

Understanding the mind of the market

1 Market and Competition

Market = is a group of buyers and sellers of a particular good or service

Competition = is the method used under social cooperation to improve one’s own
welfare

2 Biological vs Market Competition

Are not the same.

[Biological Competition] In the animal kingdom, you have a limited supply. Who gets the biggest piece
of a fixed-size pie? Predators fight for the biggest piece of their prey (ex: tigers).

[Market Competition] In the market, who gets the biggest piece of a growing-size pie? By trade and
cooperation, we’ll get better off. They fight one another by making better product. In the end, the
consumers win. When everyone wants a slice of the pie, the pie gets bigger.

3 Demand
How much are you willing to pay?

3.1 The Law of Demand

Ceteris Paribus (all other things being equal), there’s an inverse relationship between the price of a
good or service and the quantity that people are willing to buy from that good or service

Price is on the Y-axis, quantity demanded on the X-axis. It’s sloping downward (inverse relationship).
That downwards curve is the demand curve. The law refers to the quantity demanded.

3.2 Translated
If the price of something goes up, holding everything else constant, you will buy less. If something
becomes more scarce, it becomes more valuable.

3.3 Why does it slope down?

 Income Effect (Scarcity)  most powerful
Scarcity of income, you’re on a budget constraint. Holding your income constant, if the price
of a good or service increases, then you have less money to spend on it.
 Diminishing Marginal Utility
*see table
 Every extra unit is giving you less pleasure than the unit before it.
 Substitution Effect
If the price of a good or service increases, then you switch to buying its substitutes.

4 Movements Along the Demand vs. Shifts in Demand

4.1 Along a demand
A movement along the demand curve results from a price change alone. This is known as change in
the quantity demanded. The curve does not move, but the points do.

4.2 Shifts in demand (left/right)

A shift in the demand curve occurs when something other than price changes. This is a change in
demand. The curve shifts (left/right). Nothing happens to the price.

4.2.1 What causes a demand curve to shift?

 Change in income
 Change in tastes (or preferences)
 Change in the price of related goods (substitutes or complements)
 Change in the number of buyers
 Change in expectations

4.2.2 Change
- To the right  at every single price you’ll buying more
- To the left  at every single price you’ll buy less

4.2.3 Demand shifts

4.2.3.1 Change in income
4.2.3.1.1 Normal goods
You get a raise, so your demand curve shifts outwards (to the right). You quit your job to go back to
school, so your demand curve for a normal good shifts in (to the left).

Normal good = more is better. Something you desire at all normal income.

4.2.3.1.2 Inferior goods

You quit your job to go to school, so your demand curve shifts outwards. Example: ramen noodles are
easy to prepare and is cheap, so ‘poor’ people shift to ramen noodles, which is an inferior good. You
get a raise, so you won’t go for ramen noodles anymore, your demand curve shifts in. Inferior good is
something you desire when you don’t have money.

4.2.3.2 Change in preferences

“Scientists say” Consuming an ice cream cone can reduce your chances of colon cancer. If something
is more desirable, the preference for it changes. If they say that ice cream may kill you, people won’t
want it anymore (shifts in).

4.2.3.3 Change in the number of buyers

Population growth, demand for diapers shifts out, and vice versa.
4.2.3.4 Change in expectations
Incandescent light bulbs will be banned next year, shifts out. We buy those bulbs knowing, that in the
future, it’ll be extinct/illegal. We want more of them while they’re in the market. Expectations means
expectations for the future. iPhone 6s will be cheaper next month when iPhone 7 hits the market. The
old model will be put on a sale. We expect that 7th model will be out soon and the price for 6th model
will go on a pretty steep sale. When it’s cheap, we buy the 6th model.

4.2.3.5 Change in the price of related goods

4.2.3.5.1 Substitutes
When the price of Guinness increases (the quantity demanded decreases, keep in mind that the curve
doesn’t shift, the movement is along the curve), so the demand for Bud Light increases (the curve
shifts out) because Bud Light is a substitute people are substituting Guinness for. Nothing happened
with the price of Bud Light, but the consumers of Guinness switches. In reality, there are no perfect
substitutes, but there are substitutes. Ex: Pepsi and Coca-Cola. Video: not every form of paper can be
replaced by digital (Ex: toilet paper).

4.2.3.5.2 Complements (two goods that go hand in hand)

If the price of strawberries increases, there is a decrease in the quantity demanded. Since whipped
cream is a product that is used with strawberries often, the demand for whipped cream decrease
(curve for whipped cream shifts in) until the price of strawberries goes down. Ex: PB&J.

SC: You work at a restaurant/bar. Your boss comes to you, knowing you are studying
economics, and asks for your opinion on the following question: “Which of the following
would change the demand for drinks the most?”  A reduction in the price of a
complementary good (snack food, appetizer).

5 Supply
How much are you willing to accept?

5.1 The Law of Supply

Ceteris Paribus, there is a direct relationship between the price of a good or service and the quantity
that people are willing to supply of that good or service. The curve slopes up!

5.2 Translated
If you get paid more, you do more.

5.3 Why does it slope up?

 Opportunity Cost
People rent their people’s houses for SXSW because hotels are full/limited. (graph) The cost
of forgoing something increases.
6 Movements along the Supply vs. Shifts in Supply
6.1 Along the Supply
A movement along the supply curve results from a price change alone. This is known as a change in
the quantity supply.

6.2 Shift in Supply

A shift in the supply curve occurs when something other than the price changes. This is a change in
supply.

6.2.1 What causes a supply curve to shift?

 Change in input costs
 Change in technology
 Change in government policy
 Change in the number of sellers
 Change in expectations

6.2.2 Supply shifts

6.2.2.1 Change in input costs
The price of sugar decreases, the price of ice cream increases because the input cost has gone up and
vice versa.

6.2.2.2 Change in technology

The invention of an ice cream scooper makes serving ice cream more efficient (same volume, uniform),
this is a positive shock (shifts to the right). An example of a negative technology shock is hard to find
because of civilization. Loos of electricity could be one, though.

6.2.2.3 Change in government policy

A new tax law exempts all organic ice cream producers from paying taxes  wider profit margin 
positive shock || A new FDA regulation requires ice cream suppliers to provide nutritional information
 costly to make a sticker / provide research  negative shock.

6.2.2.4 Change in the number of sellers

More people opt to sell their organs vs. Uber and Lyft leave the market for ride-sharing.

6.2.2.5 Change in expectations

Regarding the housing market, expectations: (2008, crash of housing market) the economy is going
to bust and housing prices will plummet  might as well sell right now before the value plummets,
the supply of houses in the market will increase. || The economy picks back up next year after the
slump  people wait for the prices to increase so they don’t sell now  supply of houses decrease.

7 Supply and Demand

Together gives us equilibrium

Supply  determines producers’ behavior / side of the equation; Market Price

Demand  determines consumers’ behavior / side of the equation; Market quantity

(graph) There is no reason for demand to slope up

Equilibrium = when the Y value is the same (the quantity supplied = the quantity demanded = market
clearing),

Market clearing = the price is just right to clear the market completely. Equilibrium
price x Equilibrium quantity.

Economics analyzes the point going towards equilibrium, even though it does not even exist. Ex: the
grocery store is cleared; everyone gets what they want.

7.1 How to Analyze Changes in Equilibrium

THE THREE STEPS

 Decide which curves shifts (supply, demand, or both)

 Determine the direction of the shift
 Use the diagram to determine what happens to the equilibrium price/quantity

8 Applications
 Hula-hoop craze
Change in demand – Change in taste & preferences. People suddenly realized the use of hula-
hoops. (graph)

Surplus = a situation where

the quantity supplied is
greater than the quantity
demanded. (i.e., price is too
high to clear the market.)

Step 1  The Craze = change

in preferences

Step 2  The craze 

demand shifts out

Step 3  Equilibrium price

and quantity increase after
the craze
 SC: Rolex and iWatch aren’t substitutes, they’re both luxury goods.

 Valentine’s Day (Chocolates and roses)

Step 1  The Craze = change

in preferences

Step 2  The craze 

Demand shifts out

Step 3  Equilibrium price

and quantity increase

Even love has a price

Shortage = a situation where

quantity demanded is
greater than quantity
supplied (i.e., price too low
to clear the market).

*The market by equilibrating supply and demand (when the price rises), does something:
rationing  nobody outside their will is dropping out of the market. Everyone drops out
voluntarily. It makes the line shorter, it makes people who value it the most get it.

 Market for MJ is legalized in Washington

quantity increases after

Step 1  Legalization = legalization
change in gov. policy (supply
shifts)

Step 2  Legalization =
reduced costs | Supply shifts
out

Step 3  Equilibrium price

decreases and equilibrium
The supply is limited If it is illegal (Suppliers are scared)