Chapter 2 - Supply and demand

Friday, February 4, 2022

10:42 AM
 
How do consumers decide what products to buy and how much of each?
How do producers know what products to produce? And who decides at what price the products sell?
 
Economist's standard approach: Simplify the problem until it becomes manageable.
 
Supply = the combined amount of a good that all producers in a market are willing to sell; = cat
de mult vinde o companie
Demand = the combined amount of a good that all consumers are willing to buy. = cat
cumpara clientii
 
Market:
 The product being sold - broad market means for ex all groceries not just oranges,
 A particular location - broad market means for ex all groceries sold in Europe and not just
in Vaslui
 A point in time - broader market means all year and not just one day
 
 
Key Assumptions of the Supply and Demand Model
 
1. We restrict our focus to supply and demand in a single market = we ignore the other
markets unless it influences the market we're interested in
2. All goods sold in the market are identical
 
Commodities = goods that are treated in the market where consumers see different varieties of
the goods as being interchangeable (similar/identical)
Example: gold, wheat, soybeans, no.2 pencils
Products that are not commodities: custom-make jewellery, cars, the meals on a menu, wedding
dresses (because people care a lot about the different varieties of these products, they don’t just
accept a random one)
 
1. All goods sold in the market sell for the same price, and everyone has the same information
about prices, quality, etc. (similar with the second one but adds that there are no special or secret
deals for particular buyers and no quantity discount. Everyone knows how much anyone pays)
1. There are many buyers and sellers in the market (no customer or producer alone has a very big
impact on the market and price levels.
Ex: whether specific a person eats bananas or not or gives up using some kind of shampoo
will stop the market. The producers will still make it for the rest of the consumers
 
   
Demand = people's willingness to buy goods
 
1. Factors that influence the demand:
 
1. Price: ex: some consumers might be willing to pay $40 for tomatoes but most of them can only
afford $1
2. The no. of consumers: the more people are in the market, the more products need to be sold
3. Consumer income or wealth: as a consumer becomes richer, they might:
1. Buy more products of a kind: food, clothes, cars
1. Stop buying other kinds: when you get a car you no longer pay for public transport.
2. Consumer tastes: the customer tastes might change. Ex: when they see advertisements, when they
are told some specific product is likely to bring cancer, when they are encouraged to buy something,
etc.
3. Prices of other goods: when the pricing of something increases very much, people are likely to find
ways to live without that. Ex: if tomatoes are expensive, people will buy peppers.
 
Substitutes: goods that can be bought in place of other goods (usually, if the price of a substitute falls,
people will buy that more instead of the original product because they can live without it
Complements: goods that are often purchased in a combination with another good.
ex: when the price for cheese goes down, people will buy more of it and end up buying also more
tomatoes because they need tomatoes to go with the cheese
 
 
1. Demand Curves: - NO CHANGE IN OTHER FACTORS, JUST PRICE
 
 It will be hard to consider all those factors and see what happens. Therefore, we assume that only
price changes and the other factors are constant.
 In a graph we represent the relationship between the quantity sold by customers demand of a
good and the good's price
 
 Supply = produces' willingness to supply goods
 
 Factors that influence supply:
 
a. Price = If producers expect the good to sell at a very good price, they will supply more but if they
expect to sell at a very low price, they will supply less
b. Suppliers' Cost of Production = if the cost of production elements change in price then there will be
a change in the price at which they will sell the goods which influence the quantity of goods
supplied.
c. Production technology = changes in the processes of making, distributing and selling the goods
means a change in the cost of production.
d. The number of sellers = many sellers bringing products somewhere raises the quantity available
supplied
e. Sellers' outside options = if farmers supply goods at a specific market, they might then decide to
supply in other markets too.
 
1. Supply Curves: - NO CHANGE IN OTHER FACTORS, JUST PRICE
 
 There are two factors seen to influence supply: price & everything else (2 categories)
 The supply curve isolate the relationship between the price and quantity supplied
 Producers are willing to supply more if the price increases
 Since producing costs rise when the output quantity rises, they need to sell the products for more
 
 

 
CU CAT PRETUL CU CARE SE ASTEAPTA EI SA VANDA ESTE MAI MARE CU ATAT
VOR ADUCE O CANTITATE MAI MARE
 
 = DEMAND CURVE

 
Q = Quantity supplied
P = Price in dollars per pound
 
= INVERSE DEMAND CURVE

Supply choke price = the price at which the producers will supply 0 goods ($1 in our case)
 
 Shifts in the Supply Curves:
 

 
 

The supply shifts only when a non-price factor changes

 
 If a faster harvesting method appears, the supply will shift from S1 to S2
 If there is flooding => the supply curve will shift from S1 to S3 which means producing less
 
Changes in quantity supply = when we move along the level curve
Changes in supply = when we move the curve itself since it is influenced by more than just the
price factor
 =SUPPLY CURVE

Q = the number of supplied products

X = quantity
P = price
CONNECTION BETWEEN SUPPLY AND DEMAND
 
 Price is the only factor that has an influence on both
 Price can be adjusted to make the quantity supplied equal with the quality demanded

Market Equilibrium
 
Market equilibrium = The point on the graph when the demand curve and supply curve
cross
Equilibrium price= The only price at which supply quantity and demand quantity equal
(Pe)
 
 

FOR EXAM: - egalare de doua functii

You can either use the demand and supply equations or the demand and supply inverse equations
 
 Iei ecuatiile de la supply and demand si le egalezi
 Incerci sa scoti P care va fi pretul de echilibru
 Plug the Pe into either the demand or supply equation to determine Q echilibru
 
Verificare:
 Baga Pe in ambele ecuatii (supply and demand) si vezi daca obtii acelasi Q.
Daca nu, you made a mistake along the way

Why

equilibrium?
Equilibrium means that the quantity supplied and the customers’ demand equals
If there was no equilibrium, there will appear some nereguli:
1. If the price is higher there will be excess supply because people don’t want to buy
2. If the price is too low then there will excess demand and not enough supplies
  

The effect of demand shifts – S ct, D changes

If one of the other factors apart from price change then we need to calculate a new equilibrium
That is because if something changes and customers request more or less quantity or suppliers produce
less or more than initially if we don’t calculate the new equilibrium there might be excess demand or
excess supplies.
Acest lucru se face folosind aceiasi pasi ca mai sus doar ca schimbam Qs si Qd

The effect of supply shifts – D ct., S changes

When there is a change in supply (producers are willing to bring more) the Demand remains constant.
Therefore, we will calculate a new Pe and Qe.
If we:
1. Decline the supply – increase Pe and decrease QE
2. Increase the supply – decrease in Pe and increase in Qe
Notes:
1. When there is a change in demand, price and quantity move in the same direction.

Explanation: when customers see that people want to buy more of the goods, they will raise the prices
2. When the supply changes, price and quantity move in the opposite directions

Explanation: When the suppliers want to sell more of something, they will lower the price and
Gandeste-te mereu la graphic, Out inseamna ca se duce inafara linniei si in inseamna ca se duce in
interiorul liniei. Si daca se duce inafara vezi ce creste is ce scade pana la urma.

EXAM”: Shocks of the market:

1. Da-ti seama care e socul (factor)

(it could be the pandemic which wipes out the customers, electricity fall, new invention that makes it
cheaper to produce a good, etc.). IMP: A change in price cannot be the shock

2. Does the shock shift the demand or supply curve?

a) Shift in demand: vezi daca ai alti factori care influenteaza cat vrea lumea sa cumpere
Question: If the price of this good remains constant, would the people want to buy more or less of this
good after the shock? (adica exista ceva maim ult decat pretul care sa influenteze consumatorii sa ia
mai putin?)
If the customers want the same amount after the shock it might mean that is the supply changing.
b) Shift in supply: If the price of this good is constant, would the producers supply more or less?
Ex: if the price for grapes increases, the supply for jam is most likely to decrease too.

1. Draw the
supply and
demand
curves before
and after the
shock.
Always use
 the graph since outward means increasing and inward means decreasing. Gandeste-te unde se duce
linia In graphic ca sa vezi cum merge.
Obs: poti sa ai doua shift-uri at the same time. When you have a change in both the movement of the
equilibrium price and quantity differ. To see in which direction we are going:
1. Size of the shift
2. Slope of the curve:
a) Shift in demand = we will have either bigger lor smaller price in equilibrium price and the
quantity and that depending on whether it is steep or flatter
b) The size of the change in price is inversely related to the size of change in quantity (When we
have a great increase in price that results in a small increase in quantity)
Steep means: Great change in price and small change in quantity
Flatter means: Smaller
change in price and greater
change in quantity
 Price si demand =
invers

proportionale
 Price si supply = direct proportionale

What happens when the curves shift?

The direction in which they go (price and quantity) depends on:
1. The size of the shift
2. Slopes of the curves

- If demand shifts, the slope of the supply curve determines the size of the change in equilibrium
price and quantity, and vice versa.
- The size of the change in price is inversely related to the size of the change in quantity
When we have a shallow slope => big increase in Q, small increase in P
When we have steeper curve = > big increase in P, small increase in Q

Flatter curve => Big Q small P

Steeper curve => small Q big P

Elasticity
• Steep curves: large changes in price and small changes in quantity, all else equal
• Shallow curves: small changes in price and large changes in quantity, all else equal
Measure that describes the sensitivity of quantity demanded or supplied to changes in price, income, or
price of related goods.
• Percentage change in one
variable (e.g., quantity)
divided by the percentage
change in another (e.g.,
price)
• Elasticities are unit-free (i.e.
just a number)

Price elasticity of demand:

percentage change in
quantity demanded
divided by percent change
in price (the sensitivity of
customers’ quantity demanded to price)

E
D = % c h a n g e i n q u a n t it y d e ma n d e d
% chan gein pr i ce
Ex: QD = 100-
3P => slope of
the demand
curve = -3
Edp = - 3 * P/Q
=- 3*5/85
= -15/85
It works using the inverse function as well
Edp = 1/slope of the inverse demand curve * P/Q

Price elasticity of
supply: percentage
change in quantity
supplied divided by
percent change in price

Es

= = panta * p /QS
¿ Δ Ol
s
S
ΔQ ΔP
¿
QS P
Δ P Q
s

Terminology
• Inelastic: Demand is inelastic if 0 < |ED | < 1
• Unit elastic: Demand is unit elastic if |ED | = 1
• Elastic: Demand is elastic if |ED | > 1
• Perfectly elastic: Demand is perfectly elastic if |ED | = ∞
• Perfectly inelastic: Demand is perfectly inelastic if |ED | = 0
Important: Elasticities do not have units attached.
• Allows for the comparison across different goods and services in different markets
• Above also used to describe supply
Elasticities and Linear Demand and Supply
  Often we assume supply and demand to be linear



ED p
:

 Negative
 Large price elasticity – elastic – flatter; ex: -5
 Ex: fresh fruits: increase price in apples decline in demand => increase in substitutes
 Less price elasticity – steeper – ex: -0.5
s
Ep
:

 Positive
 Large price elasticity: flatter - +5 = elastic
 Ex: softwares: by slightly increasing the price you will have more supply
 Less price elasticity or inelastic = steeper = ex: +0.5

Income of elasticity demand

Income elasticity of demand: the ratio of the percentage change in the quantity demanded to the
corresponding percentage change in consumer income:
The sign of EI depends on the type of product: EI $ is negative for inferior goods. ‒ Consumption
decreases with increases in income.

• EI is positive for normal goods. ‒ Consumption increases with increases in income.

• Luxury Goods: EI > 1

Cross-price elasticity of demand: The ratio of the percentage change in one good’s quantity demanded
(e.g.,, good X) to the percentage change in the price of another good (e.g.,, good Y)

EXY is negative for complements ‒ Consumption of good X decreases with an increase in the price of
a related good Y, and vice versa
EXY is positive for substitutes ‒ Consumption of good X increases with an increase in the price of a
related good Y, and vice versa