Demand and Supply
(ch.4 ch.5 ch.7)
Demand: the amount of a good that buyers are willing and able to purchase.
Demand curve
It is an economics tradition that draws price in vertical axis, (quantity in horizontal one).
Cf. mathematics: e.g. y=2x or y=6-x
Demand curve is downward sloping. Why?
Law of demand:
if other things being equal, the quantity demanded of a good falls when the price of
the good rises.
Diminishing marginal utility: the utility or value of additional unit decreases.
Demand curve shift vs Move along the demand curve.
Demand curve shows change of quantity to the price change (move along the demand curve), if
other things being equal.
If other things change it can make a shift of demand curve.
e.g. KBS news “avocado is very good for your health”
health warning on cigarette package.
Situation of substitute goods and complement goods makes shift in demand curve.
Supply: the amount of a good that sellers are willing and able to sell.
Law of supply:
if other things equal, the quantity supplied of a good rises when the price of the good
rises.
Supply curve is upward sloping.
Behind this upward sloping, there is increasing marginal cost. But we will postpone to discuss
marginal cost for later class. At the moment, intuition that people want to sell more when price is
high maybe enough.
Supply curve shift
What makes supply curve shift?
Weather, technology, input price
Market equilibrium:
a situation in which the market price has reached the level at which quantity supplied
equals quantity demanded.
Equilibrium price:
the price that balances quantity supplied and quantity demanded.
Elasticity: very important concept in economics
Measure of responsiveness to change
Demand elasticity:
% change in quantity demand / % change in price
Or (dQ/Q) / (dP/P)
Which is more elastic, necessities (food) or luxuries (colored eyeglass)?
The case of STARBUCKS coffee
Availability of substitute increases elasticity.
Flatter demand curve is more elastic. perfectly elastic : horizontal line
Steeper demand curve is more inelastic. perfectly inelastic (0): vertical line
Supply elasticity:
% change in quantity supply / % change in price
Or (dQ/Q) / (dP/P)
Flatter supply curve is more elastic. perfectly elastic : horizontal line
Steeper supply curve is more inelastic. perfectly inelastic (0): vertical line
Agricultural product supply is usually inelastic.
In the long run, both demand and supply become more elastic.
Consumer surplus
In market equilibrium, price, quantity demand and quantity supply is decided simultaneously.
This market price does not necessarily reflect the value of each unit that consumers considers.
According to law of diminishing marginal utility the first unit value is much higher than
following unit. But the price you pay is same (that is market price). The total value you enjoy
from the consumption is much higher than the actual payment. This creates consumer surplus.
Or you can think of different consumers: Consumer A is willing to pay 50, B 40, C 30 and
D 20. If the market price is decided at 30, three consumers will actually buy at 30, it would give
A and B surplus.
Demand curve shows willingness to pay.
Consumer surplus is total willingness to pay minus actual payment.
Willingness to pay (area below demand curve)
Actual payment (market P * Q rectangle)
Supply curve shows sellers’ (producers’) willingness to receive for the product.
Think of different producers: Producer Z is willing to sell at 10, Y 20, X 30 and W 40. If the
market price is decided at 30, three producers will actually sell at 30 and it would give Z and Y
surplus.
Producer surplus is actual total receipt minus willingness to receive for the product
Actual receipt (market P * Q rectangle)
Willingness to receive (area below supply curve)
Total surplus = consumer surplus + producer surplus
Market efficiency: total surplus is maximized in market equilibrium.
If government intervenes in the market and disrupt equilibrium, it reduces total surplus.
e.g. agricultural price support with government procurement