Supply and demand
-quantity demanded, demand function and demand curve
-market demand
-quantity supplied, supply function and supply curve
-The market supply
When we consider demand, what are the possible factors that will affect your decision
about how much to purchase this good? For example, cars. Price of cars, your income,
price of gas, price of bus ticket, preference, etc. At this point, we will consider about the
first four factors. The other factors are not that important to economists, maybe yes to
psychologists.
Demand function is the relationship between quantity demanded and all the factors.
Q=f(p,pg,pt,y)
Demand curve is the relationship between quantity and its own price, given all other
factors constant. It basically says what will happen to the quantity you purchase when
price of that good goes up (or down). For most of goods, when price goes up, people buy
less of that good. So demand curve has a negative slope, and this is called LAW OF
DEMAND.
Now, how do we derive demand curve from demand function?
Notice that demand curve doesn’t say anything about any other factors except for its own
price. So what we do is to give any number to all those other factors and the we find the
demand curve.
For example,
Q=171-20p-20pg+3pt+2y
Then let pg=4, pt=1/3,y=12.5, and we can plug all those numbers into the above equation,
then we get
Q=171-20p-20*4+3*1/3+2*12.5
=117-20p
The above equation is called demand curve. If we put it into a graph, then it looks like
p
117/20
Slope=-1/20
Q
117
When price goes up, you want to buy less of that good. It is a movement along the
demand curve. We call the demand for a given price as quantity demanded.
Now let’s look what will happen if other factors change. For example, if pg increase.
When pg goes up to 5, then demand curve becomes
Q=171-20p-20*5+3*1/3+2*12.5
=97-20p
So for a given price p, the quantity demanded actually goes down when pg goes up. The
demand curve will shift to the left. Notice that pg and p have the same effects on Q. And
this means that car and gas are complementary goods. Complementary goods means that
when you consume more of one good, you have to consume more of the other one. Those
two goods are like a bundle. They have to go together. There are a lot of examples of
complementary goods. For example, milk and cereal, camera and film.
What will happen if pt goes up?
When pt goes up to 1, demand curve becomes
Q=171-20p-20*4+3*3+2*12.5
=150-20p
So for a given price p, the quantity demanded goes up when pt goes up. Demand curve
shift to the right. Here, bus price has a positive effect on the amount of cars you purchase.
And these two goods are called substitution goods. They mean that when you consume
more of this good, you consume less of the other good. They give the same usage.
So, if dQ/d(other price)>0, then substitutes,
If dQ/d(other price)<0, then complements.
What happens if income goes up?
If income goes up to 20, then demand curve will shift right. With higher income, for a
given price p, people would like to buy more cars.
Things to notice here:
1. What factors shift the demand curve? All factors except for its own price.
When we talk about a particular demand curve, what factors have been held
constant? All other factors.
P-Q change is along the demand curve. Factor-Q change is the shift of demand
curve.
2. How do we interpret intercepts?
P-axis intercept says that when price is 117/20, people don’t want to buy any of
that good. (stop buying)
Q-axis says that when price is 0 (free), people would like to buy 117 of cars.
3. Slope=▲p/▲q=-1/20
How to get it?
4. ▲q/▲p=-20. When price goes up by 1 unit, people will consume 20 less of cars.
5. p=g(p) is an inverse demand curve. It will be useful for later studies.
The market demand:
Demand curve gives out how much one person is going to buy for a given price. If
we have another demand curve for another person, we can simply add these two
quantities for the same price and then we have the market demand if the market is consist
of these two people. So the way to derive market demand is simply to find demand curve
first, and then add these two equations together.
Supply
When we consider about supply, there aren’t too many factors that affect producers to
decide how much to produce. Price of goods, cost of labor, cost of machine, etc.
Normally, we put the good’s own price and cost into the supply function.
For the previous example that we use,
Qs=g(p, wage, capital cost)
When p increases, firms/producers want to produce more goods because it will provide
them with more profit. When cost increase, produce would like to reduce their supply
given same capital constraint.
So,
P increases
Quantity supplied increases along the supply curve.
Wage increases (cost increases) --- supply curve shift to the left for same price.
An example of supply function:
Qs=178+40p-20w-60r
Where w=wage of labor, r=interest rate for producer’s loan.
When w=5.5, r=1.05
Qs=178+40p-2*5.5-60*1.05
=104+40p
Suppose w=10, then
Qs=178+40p-2*8-60*1.05
=99+40p
So when wage rises, supply curve shifts to the left, which means that for a given price,
producers will supply less goods than before.
The market supply
Similarly, market supply will be the sum of quantity supplied for a given price.
If Qs1= 104+40p
Qs2= 86+20p
And Market supply is
Qsm= 190+60p
More examples about market supply:
How do we find out the market supply when there is import?
Scenario:
(1) Japan imports rice from America, but Japanese put a ban on imports. What is
the effect of this policy on market supply?
Solution: Compare with the market demand when there is no demand.
For Japan, there is a domestic supply and also foreign supply, therefore, the market
supply for Japan will be the sum of these two supply curve.
Suppose Qsd=20+4p, and Qsf=10+3p, then Japan’s market supply will be
Q=50+7p
And this is the case when there is not a ban.
When there is a ban, which says that imports is illegal, then Qsf=0, and Japan’s new
supply curve is
Q=20+4p.
Hence, when there is a ban, Japan has a less supply of rice comparing with when
there is no ban.
Also show the effect by the graph.
Insert figure 2.05
(2) America imports steel from other countries. But America puts a quota on the
imports. Quota means that the imported steel from other countries cannot exceed Q.
Show the effect graphically.
Insert figure 2.1 here.
Explanation: foreign supply=supply curve, when Qf < Q,
=Q
when Qf ≥ Q,
Therefore, when market supply=domestic supply + foreign supply, when Qf < Q,
=domestic supply + Q,
when Qf ≥ Q,
So, when is a quota restriction, the foreign supply is cut off.
MARKET EQUILIBRIUM
Def. Equilibrium is a situation in which no participant wants to change its behavior.
Example (Figure 2.6):
Qd=286-20p
Qs=88+40p
To solve out a equilibrium, just let Qd=Qs, and we can get
P*=3.3, Q*=220
What happens if the market is in disequilibrium?
Say, p<3.3, then there is excess demand. Price is too low for producers, so producers will
supply less goods, while consumers would like to buy more than what has been supplied
in the market, therefore excess demand happens. Since consumers want more, some one
will try to offer a higher price to get the good, otherwise no producer is going to supply
more. So this kind of behavior will bid the price up, and finally price will move to
equilibrium price, where everybody is satisfied, i.e., no one wants to deviate.
If p>3.3, then excess supply rises. Producers have been producing more than enough
what consumers want to buy at this high price. Therefore producers will lower the price,
and seeing that price is lower now, consumers will buy more goods. And this will force
price to move down toward equilibrium price. Again, at equilibrium, no one wants to
deviate.
Now, what happens if market environment changes? How will equilibrium price and
equilibrium quantity respond to that?
SHOCKS IN THE MARKET
If D shift right , then p goes up, and q goes up, caz more demand drives price up.
If D shift left, then P goes down, and Q goes down also.
If S shift right, then P goes down and Q goes up.
If S shift left, then P goes up and Q goes down.
But when there is a combination of shocks on both demand and supply, then the effects
on P* and Q* will be ambiguous.
Example: Qd=286-20p
Qs=178+40p-60ph
1. Find the equilibrium price when Ph=1.5
2. Find the new equilibrium price when ph=1.75
3. What if we want to know equilibrium prices when ph=2, 2.1, 2.5….?
4. And what about the equilibrium quantity?
Government intervention:
Trade policies: trade ban and quota. (Insert graph 2.8 and 2.9 here)
1. Japanese ban on rice import
Result: P* goes up, Q* goes down
2. American quota on steel
Result: two cases.
If quota is bigger than Q(P*), then no effect on equilibrium.
If quota is less than Q*, then P* goes up, and Q* goes down.
Price ceiling and Price floor:
A price floor sets a minimum price and it creates excess supply in the market.
A price floor only works when it is set above equilibrium price.
Example: A minimum wage leads to unemployment.
A price ceiling sets a maximum price in the market. An effective ceiling should be below
equilibrium price and it will create excess demand (shortage) in the market. So the result
is some people cannot get what they want even they would like to pay higher price to get
it. Producer will not produce enough since the price ceiling prevent for an incentive to do
so. Then illegal market could emerge.