David Youngberg
ECON 202—Montgomery College
LECTURE 04: ANATOMY OF SUPPLY AND DEMAND
I.
II.
III.
What is our goal?
a. Efficiency—Maximizing output with a given amount of input.
i. Also known as minimizing waste.
b. Efficiency seems like a dry, heartless concept but it isn’t.
i. By being able to do more with less, we can use what’s saved to
do other things—in effect we lower our opportunity cost and do
the things we would normally forgo.
ii. These other things are not just consumer items. Innovation, art,
education, meditation, music, socializing, and traveling are all
things we can do.
iii. Indeed the history of humanity includes more of these higher
pursuits as people save the time and money to not just make
these things but appreciate them. Efficiency helped bring about
the works of Mozart, Shakespeare, Aristotle, and Confucius—
people don’t ponder art and philosophy when they’re struggling
to survive.
Perfect Competition
a. Assumptions of perfect competition
i. Homogenous products (identical goods)
ii. Perfect information
iii. Freedom of entry and exit
iv. A large number of buyers and seller
b. Thus, everyone is a price taker—that is no one can deviate from the
market price and no one can influence it.
The anatomy of the analysis
a. Understanding surplus on the diagram.
i. We take all prices as uniform across a particular market, such as
socks, but people will value supplying or consuming that unit
differently. We can note the difference as surplus, assuming the
transaction took place.
ii. Reservation price is the most a person will pay for something or
the minimum a person is willing to sell something for. Supply
and demand curves are made up of reservation prices.
iii. The difference between the most you would buy something for
and what you did buy it for is your consumer surplus.
iv. The difference between the least you would sell something for
and what you did sell it for is your producer surplus.
Price
S
Total
Consumer
Surplus
Pe Total
Surplus
Producer
Surplus
D
Quantity
Surplus
Qe
v. While individual consumer surplus is Reservation Price –
Market Price, total consumer surplus is all the reservation
prices, or the demand curve, minus Market Price. To calculate
total consumer surplus, remember the formula for a triangle.
vi. Similarly, there is a difference between individual producer
surplus and total producer surplus.
b. Understanding movements along a curve.
i. When the world changes, people respond to that change by
adjusting the quantity they consume or sell. The move along the
supply or demand curve reflects a change in the quantity
demanded or supplied.
ii. Movements along the curves tend toward equilibrium.
Price
Change in
Quantity
Demanded
S
Pe
Change in
Quantity
Supplied
Qe
D
Quantity
IV.
A Quick Note on the Supply of labor
a. The supply of labor is much like a standard supply curve. The more
people are paid, the more hours they are willing to work.
i. For individuals this is not always the case, since supplying
something requires time and effort (something people prefer
using for their own ends). If you are paid $1,000 an hour to
mow lawns, you would probably work only an hour a day. At
some point, an individual’s supply curve bends backwards.
ii. But for the market, the supply of labor slopes up. If lawn
mowing is being paid so much an hour, many people would
leave their current job and enter the market for lawn mowing.