Paul Samuelson. Basic Elements of Supply and Demand Demand- refers to the quantity of goods and...

Paul Samuelson

Basic Elements of Supply and DemandDemand- refers to the quantity of goods and

services that consumers are willing and able to buy at different levels of price

Law of DemandWhen price increases, quantity demanded

decreases. When price decreases, quantity demanded increases, ceteris paribus

All other factors held constantAll thing things are equal.

Quantity demanded tends to fall when price rises because:1. Substitution effect

2. Income effect

Factors Affecting Demand1. Consumer Income2. Price of related goods3. Population4. Tastes and Preferences5. Special Influences

Note that:Models are simplified theories that show the key

relationships among variables.

Often, these relationships are expressed in functions.

- a mathematical concept that shows how

one variable depends on a set of other variables.

Demand Equation: Movement Along the Demand CurveQ = 100- 1p

Quantity Price

100 0

105 5

110 10

115 15

120 20

125 25

130 30

Economists when graphing demand curves, always put price on the vertical axis and quantity on the horizontal axis.

Alfred Marshall, conceived of the demand function with a market price as a function of quantity available for sale.

He observed English country markets with numerous sellers bringing their quantities to the marketplace. The demand function specified what price consumers, taken together, would pay for a given quantity.

Today, we assume that consumers take market prices as given and choose quantities that maximize their utilities.

However, Marshall’s influence is so strong that we continue to draw our graphs with price on the vertical axis. Marshall did this because to him, the dependent variable was price and the independent variable was quantity.

HoweverThe modern theory generally conceives of the

demand function with the quantity as the dependent variable and price as independent variable.

Shift in the Demand CurveQ= 8-P+2Y

Suppose: Y=1 Y=2

Movement along the demand Curve

Shift in the Demand Curve

Q = f(P)

Illustrate the law of Demand

Pb, Y, Pop,TP, and SI are held constant

Q= f( Pb, Y, PoP, TP, SI)

Pb, Y, PoP, TP, and SI can change

SupplyQuantity of a good and service that producers

are willing to sell in a given price.

Law of SupplyWhen price increases, quantity supplied

increases. when price decreases, quantity supplied decreases

Factors Affecting the Supply Curve

1. Technology-Computerized manufacturing lowers costs

and increases supply

2. Input Prices-A reduction in the wage paid to autoworkers

lowers production costs

3. Price of Related goods- If truck prices fall, the supply of cars rises.

4. Government Policy-Removing quotas and tariffs on imported

automobiles increases total automobile supply.

5. Special Influences-Internet shopping and auctions allow

consumers t0 compare the prices of different dealers more easily and drives high-cost sellers out of business.

Movement in the Supply curveQs= 50+3P

Shift in the supply curveSuppose that there is an improvement in

technology

Qs= 5+P+2TC, TC=2

Market EquilibriumEquilibrium condition: Qd= Qs, is known as the

equilibrium condition equation. The result is equilibrium price (Pe) and equilibrium qunatity (Qe).

Algebraic computationGiven: Qd= 10-P

Qs = 5+ PReq.1. Equilibrium Price (Pe)2. Equilibrium Quantity (Qe)

Solution: Qd = 10-P Qs = 5+P

10-P = 5+P-P+P= 5-102p= -5

Pe = 2.5

10- (2.5) = 5 + (2.5)

Therefore, Qd = Qs = 7.5

Qd Qd P Demand-Supply Balance

Market Condition

Direction of Price Change

5 10 0 -5 Shortage Increase

6 9 1 -3 Shortage Increase

7 8 2 -1 Shortage Increase

7.5 7.5 2.5 0 Equilibrium Neutral

8 7 3 1 Surplus Decrease

9 6 4 3 Surplus Decrease

10 5 5 5 Surplus Decrease

Surplus- a situation in which Qs is greater than Qd.

Shortage-a situation in which the Qd is greater than Qs.

The equilibrium price and quantity depend on the position of the supply and demand curves. When some event shifts one of these curves, the equilibrium in the market changes.

The analysis of such change is called comparative statics because it involves comparing two unchanging situations- an intial and a new equilibrium.

Example: A Change in demandSuppose that one summer the weather is very

hot. How does this event affect the market for ice cream?

1. The hot weather affects the demand curve by changing people’s taste for ice cream. That is, the weather changes the amount of ice cream that people want to buy at any given price.

The supply curve is unchanged because the weather does not directly affect the firms that sell ice cream.

Because hot weather makes people want more ice cream, the demand curve shifts to the right. This shift indicates that the quantity of ice cream demanded is higher at every price.

3. The increase in demand for ice cream raises the equilibrium price from $2.00 to $2.50 and the equilibrium quantity from 7- 10. In other words, the hot weather increases the price of ice cream and the quantity of ice cream sold.

Example: A Change in SupplySuppose that , during another summer, a

hurricane destroys part of the sugar cane crop and drives up the price of sugar, How does this event affect the market price for ice cream?

1. The change in the price of sugar, an input into making an ice cream, affects the supply curve. By raising the costs of production, it reduces the amount of ice cream that firms produce and sell at any given price. The demand curve does not change because the higher cost of inputs does not directly affect the amount of ice cream that households wish to buy.

The supply curve shifts to the left because, at every given price, the total amount that firms are willing and able to sell is reduced.

The shift of the supply curve raises the equilibrium price from $2.00-$2.50 and lowes the equilibrium quantity from 7-4.

A Change in Both Supply and DemandNow suppose that the heat wave and

hurricane occur during the same summer.

1. The hot weather affects the demand curve because it alters the amount of ice cream that household want to buy at any given price. At the same time, when the hurricane drives up sugar prices, it alters the amount of ice cream that firms want to sell at any given price.