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UNIT 5 DEMAND AND SUPPLY

Text 5.1

Demand

“Much will have more.”

“Appetite comes with eating.” – English proverbs

(1) Introduction. An old story says that if you want an “educated economist”, all you have to do is get a parrot and train the bird to say “supply and demand” in response to every question about the economy! Not smart enough, but it’s quite true that the theory of supply and demand, along with the price theory, is a central part of economics. Let’s start the discussion of the two concepts with demand as it is a more simple concept to understand than supply.

(2) The concept of demand. Each of us buys something because we want to. The more we want something, the more we are likely to pay to get it. The more we would pay for it, the higher our demand for it is. If you aren’t ready to give up anything (any money) for something, then you have no demand for it. You may have some desire for it. But if you aren’t ready to pay a price to get it you do not demand it. Desire? Yes. Demand? No.

To emphasize this point economists use the term effective demand – that is, the demand backed up by ability to pay, and not just based on want or need. (When there is a willingness to purchase a good or service, but where the consumer lacks the real purchasing power to be able to afford the product, or where a particular product cannot be met by existing suppliers, economists speak about latent demand.)

Demand, thus, is the amount of a good that consumers are willing and able to buy at all possible/alternative prices over a certain period of time/in a given period of time. The source of willingness is wants and needs, while the source of ability is mostly income.

(3) Demand is “a propensity to buy”. The “demand” for something doesn’t mean “how much of it people are buying.” It only means “how much of it people would be buy­ing if ... ”. If what? If the price happened to be, say, $5 or $10 or $30 or maybe 50 cents. So “de­mand” in economics doesn’t mean what it normally means to most people. In economics, it really means “propensity to buy”, – that is “how much I would buy, if ...”.

(4) The Law of Demand: higher price, smaller quantity; lower price, larger quantity. If you have a demand for something, that means two requirements are being met: (a) you want it, and (b) you are willing and able to spend some money to get it. However, whether or not you actu­ally will buy depends on how high the price is. (You may be willing to pay to get something, but you may not be willing to pay a price which you think is too high.) And the higher the price, the less of it you will actually buy; conversely, the lower the price, the more of it you will actually buy.

So, price is a major determinant of demand. You know it is true from your own personal experience. Right? And so you already know the law of demand which says/postulates: “The quantity demanded of a good is inversely related to its price, ceteris paribus”. In plain English, it simply means that people would buy more of something at a lower price than they would at a higher price, with all else equal/(with) all other factors held constant/unchanged.



(5) The three ways to visualize the Law of Demand.There are various ways to visualize the relationship between price and the quantity/amount of a product that people will/would buy. As was stated above, this relationship is inverse or indirect because as price gets higher, people want less of a particular product, and vice versa.

Mathematically, one can say that quantity demanded is a function of price, with all other factors (besides price) held constant, or:

Qd = f (Price, other factors held constant).

A Demand Schedule
Price of Widgets Number of Widgets People Want to Buy
$4.00
$3.00
$2.00
$1.00

(6) The demand table. A more elementary way to express the relationship is to represent it in tabular form (in the form of a table/chart). The numbers in the table on the left reflect the way people will behave at each price, i.e. the amount of “widgets” (imaginary products) they will buy as their price goes up or down. For example, when the demand price decreases from $4.00 to $1.00, the quantity demanded increases from 40 to 100 widgets because buyers are normally willing and able to buy more at lower prices. The demand for a good, thus, can be thought of as a schedule of prices and quantities in the mind of the buyer.

(7)The demand graph.The same information can also be plotted on a graph, where it will look like the graph in Figure 1. The demand curve labelled DD is nothing more than a graphical representation of the law of demand. It shows the relation between the demand price measured/plotted on the vertical axis, and the amount of a good one or more consumers are willing and able to buy at different prices measured/plotted on the horizontal axis. Notice that for basic economic analyses the demand curve is often approximated as a straight line.

(8) Understanding the demandgraph.The typical demand curve slopes downward from left to right. The negative (downward to the right) slope of the demand curve graphically illustrates the indirect law of demand relation between demand price and quantity demanded, i.e. if price rises, the quantity demanded (NOT demand!) will decrease, and less will be purchased in a given period of time; if price falls, the quantity demanded will increase, and more will be bought in a given period of time.

For example, as the demand price decreases from P1 to P2 (see Fig.1), the quantity demanded (NOT demand!) increases from Qs1 to Qs2, since buyers are willing to buy more at lower prices, and vice versa.

The entire set of price-quantity pairs that reflect buyers’ willingness and ability to buy a good is referred to as demand. In a graph, it is represented by the entire demand curve.


(9) Movements along the demand curve vs shifts of the demand curve.As described above, a demandcurve shows the relationship between the price of an item and the quantity of that item demanded over a certain period of time. Any change in the price of a good results in a change in the quantity demanded. In the graph, the changes are reflected as a corresponding movement along the existing demand curve to a new point (either upwards or downwards), reflecting (or: matching, indicating) the actual price-quantity pair.

Since the entire demand schedule remains the same, the demand curve in question also remains in its place, and there are no shifts of the curve from one position to another (either to the left or to the right) in the graph.

(10) Demand-shifting factors. A given demand curve shifts either to the left or to the right (inwards or outwards) only if there is a change in the entire/total demand as a result of a change in or due to any factor other than the price of the good. These non-price influencing factors are sometimes called the conditions of demand or demand determinants, some of the most important of them being income, taste, prices of substitutes or complements, expected future prices, information, seasonal changes, and number of buyers.

In the diagram above (See Fig.2) a decrease in the entire demand has shifted the demand curve to the left, the new demand curve being D1. An outward shift in demand (i.e. to the right) takes the curve to D2.

(11) Individual, market, and aggregate demand.As was stated above,the demand for a good is a schedule indicating the quantities individuals are willing and able to buy at all possible prices, everything else remaining constant. An individual demand refers to the quantity of a good a consumer is willing to buy and able to buy at all prices within a period of time, with all other factors remaining constant. The market demand is simply the horizontal sum/the sum total of the individual demands within the marketplace or, to put it another way, the sum of the amounts demanded by each of the individuals.

For example, if, at the price of $10, Bill wants to buy 10 units of the product, Jose wants to buys 20 units, and Mary wants to buy 30 units, then, of course, the market demand is 60 units. If Jordan becomes a buyer and wishes to buy 40 units, the market demand rises to 100 units. Therefore, if there are more buyers, there must be more market demand.

Aggregate demand is the total demand for goods and services in the economy during a specific time period.

(12) Price elasticity of demand. The demand curve shown in Fig.1 demonstrates that at lower prices people would buy more, and at higher prices would buy less. It means that the quantity people buy is very sensitive/responsive to the change in price. Reduce the price and demand increases: latent demand emerges, and demand is attracted away from other goods and services. For example, if the price moves down from $4.00 to $1.00 per unit, the quantity people will buy increases from 40 units to 100 units. The economist would say that the demand for widgets in this example is rela­tively elastic, or price elastic.

Elasticity means sensitivity, or responsiveness of buyers to price changes. When used without a modifier, it usually refers to price elasticity which is the percentage change in quantity demanded of a good or service divided by the percentage change in its (own) price.

If the quantity bought does not change very much when the price changes, we say that responsiveness is low, and the demand is relatively inelastic, or price inelastic. The degree of responsiveness of buyers/ quantity demanded to changes in the products price is reflected in the slope of the demand curve: the higher (is) responsiveness, the steeper (is) the slope.

***

Text 5.2

Supply

“He gives twice who gives quickly.”

“He that comes first to the hill may sit where he will” – English proverbs

(1) Introduction to supply. Thus far, we have been focusing exclusively on buyers, and on demand. But buyers and demand are only half of the market and the market exchange process. It’s time now to consider the behaviour of sellers, and the concept of supplywhich make up the other part of the market and the market exchange process.

(2)The concept of supply. Broadly speaking, supply is similar to but opposite from demand. It is the quantity/amount of a good that producers are willing and able to make/sell at various/all possible prices during a given time period.

(3) Supply is “the propensity to sell”. Just like demand, supply is an “if … then …” concept. It doesn’t mean “how much of something sellers are currently selling.” It means “how much sellers would sell, if …”. If what? If the price were, say, $1, or $5, or $10, or $30, or whatever. In other words, supply is not the amount of goods flowing across the market from the sellers to the buyers. In economics, it really means “propensity to sell” – that is, “how much sellers would sell, if …”.

(4) Supply vs quantity supplied. Supply can be thought of as the relationship between a range of prices and a range of quantities. In other words, it includes not just the quantity sold at the current price, but any and all quantities that would be sold at other prices – higher and lower. The price part of this relation is termed supply price and the quantity part is termed quantity supplied.

The supply price is the minimum price that sellers are willing and able to accept for a given quantity of a good. They would be willing to accept more than this price, but not less. The quantity supplied, on the contrary, is the maximum amount of a good that sellers are willing and able to sell at a given supply price/to offer at one price.

Supply price and quantity supplied come together as matched pairs. One supply price, one quantity supplied. Supply, then, can be referred to as the combination of these matched price-quantity pairs.

(5)The Law of Supply: higher price, higher quantity; lower price, smaller quantity.Price is a major determinant of the amount sellers will want to sell. Because a higher price leads to higher profits, one expects that a greater quantity should be supplied when the price is higher. So we can conclude that as the price of the product rises (falls), the quantity supplied will rise (fall), all other variables remaining the same. Economists call this statement the law of supply.

From the law of supply it follows that the relationship between price and quantity is a direct/positive one – that is, both quantity and price change in the same direction: when price increases so does quantity, and the higher the price, the larger the quantity supplied. Reasons for positive relationship between price and quantity supplied are that as the price of a good increases, the good becomes more attractive to producers relative to other goods that can be produced with similar resources.

(6) The three ways to visualize the Law of Supply.The relationship between the quantity of a product that sellers want to sell during some time period (i.e. the quantity supplied) and their current market price is what economists call the supply schedule.The supply schedule can be illustrated either in the form of a table/chart or a graph, or expressed mathematically in functional form as:

Qs = f(price, other factors held constant).

(7) The supply table. A table is an elementary way to express a supply schedule. Such a table constructed for an imaginary product is shown in the following example below.

The numbers in the table reflect the way sellers will behave at each price, i.e. the maximum quantity of a product they will sell as the price goes up or down.

A Supply Schedule
Price of Widgets Number of Widgets People Want to Sell
$1.00
$2.00
$3.00
$4.00

For example, when the supply price increases from $1.00 to $4.00 per unit, the quantity supplied increases from 10 to 140 widgets because sellers are normally willing to sell more at higher prices. The supply of a good, thus, can be thought of as a schedule/list of prices and quantities in the mind of the seller.

(8) The supply graph.The same supply schedule can be shown with a graph which will look like the graph shown in Figure 3 below, with the supply price measured/plotted on the vertical axis, and the amount of a good one or more producers are willing and able to sell at different prices measured /plotted on the horizontal axis.

(9)Understanding the supply graph. The supply curve labelled SS in Fig. 3 is nothing more than a graphical representation of the law of supply. It shows the positive relation between the supply price and the amount of a good one or more producers are willing and able to sell at all possible prices/at every possible price.

Unlike the typical demand curve, the typical supply curve slopes (increasingly) upward from left to right. Notice that the line does not begin at the origin. There is some price – above zero – at which no seller will sell at all. For basic economic analyses the supply curve is often approximated as a straight line, just as it is the case with the demand curve.

The positive slope of the supply curve graphically illustrates the direct law-of-supply relation between supply price and quantity supplied: the higher the price, the greater the quantity supplied, with all other relevant factors held unchanged, and vice versa.

For example, as the supply price increases from P1 to P2, the quantity supplied (NOT supply) increases from Qs1 to Qs2, since sellers are willing to sell more at higher prices, and vice versa.

 

The entire set of price-quantity pairs that reflect sellers’ willingness and ability to sell a good is referred to as supply. In a graph, it is represented by the entire supply curve.

(10)Movements along the supply curve vs shifts of the supply curve. As with the demand curve, one should differentiate/distinguish between a movement along the supply curve and a shift of the supply curve.

As described above, a supply curve shows the relationship between the price of an item and the quantity of that item supplied over a certain period of time. Any change in the price of a good results in a change in the quantity supplied. In the graph, the changes are reflected as a corresponding movement along the existing supply curve to a new point (either upwards or downwards), reflecting/matching/indicating the actual price-quantity pair.

Since the entire supply schedule remains the same, the supply curve in question also remains in its place, and there are no shifts of the curve from one position to another (either to the left or to the right) in the graph.

(11) Supply-shifting factors. A given supply curve shifts either to the left or to the right (inwards or outwards) only if there is a change in the entire/whole supply schedule as a result of a change in any factor other than the price of the good.The most important non-price supply-influencing factors are costs of production, prices of related goods or services, number of sellers or producers, technology and productivity, expected future prices, government taxes, and unexpected events. Similar to the demand-influencing factors, they are sometimes called the conditions of supply or supply determinants.

A change in any one of the supply non-price determinants will change the entire supply schedule and shift the supply curve either to the left or to the right. In the diagram above (See Fig.4) a decrease in the entire supply has shifted the supply curve SS to the left, the new supply curve being S2S2. An outward supply curve shift (i.e. a shift to the right) taking the curve to S1S1 reflects a corresponding increase in supply at each and every supply price level.

(12) Individual, market, and aggregate supply.As with individual demand, an individual supply for a particular good or service refers to the quantity of a good a producer/seller is willing and able to produce/sell at all possible prices within a period of time, with all other factors remaining constant. The market supply is simply the horizontal sum /the sum total of the individual supplies within the marketplace or, to put it another way, the sum of the amounts supplied by each of the sellers. Aggregate supply is the total supply of goods and services in the economy during a specific time period.

(13) Elasticity of supply.Price elasticity of supply, or simply elasticity of supply, is the degree of responsivenesswith which quantity supplied changes for a given change in price. It is often referred to as a proportional change in the quantity supplied to a proportional change in price. Elasticity of supply is typically calculated as the percentage change in the quantity supplied of a good divided by the percentage change in the price of the good/in its (own) price.

Similar to demand, if the quantity supplied changes a lot when the price changes a little, the supply is said to be (price) elastic. If the quantity changes little when the prices changes a lot, it is said to be (price) inelastic. The degree of responsiveness of quantity demanded to changes in the product’s price is reflected in the slope of the demand curve: the lower (is) the responsiveness, the steeper (is) the slope. Zero elasticity, or perfectly inelastic supply, is graphically represented as a vertical supply curve.

 

***

Text 5.3

Supply, Demand, Price, and Market Equilibrium:

Putting It All Together


Date: 2015-12-24; view: 916


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