Topic 3 - Supply and Demand: an Introduction

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Supply And Demand

Central Planning Vs. Market (Unplanned)

  • Centralised - Decisions made by an individual or small group on behalf of a larger group (e.g. by a government)
  • Unplanned/Free Market - Individual in private markets decide what products to buy or produce

Most modern industrial countries are ‘mixed’ where goods and services are allocated by free markets to a large extent but with regulation

  • Free markets tend to assign production tasks & consumption benefits more effectively, but there is a need for regulation as demonstrated by the GFC.

Markets

Buyers and Sellers need trade because most people specialise in a certain are and are not self sufficient.

A 'market is a set of conditions that allows willing & able buyers & sellers to exchange goods and services. the price is determined by both supply (production costs + other factors) and demand (value to consumer).

SD3.jpg

[1]

The Demand Curve

The Demand Curve is a representation of the relationship between the amount of a particular good or service that buyers want to purchase in a given period and the price of that goods or service. [2]

Assumptions - ceteris paribus, to isolate the relationship between price and demand

Law of Demand - demand rises as price falls, causing a downward sloping demand curve

  • Income Effect - a price increase (decrease) reduces (increases) purchasing power/real income, leaving extra income to purchase higher quantities
  • Substitution Effect - price increases will cause people to switch to alternatives

Factors Causing Shifts In Demand

  • Changes in the prices of other goods - Complements and Substitutes
  • Changes in Income - Normal Goods and Inferior Goods
  • Changes in Tastes and Preferences
  • Changes in Population
  • Expectations of Changing Future Prices or Future Products

The Supply Curve

The Supply Curve is a representation of the relationship between the amount of a particular good or service that sellers want to supply in a given period of time and the price of that good or service. [3]

Assumptions - ceteris paribus, to isolate the relationship between price and supply

Law of Supply - supply rises as price rises as more people will be willing and able to supply (vice versa) causing an upward sloping supply curve

  • Principle of Increasing Opportunity Costs: At higher prices more people will be willing and able to supply as the price becomes higher than most peoples opportunity costs.

Factors Causing Shifts in Supply

  • Changes in Costs of Inputs
  • Changes in Technology
  • Weather – Especially for Agricultural Goods
  • Number of Producers
  • Expectations of Changes in Future Prices

Market Equilibrium

[4]

Equilibrium refers to a stable, balance or unchanging situation where demand is equal to supply.

  • If Market Price > Equilibrium Price
    • Supply > Demand = Surplus
      • Sellers become frustrated and start lowering the price incrementally until excess supply is cleared
  • If Market Price < Equilibrium Price
    • Supply < Demand = Shortage
      • Buyers become frustrated and start to offer higher prices incrementally until the shortage is supplied.

Price Ceiling And Price Floors

  • Price Floor - when the price is set up above the equilibrium price creating a surplus of supply
  • Price Ceiling - when the price is set below the equilibrium price causing a shortage of supply
    • Example [5]
      • Rental Housing - Equilibrium = 200,000 Apartments at $1600/mth
        • Legislators enact a price ceiling of $800/mth to help the homeless
          • Supply shrinks to 100,000 creating a shortage and now MORE people cannot get accommodation
            • encourages devious strategies and black markets as there are unexploited mutually beneficial opportunities (cash on the table) and empowers landlords

Markets And Social Welfare

Invisible Hand Principle - Markets deliver information to producer how to allocate resources. Prices tell producers how much consumers value the good/service, while inform the consumer about the opportunity costs of supplying

  • Consumer Surplus = Buyer Reservation Price - Price
  • Producer Surplus = Seller Reservation Price - Price
  • Total Economic Surplus = Consumer + Producer Surplus

References

  1. http://2.bp.blogspot.com/-e9ZGCPOWEEc/TdrIpLaB_II/AAAAAAAAAEE/YH7r_Jz_0bo/s1600/supply%2Bdemand%2Bequi1.gif
  2. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  3. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  4. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
  5. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
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