(Microeconomics)

Demand and the Law of Demand

• Demand for a product is the quantity the customers are willing and able to pay for each and every price

• The law of demand states that as price increases, demand for that product decreases (inverse the relationship). When the price of a product increases, the quantity demanded decreases (all other things remain unchanged) and vice versa.

  • The curve also helps identify what price the customers would be willing to pay

Reasons for the Law of Demand

1. Income effect: when prices are low, people are easily able to afford it since their budget would allow it

   • As prices increase, people’s budget would tend to become tighter, as they wouldn’t be willing to spend more on a product

2. Substitution effect: when products price increase, they tend to increase in relative to other products

   • If product A were to become expensive, product B would most likely be cheaper than A

   • Due to the existence of substitutes, customers immediately leave product A for B

3. Diminishing marginal utility: As more units of a product are consumed, the satisfaction/utility it provides tends to decline

   • Apple users would purchase at maximum, a limited phones-they wouldn’t purchase a new iPhone every month since that extra phone would offer them no utility or not as much

Change in Quantity Demanded vs. Change in Demand

• Quantity Demanded: Has an inverse relationship with changes in the price of a particular good.

  • Change in the quantity demanded only occurs due to change in price-movement along the curve

• If product A would become expensive(P2 to P1), the quantity demanded would fall (D2 toD1)

  

• Changes in demand are when the entire curve would shift upwards or downwards

Determinants of Demand

• Determinants of Demand: the factors that cause consumers to buy more or less at the same price; these are substitutes, preferences, population, income, complements, and expectations

  • These are the determinants of demand which are variables causing consumers to buy more or less of a product, irrespective of the price

1. Substitutes Available

   • Two goods would be considered substitutes if an increase in the price of one good causes an increase in demand for the other good

2. Population preference

   • This is the consumer’s taste for a product at any point

   • If consumers like a product, the demand curve for that product shifts upwards and vice versa if they dislike it

   • A good example is when the trend of vegetarianism hit the public, the consumption of plant-based food drastically increased

3. Population/number of consumers

   • The bigger the market for a product, the more likely the demand curve would shift upwards

   • If country A has a low birth rate in a particular year, the demand curve for baby-related products would shift downwards

4. Income

   • Goods are usually categorized into 2 types, inferior and normal

   • Demand tends to decline (shift downwards) for inferior goods with an increase in consumer income

   • Demand for normal goods increases (shifts upwards) with an increase in consumer income

5. Complementary good

   • These goods are purchased separately but used together. The relation here is inverse of that of substitute goods

   • If two products are substitutes, an increase in the price of one good causes demand for the other good to decline as well

6. Expectation

   • Consumer expectation pays a major role in the determination of the price

   • if consumers expect that the price of something would increase in the future, they would buy the product at a larger scale leading to the demand curve shifting upwards

   • A good example would be when government warns of the possible chances of future inflation, leading to people stocking up on goods at their homes

Supply and the Law of Supply

• Quantity Supplied: has a direct relationship with changes in the price of a particular good

  • Since price has a different impact on both buyers and sellers, the supply curve is different than a demand curve

  • The market supply shows the quantity a supplier is willing and able to offer at various prices at a given time

• The law of supply states that when prices increase, the supply increases as well (direct relation)

Reasons for the Law of Supply

1. Rising prices give greater opportunities to suppliers to earn a profit

2. With every additional unit, suppliers face an increase in the marginal cost of production

   • Charging higher prices provides them with the easiest way to cover the cost

   • The vice versa is also true; lower prices wouldn’t provide the incentive to motivate the supplier and thus reduces the quantity of product

Change in Quantity Supplied vs. Change in Supply

• Change in quantity supplied only takes place when price change takes place

• As price increases (P1-P2), the quantity supplied also increases from Q1 to Q2. The change occurs along the supply curve

• Shift in supply is due to the determinants of supply

• Determinants of supply are the factors that influence the supplier to offer more or fewer goods at the same price

DETERMINANTS OF SUPPLY

1. Resource costs and availability

   • The cost of production (land, labor, capital) has an inverse impact on the supply

   • When the cost of these increases, the supplier decides to produce less of the products since he is unable to afford the production cost

2. Other goods and services

   • Suppliers who produce more than one product (profit-maximizing firms) have an easier time switching to the production of another product if issues do arise in prices

3. Technology

   • Newer technology causes the cost of production to decline and helps improve the efficiency of the supplier

   • This allows the supplier to produce more, shifting the supply curve outwards(toward right)

   • E.g. machines on the production line help reduce unit costs due to which more products are affordable by the supplier

4. Taxes and Subsidies

   • Taxes are added up to the unit cost of production, thus making it more expensive

   • Due to this, heavily taxed products are produced in less quantity by suppliers(supply curve shifts towards left)

   • Subsidies are the opposite of taxes and help reduce price per unit

   • This allows suppliers to produce more of the product(supply curve shifts towards the right)

5. Expectation

   • If suppliers expect prices to increase in the future, they would hold back supply for the current time with the future goal of earning more profit later (and vice versa)

6. Number of sellers

   • As the number of sellers increases in the market, the supply automatically increases

   • This allows consumers more choices at a lower price due to an increase in competition

MARKET EQUILIBRIUM: SUPPLY AND DEMAND TOGETHER

• The market equilibrium price is that price which the market sets, where buyers buy the exact amount which the sellers are willing to produce. It’s also known as market-clearing price

• The Equilibrium Price: price at which quantity supplied equals quantity demanded

  • A surplus would only exist when the quantity supplied is greater than the quantity demanded

  • A shortage would only exist when the quantity demanded is greater than the quantity supplied

• In a competitive market where a surplus exists, prices eventually fall back to the equilibrium

  • In a competitive market where a shortage exists, prices eventually get pulled back up to equilibrium. This is because the shortage creates more demand from buyers

  • The suppliers utilize this and supply more at higher prices, thus bringing prices back up

• Disequilibrium:This occurs when there is a shortage or surplus in the market. This surplus is what creates market disequilibrium

Changes in Equilibrium

• Supply increases towards the right and decreases towards left

• Demand increases towards the right (moves upwards) and decreases towards the left (moves downwards)

• Just shift it, noting your new equilibrium price and quantity

  • General Rules:

    • When supply is constant and only demand increases, equilibrium price and quantity increases

    • When supply is constant and only demand decreases, equilibrium price and quantity decreases

    • When demand is constant and only supply increases, equilibrium price and quantity decreases

    • When demand is constant and only supply decreases, equilibrium price and quantity increases

The Double-Shift Rule

• Double-shift rule: This rule states that when there is a simultaneous shift in both demand and supply, either price or quantity would stay indeterminate