Demand
Demand refers to the amount of a good or service that consumers are willing and able to purchase at each price.
Price refers to what the buyer pays for a unit of the good or service.
The quantity demanded is the total number of units consumers are willing to buy at some price.
The law of demand says that, assuming price as the only variable, the quantity demanded decreases inversely proportional to price.
Demand schedules are tables showing the quantity demanded at each price.
| Price (per box) | Quantity Demanded (1000s) |
|---|---|
| $2.50 | 250 |
| $3.00 | 200 |
| $3.50 | 150 |
| $4.00 | 100 |
The above demand schedule can be graphed as a demand curve, with price on the y-axis and quantity demanded on the x-axis. This is opposite to how graphs are done in mathematics.
Supply
Supply refers to the amount of a good or service that producers are willing and able to supply at each price.
The quantity supplied is the total number of units producers are willing to supply at some price.
The law of supply says that, assuming price as the only variable, the quantity supplied increases proportional to price.
Equilibrium
On a graph showing both the demand curve and the supply curve, the point where they intersect is called the equilibrium point. This means that the quantity suppliers are willing to produce match the quantity consumers are willing to purchase, with no surplus or shortage.
When the price is above the equilibrium, there is too much supply. The excess supply is called a surplus.
When the price is below the equilibrium, there is too little supply. This is called a shortage.
Ceteris Paribus
Demand curves and supply curves examine the relationship between two and only two variables, keeping all other factors constant. This is called ceteris paribus.
Factors Affecting Demand
The demand curve shifts to the right when demand increases and vice versa.
Normal goods: demand increases as income increases
Inferior goods: demand decreases as income increases
Substitutes: used in place of one another
Complements: consumed together
Demand-Increasing ()
- popularity rises
- customer population rises
- income rises for normal goods
- substitute price rises
- complement price falls
- encouraging future expectations
Demand-Decreasing ()
- popularity falls
- customer population falls
- income falls for normal goods
- substitute price falls
- complement price rises
- discouraging future expectations
Factors Affecting Supply
The things used to produce a good or service, including labour, materials, etc., are called inputs.
Supply-Increasing ()
- favourable conditions
- input prices fall
- technological improvements
- lower taxes/regulation changes
Supply-Decreasing ()
- poor conditions
- input prices rise
- decline in technology
- higher taxes/regulation changes
The Four-Step Process
- Draw the supply and demand model before the change
- Decide whether change affects supply or demand
- Decide whether change shifts the curve to the left or to the right
- Identify the new equilibrium
Price Controls
Price controls refer to legislation used to regulate prices.
Price ceilings prevent prices from rising above a ceiling. Since ceilings are set below the equilibrium, demand exceeds supply, creating a shortage.
Price floors prevent prices from falling below a floor. Since floors are set above the equilibrium, supply exceeds demand, creating a surplus.
Ceilings set above the equilibrium or floors set below the equilibrium are non-binding, as they have no impact.
Surplus
Consumer surplus is the area bounded by the x-axis at the equilibrium price and the demand curve. This is the total difference between what some consumers were willing to pay versus what they actually paid.
Producer surplus is the area bounded by the x-axis at the equilibrium price and the supply curve. This is the total difference between price at what some suppliers were willing sell at versus what they actually sold.
Social surplus is the sum of the consumer surplus and the producer surplus. Social surplus demonstrates market efficiency, since surplus is maximized for both consumers and producers at the equilibrium.
Deadweight Loss
Price ceilings transfer some surplus from producers to consumers, creating a greater consumer surplus. However, ceilings reduce the total surplus.
Price floors transfer some surplus from consumers to producers, creating a greater consumer surplus. However, floors reduce the total surplus.
The difference between the surplus at equilibrium and the surplus with price controls is called deadweight loss. Deadweight loss demonstrates the economic inefficiencies of market interventions, since it benefits neither consumers nor producers.