Students Again

Demand Schedule – This is what it is called when we list the number of units people would be willing to purchase at each of a list of prices. Each combination of a particular price and its resultant quantity demanded represents a single point on a demand curve.

Law of Demand – Not surprisingly, if we look at our demand schedule, we find that as we increase the price, people (consumers) will buy less of the product. This shouldn’t come as any surprise since we spend our lives looking for deals and watching people line up outside of stores the day after Christmas for the big clearance sales.

As Price rises, QD falls ---- or --- As Price falls , QD rises

Demand Curve – If we put the data from the demand schedule on a graph with price on the vertical axis and quantity on the horizontal axis – the resulting curve is the demand curve. Demand is the entire curve – not just one spot. Therefore, if we move from one spot on the demand curve to another spot on the demand curve – this is a change in quantity demanded – BUT NOT a change in demand. If something changes the relationship between prices and their corresponding quantities demanded, then that would be a change in demand (as well as a change in quantity demanded).

Moving from point “A” to point “B” is the result of a price change. The relationship between price and quantity demanded is unchanged – therefore, this is not a change in demand.

Movement from C to D is a change in the relationship between the Price P1 and the quantity demanded.

Demand – The term “demand” refers to the relationship between all the possible prices and the levels of quantity demanded that relate to each. In this way, the entire demand schedule would be demand – or the entire demand curve. If the curve does not move or if we don’t re-write the demand schedule, then it is not a change in demand.

Quantity Demanded – The number of units desired at a particular price. Each point on a demand curve represents the quantity  demanded at that price. Each line on a demand schedule represents a price and its resultant quantity demanded.

Equation of Demand – a mathematical shorthand depicting the various things that might effect the quantity demanded.

QD = ƒ(Price; …..)

We would read this as “The quantity demand of our product is a function of Price and…..”. We list Price first because it is different  from the rest of the things that effect QD because changes in Price only cause a change in quantity demanded. The rest of the things we would put into the equation (which we will get to later) all cause a change in demand as well. These are the things that would be  held constant in order to see what the relationship between price and quantity demanded was in the first place. This is the Ceteris Peribus stuff we talked about earlier in the class.

Price Change = movement along the demand curve

Other things equal: These are the items that come after Price in the demand equation. A change in any of these will cause a shift in the demand curve (like in the second graph above.

• Tastes and Preferences – This category includes all the things that change one’s desire for a product (other than price) – like advertising, past experience with a product including brand loyalty, slogans, consumer reports, findings from educational or medical journals etc.
• Price of a substitute – If the price of another good that we view as being similar was to change, it could effect the number of units we would buy of our first product. For example, if we were studying the market for Coca-Cola and the price of Pepsi was reduced, people might buy more Pepsi (Law of Demand) but they might also buy less Coca-Cola as a result. This happens because we, as consumers, see these products are roughly interchangeable. So even though the price of Coca-Cola didn’t change, we get a new QD. This is just what might cause the movement from “C” to “D” we saw above.
• Price of compliments – Compliments are goods we use together – like peanut butter and jelly. When the price of peanut butter rises, we buy less Peanut butter (Law of Demand), but we also will buy less jelly since we use these products together.
• Population – As the population increases, we buy more of everything, even if prices do not change.- Income – The more money we make (income), the more of a product we would normally buy, because we can afford more. Actually, it depends on how we view the product…
  • Normal goods – these products are the ones that we buy more of as our incomes rise. This could be Cadillacs, or clothes or concert
    tickets.
  • Inferior goods – these products we actually buy less of as our income grows because we can now afford a product that we perceive as being a better product to meet that need. For example, we buy less Spam as we can afford more prime rib. There are lots of these products, from Big K cola, to Yugo automobiles, to hamburger helper.
• Wealth – Economists use the term income and wealth differently. We use income to represent new money (money coming in) and wealth to mean money we already have. They both effect effect our spending behavior in the same way. The more money we have, the more we spend.
• Expectations of consumers – this is a bit of a catch all to show that if a consumer expects something to change (like their income, wealth, the prices of compliments, substitute or the product itself) they may change their current behavior. It doesn’t even matter if they are right, as long as they change their spending behavior based on the belief.

This makes the final Demand Equation look like:

QD = ƒ(Price; Tastes and Preferences, Income, Wealth, PCOMP, PSUBST, Population, Expectations of Consumers)

Supply Schedule - Much like the Demand Schedule, this is a list of prices and their resultant quantities supplied. It traces out the  points on the Supply Curve.

Supply Curve – This is the resultant upward sloping curve from plotting the points from the supply schedule. The entire Curve is supply. Each point would be a line from the supply schedule.

Supply - The entire relationship between the set of prices and the number of units of product that a supplier is willing to produce.

Law of Supply – As with demand, the relationship between quantity supplied and price is predictable. In fact it is so predictable, that the relationship is referred to as a law – the Law of Supply. The Law simply says that as price rises, quantity supplied rises.

As P rises, QS rises ---- or ------ As P falls, QS falls

Quantity Supplied – The number of units produced at a particular price. Equivalent to a line on the supply schedule or a point on the  supply curve.

Equation of Supply – Again, this is a mathematical shorthand for the list of things that effect the supply curve – including Price. The  rest of the factors that effect supply are listed below.

QS = ƒ(Price; …..)

Price – movement along the supply curve – A change in the price a supplier would receive for his output, would change how much the supplier would be willing to produce.

Other things equal (shifts in the supply curve):

• Price of other goods – Unlike in the demand equation, the other goods this refers to is not another good they could have bought,  but rather another good they could have produced. The best example would be if we think of a corn farmer who reacts to a change in the price of wheat. If he thinks wheat prices are going up, he may plant more wheat – and thus less corn. As the price of the other goods rises, we expect the supply of this good to fall.
• Price of inputs – there are three main inputs – also known as the factors of production, or scarce resources. As the price of any of them rises, producers will scale back production and supply falls.
  • Price of labor (wages – P_L) -
  • Price of land (rent – P_A) -
  • Price of capital (interest – P_K) –
• International effects – The international effects that would effect supply include anything that would effect exports or imports – like trade agreements (NAFTA) or tariffs, embargoes, quotas - and even exchange rates.
• Number of Producers – all other things equal, an increase in the number of corn farmers causes the supply of corn to rise.
• Technology – new technology is always cost saving (otherwise it would not be adopted). There are two types of technological advances – innovations and inventions.
  • Invention – these are new products – like the advent of the automobile. Technological advances of this type make some products obsolete and create new markets for others.
  • Innovation – these are new ways of doing things – like the assembly line, that make production easier, faster, more efficient. This allows the same resources to go farther, or for the same number of outputs to be made with fewer inputs.

In all, the supply equation ends up looking like this:

QS = ƒ(Price; PL, PK, PA, POTHER GOODS, International Effects, #Prods, Technology)

Putting the supply curve and demand curve of the same graphs gets you this:

Equilibrium – This is the point where the Supply Curve and the Demand Curve meet. Markets always tend towards equilibrium –  (although its possible that government intervention could keep a market from actually getting there). If the market is barrier free and the price is too high, producers, acting in their own rational self-interest, will reduce the price to the equilibrium price. If the price is too low, consumers, through competition for scarce outputs will bid he price up to equilibrium.

As the graph below shows, a price higher then the equilibrium price will cause producers to produce QS outputs when consumers are only wiling to buy QD at that price.

The gap between QS and QD is excess supply. Producers would have to store excess production - and that costs money. To avoid  those costs, they instead choose to lower the price knowing that, by the law of demand, consumers will then buy more.

The graph below shows how an initial price that is too low, will also naturally tend towards the equilibrium price.

The gap between QS and QD is excess demand. Not only would thee be stock-outs at the store (leaving customers mad that they could not get the product) but secondary markets would be re-selling the product at a higher price (like beanie babies were being re-sold). Producers eventually raise the price in response to un-met demand until the excess demand is gone.

Finally, there are the programs that could keep the price from getting to equilibrium. These are Price Ceilings and Price Floors.

Price Ceilings – Price ceilings are legal barriers to prices rising too high. Usually, the choice of barrier level is political – not economic. Since the barrier is not allowed to rise all the way to the equilibrium price the excess demand is perpetual (QD > QS). This is what happened to apartments in NYC and to power plants in California. The demand continuously out paces supply – leading to shortages of apartments in NYC and to rolling blackouts in California.

The gap between QS and QD is caused by the Price Ceiling (PC). Since the barrier exists, the market can not get to equilibrium, so the excess demand will remain. There will perpetually be a shortage of this item.

Price Floors – Price floors are minimum prices – even if the market would predict a lower price. As in the graph below, there continues to be excess supply and prices are not allowed below PF (the price floor) to increase the QD.

The price Floor does not allow a price lower than this.