Demand and Supply

microfoundations

Demand, Supply and Market Equilibrium

OUTPUT

MARKETS

FACTOR

MARKETS

HouseholdsFirms

(Goods and services)

(Land, Labor and Capital)

On Demand...

• The price of the product.

• The household’s income and wealth.

• The price of available alternatives.

• Tastes and preferences

• Expectations about future prices, income and wealth.

What factors affect demand and quantity demanded?

Some Distinctions

• Quantity Demanded (or Supplied)

• Refers to the amount of a specific good that you are

willing to buy (or supply) at a given price.

• Demand (or Supply)

• Pertains to the general relationship between price and

quantities demanded (or supplied), for all prices.

Before getting into demand and supply analysis.

A Demand ScheduleQuantity demanded for varying prices.

DEMAND SCHEDULE FOR PHONE CALLS

Price Per Call Qty. of Calls Demanded

$0 30

0.50 25

3.50 7

7.00 3

10.00 1

15.00 0

$0

$2.5

$5.0

$7.5

$10.0

$12.5

$15.0

0 1 3 7 25 30

Demand Curve for Phone Calls

p

q

Demand Curves in GeneralSome notes on demand curves.

PRICE (p)

QUANTITY (q)

d

Demand: Beyond Price

• Given a demand curve, when prices change we merely

move along the demand curve to ascertain quantity

demanded.

• That is, the demand curve stays in place.

• If anything else other than price changes, then what occurs

is a shift of the demand curve.

• In such a situation, the entire demand curve will change

position.

What happens if we consider the other factors that affect demand?

Shifting Demand Curves

• Household Income and Wealth

• Income: a measure of a household’s earnings in a given

period (a flow variable).

• Wealth: the total of what a household owns less what it

owes (a stock variable).

• If the good is normal, the household will buy more of it as

income/wealth rises, and less if it falls.

• If the good is inferior, the household will buy less of it as

income/wealth rises, but more if it falls.

The demand curve shifts depending upon what factor affecting demand changes.

PRICE (p)

QUANTITY (q)

d

Given: Demand Curve

PRICE (p)

QUANTITY (q)

d

If the good is normal, an increase in income shifts the curve outward.

d’

PRICE (p)

QUANTITY (q)

d

If the good is normal, an increase in income shifts the curve outward.

d’

If the good is inferior, an increase in income shifts the curve inward.

Shifting Demand Curves

• The prices of alternative (related) products

• Substitutes: Goods that can replace the good in

question.

• Complements: Goods that we typically buy together with

the good under consideration.

• As the price of substitutes increase, we will buy more of our

product.

• As the price of complementary goods increase, we will buy

less of our product.

PRICE (p)

QUANTITY (q)

d

Given: Demand Curve

PRICE (p)

QUANTITY (q)

d

If the price of substitutes go up, it makes more sense to stick with the current good, hence the demand curve shifts outwards.

d’

PRICE (p)

QUANTITY (q)

d

If the price of substitutes go up, it makes more sense to stick with the current good, hence the demand curve shifts outwards.

d’

If the price of complementary goods go up, we have less to spend on the current good matching it, hence the demand curve shifts inwards.

Shifting Demand Curves

• Tastes and preferences

• These will affect the demand curve depending on

whether they favor the good or not.

• Examples: fashion trends, peak season travel, dietary

fads.

• Expectations of future prices, income and wealth

Shorthand SummaryShifts in the demand curve at-a-glance.

If the following changes:The shift in the demand

curve will be...

Price of substitutes Same direction

Price of complements Opposite direction

Income and wealth, and the good is normal

Same direction

Income and wealth, and the good is inferior

Opposite direction

Tastes, preferences and future expectations

Depends

Individual vs. Market DemandGetting to the bigger picture.

$1.00

$1.50

$2.00

a

4

2

1

b

3

2

1

c

6

5

2

TOTAL

13

10

4

P

Q

D

Market Demand Curve

In Supply...

• The possible selling price (revenue and profit potential).

• The marginal cost of production.

• Price of required inputs.

• Technology.

• Price of related products.

What factors affect supply and quantity supplies?

A Supply ScheduleQuantity supplied at varying prices.

SUPPLY SCHEDULE FOR SOYBEANS

Price Per Bushel Qty. Supplied Per Year

$1.50 0

1.75 10,000

2.25 20,000

3.00 30,000

4.00 45,000

5.00 45,000

$0.5

$1.0

$1.5

$2.0

$2.5

$3.0

$3.5

$4.0

0 10,000 20,000 30,000 45,000

Supply Curve for Soybeans

p

q

Supply Curves in GeneralSome notes on demand curves.

PRICE (p)

QUANTITY (q)

s

Supply: Beyond Price

• Given a supply curve, when prices change we merely move

along the supply curve to ascertain quantity supplied.

• That is, the supply curve stays in place.

• If anything else other than price changes, then what occurs

is a shift of the supply curve.

• In such a situation, the entire supply curve will change

position.

What happens if we consider the other factors that affect supply?

Shifting Supply Curves

• Cost of production

• If input costs suddenly rise, less of a product can be

produced.

• If production technologies improve, more of a product

can be supplied.

• Price of related goods

The supply curve shifts depending upon what factor affecting supply changes.

PRICE (p)

QUANTITY (q)

s

Given: Supply Curve

PRICE (p)

QUANTITY (q)

s

When the cost of production rises, the supply curve shifts inward.

s’

PRICE (p)

QUANTITY (q)

s

When the cost of production rises, the supply curve shifts inward.

If production technologies improve, the supply curve shifts outward.

s’

Shorthand SummaryShifts in the supply curve at-a-glance.

If the following changes:The shift in the supply

curve will be...

Cost of inputs Opposite direction

Technology Same direction

Price of related goods Depends

Individual vs. Market SupplyGetting to the bigger picture.

$1.00

$1.50

$2.00

x

20

31

50

y

33

46

61

z

18

27

39

TOTAL

71

104

150

P

Q

S

Market Supply Curve

P

Q

Market Equilibrium:Where Quantity Demanded equals Quantity Supplied.

Qs

Qd

P

Q

Market Equilibrium:Where Quantity Demanded equals Quantity Supplied.

E

Qs

Qd