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Econ 10A, Chapter 4 Notes

by: Devon Black

Econ 10A, Chapter 4 Notes Econ 10A

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Devon Black
Harvard University

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Supply and Demand
Principles of Economics
N. Gregory Mankiw
Class Notes
supply, demand, equilibrium pricing, market equilibrium, Microeconomics, econonomics
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This 6 page Class Notes was uploaded by Devon Black on Wednesday September 14, 2016. The Class Notes belongs to Econ 10A at Harvard University taught by N. Gregory Mankiw in Fall 2016. Since its upload, it has received 5 views. For similar materials see Principles of Economics in Economics at Harvard University.

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Date Created: 09/14/16
Principles of Economics, 7 thed. Chapter 4: The Market Forces of Supply and Demand I) Markets and Competition A) What is a Market? 1) Buyers determine demand 2) Sellers determine supply 3) Some markets are highly organized (a) E.g. most agricultural commodities markets (1) Meet at a specific place and time where an auctioneer helps set prices and arrange sales 4) Most markets are disorganized (a) Don’t all meet together (b) Buy and sell different products at different times in different places (c) Closely connected since the sellers are appealing to the same group of buyers B) What is Competition? 1) Competitive markets have enough buyers and sellers that each individual one has little to no impact on the market price 2) Perfectly competitive markets (a) Goods offered for sale are all exactly the same (b) Enough buyers and sellers that no individual can impact the market price (c) Buyers and sellers are called price takers because they have to accept the price that the market determines (d) Ex: wheat market 3) Monopoly: only one seller who then determines the price (a) Not competitive II) Demand A) The Demand Curve: The Relationship between Price and Quantity Demanded 1) Price determines how much people are willing to buy of a product (a) Demand Curve slopes downward since the lower the price, the more of it people are willing to buy B) Market Demand versus Individual Demand 1) Market demand is the sum of all the individual buyer’s demands Demands of Ice Cream 20 18 16 14 12 10 8 6 4 2 00 0.5 1 1.5 2 2.5 3 Catherine's Demand Nicholas's Demand Market's Demand 2) C) Shifts in the Demand Curve 1) Market demand curve not stable over time since it holds other factors constant (a) If the quantity demanded of a product shifts, so does the demand curve (1) If doctors said ice cream gave us longer healthier live, the entire curve would shift upwards because people would be willing to eat more ice cream, no matter the price 2) Increase in demand: shifts the demand curve to the right 3) Decrease in demand: reduces the quantity demanded at every price and shifts the demand curve to the left 4) Income (a) If you lost your summer job, your demand for ice cream would probably decrease since you have less money (b) Example of inferior good: if your income rises, you might become less inclined to take the bus, now being able to take a taxi instead 5) Prices of Related Goods (a) Froyo price falls  eat more froyo  eat less ice cream (b) Related goods satisfy similar desires = substitutes (c) Hot fudge price falls  buy more hot fudge  buy more ice cream (1) Usually eaten together = complements (i) E.g. gas and cars, computers and software, and peanut butter and jelly 6) Tastes (a) Prices can only make you buy so much of an item if you don’t like all that much 7) Expectations (a) If you expect more money later, you spend more now and vice versa 8) Number of Buyers (a) More buyers  higher quantity demanded at every price  higher market demand 9) Summary (a) Demand curve only shows what happens when price changes, keeping income, price of related goods, tastes, expectations, and number of buyers the same (1) All of those shift the demand curve III) Supply A) The Supply Curve: The Relationship between Price and Quantity Supplied 1) Price plays a big role in determining the quantity supplied (a) Profits allow sellers to buy more technology/workers that allow them to create more of the good (b) Low prices can lead to shut downs at which point the quantity supplied is zero (c) Supply schedule visualizes this (d) If the supply curve slopes upward, then, other things being held constant, a higher price means a greater quantity supplied B) Market Supply versus Individual Supply 1) Market supply is the sum of the supplies of all sellers 2) Market supply curve shows the relationship between the total quantity supplied and the price, with everything else held constant C) Shifts in the Supply Curve 1) Increase in supply: Any change that raises quantity supplied at every price (e.g. fall in the price of sugar for making ice cream) shifts the supply curve to the right (a) Vice versa for decrease in supply 2) Input Prices (a) As in the increase in supply example above, you need multiple inputs (sugar, cream, etc.) to make ice cream – any increase in price for these inputs reduces the profitability of making ice cream and resulting in a smaller supply of it 3) Technology (a) Technology often reduces costs (e.g. ice cream machine instead of manual ice cream maker), thus increasing the profitability of making ice cream 4) Expectations (a) If the firm expects the price of ice cream to rise in the future, then it will produce less now and place current ice cream into storage so as to be able to sell more ice cream later at the higher price 5) Number of Sellers (a) More sellers = more supply IV) Supply and Demand Together A) Equilibrium 1) in which q* is the equilibrium quantity and p* is the equilibrium price 2) Equilibrium price is also known as the market-clearing price because everyone in the market has been satisfied 3) Steps of getting equilibrium from a surplus (a) Quantity supplied > quantity demanded = surplus (b) Cut prices of good (c) Falling prices increase quantity demanded and decrease quantity supplied (1) Changes happen along supply and demand curves, not shifts in the curves (d) Prices continue to fall until equilibrium is reached 4) Steps of getting equilibrium from a shortage (a) Quantity demanded > quantity supplied = shortage (b) Suppliers raise prices without losing sales because qd > qs (c) Quantity demanded falls due to price increase (d) Quantity supplied rises due to price increase (e) Equilibrium is somehow found (f) Changes happen along the supply and demand curves 5) Most free markets have very short shortages and surpluses since prices eventually move toward their equilibrium levels B) Three Steps to Analyzing Changes in Equilibrium 1) Does the event shift the supply curve, the demand curve, or both? 2) Does the curve shift to the right or to the left? 3) Use the supply and demand diagram to compare the old and new equilibrium 4) Shift in demand (a) Hot weather  more people want more ice cream at any price (1) Supply curve is not affected (2) Demand curve shifts to the right (b) At the old equilibrium of $2, there’s an ice cream surplus, so they raise the price to $2.50 and the increase in demand has shifted the equilibrium quantity from 7 cones to 10 cones 5) Shift in curves versus movements along curves (a) In the previous example, the increase in demand caused ice cream sellers to sell more ice cream but the supply curve stayed the same (1) Increase in quantity supplied but no change in supply (2) The weather did not change the firms’ desire to sell at any price (b) Supply: position of the supply curve (c) Quantity supplied: the amount suppliers are able and willing to sell (d) Change in supply/demand = shift in/of the supply/demand curve (e) Change in quantity supplied/demanded = movement along a fixed curve 6) Change in Market Equilibrium due to a Shift in Supply (a) Hurricane destroys part of the sugarcane crop  higher prices of sugar (1) Change of the price of one of the inputs for ice cream affects the supply curve by making suppliers willing to sell less ice cream at any price (i) Shift (2) Demand curve does not change (b) At the old equilibrium price of $2, there’s an ice cream shortage, so the need for equilibrium forces the price up to $250 and the q* down from 7 cones to 4 cones 7) Shifts in both supply and demand (a) Heat wave and hurricane at the same time (1) Heat wave causes demand curve to shift to the right while the hurricane that destroys part of the sugarcane crop forces the supply curve to the left (b) Two possible outcomes (1) Outcome 1 (i) Price rises (ii) Quantity rises (2) Outcome 2 (i) Price rises (ii) Quantity falls (3) C) Summary: What Happens to Price and Quantity when Supply or Demand Shifts? 1) 2) No Change in 3) Increase in Supply4) Decrease in Supply Supply 5) No Change in 6) P & Q same 7) P down, Q up 8) P up, Q down Demand 9) Increase in 10) P & Q up 11) P 12) P up, Q Demand ambiguous, Q up ambiguous 13) Decrease in14) P & Q 15) P down, Q 16) P Demand down ambiguous ambiguous, Q down V) Conclusion: How Prices Allocate Resources A) Prices determine everything 1) Prices increase after natural disasters Vocabulary Market: a group of buyers and sellers of a particular good or service Competitive Market: a market in which there are many buyers and many sellers so that each has a negligible impact on the market price Quantity Demanded: the amount of a good that buyers are willing and able to purchase Law of Demand: the claim that, other things being equal, the quantity demanded of a good falls when the price of the good rises Demand Schedule: a table that shows the relationship between the price of a good and the quantity demanded Demand Curve: A graph of the relationship between the price of a good and the quantity demanded Normal Good: a good for which, other things being equal, an increase in income leads to an increase in demand Inferior Good: a good for which, other things being equal, an increase in income leads to a decrease in demand Substitutes: two goods for which an increase in the price of one leads to an increase in the demand for the other Complements: two goods for which an increase in the price of one leads to a decrease in the demand for the other Quantity Supplied: the amount of a good that sellers are willing and able to sell Law of Supply: the claim that, other things being equal, the quantity supplied of a good rises when the price of the good rises Supply Schedule: a table that shows the relationship between the price of a good and the quantity supplied Supply Curve: a graph of the relationship between the price of a good and the quantity supplied Equilibrium: a situation in which the market price has reached the level at which quantity supplied equals quantity demanded Equilibrium Price: the price that balances quantity supplied and quantity demanded; AKA market clearing price Equilibrium Quantity: the quantity supplied and the quantity demanded at the equilibrium price Surplus: a situation in which quantity supplied is greater than quantity demanded; AKA excess supply Shortage: a situation in which quantity demanded is greater than quantity supplied; AKA excess demand Law of Supply and Demand: the claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance


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