Supply and Demand

 

Demand

Law of demand: The quantity demanded rises as price falls (for normal goods), other things being constant.

1. Demand curve: A graphical representation of the law of demand. It slopes downward.

2. Movements along the demand curve: A change in price is represented by movements along the demand curve; demand is still the same, but the quantity demanded changes as the price changes.

3. Shifts in demand curve: The demand curve will shift to the left or right when anything other than the price of the good has changed. Such factors include: changes in income, changes in the price of substitute or complement goods, changes in tastes and desires, and changes in expectations about your future income or future price levels.

4. The market demand curve is the horizontal sum of all individual demand curves.

 

Supply

Law of supply: The quantity supplied rises as price rises, other things being constant.

1. Supply curve: A graphical representation of the law of supply. It slopes upward.

2. Movements along the supply curve: A change in price is represented by movements along the supply curve; supply is still the same, but the quantity supplied changes as the price changes.

3. Shifts in supply curve: The supply curve will shift to the left or right when anything other than the price of the good has changed. Such factors include: changes in prices of inputs used in production, changes in technology, changes in supplier expectations about future prices, and changes in taxes and subsidies.

4. The market supply curve is the horizontal sum of all individual supply curves.

 

Market Equilibrium and the Invisible Hand

The invisible hand theory states that prices will adjust to achieve equilibrium; this pricing mechanism coordinates individuals’ decisions so that scarce resources can be put to their best possible use.

1. When quantity supplied exceeds quantity demanded (surplus), prices tend to fall.

2. When quantity demanded exceeds quantity supplied (shortage), prices tend to rise.

3. When the quantity demanded equals the quantity supplied, prices have no tendency to change and the market is in equilibrium.



Supply and Demand

FIGURE 3 Equilibrium occurs at the price where quantity supplied is equal to quantity demanded.

4. Shifting the supply curve to the right (left) causes the equilibrium price to fall (rise) and the equilibrium quantity to rise (fall).

5. Shifting the demand curve to the right (left) causes the equilibrium price to rise (fall) and the equilibrium quantity to rise (fall).

 

Government Involvement in Market Equilibria

1. Price floor: A government-imposed limit on how low a price can be (e.g., the minimum wage).

2. Price ceiling: A government-imposed limit on how high a price can be (e.g., rent control).

3. Taxes, tariffs, and quotas

   1. Excise (sales) tax: A tax levied on a specific good at the time it is purchased.

   2. Income tax: A tax on income. It may be proportional, progressive, or regressive, depending on whether the tax rate stays the same, increases, or decreases as income increases.

   3. Tariff: A tax on imports. Taxes and tariffs raise prices and reduce quantity.

   4. Quota: A limit on how much of a good can be imported or sold in a particular country.