Fred E. Foldvary

Chapter 4 Supply and Demand

The answer to all economic questions is "supply and demand." Not!

These are tools of analysis in determining the answers.

For example, the answer to "why is there unemployment" is not "supply and demand."

What does demand mean?

from French, to ask. Je demande. Nous demandons. To ask.

In economics, demand means:

a schedule or list of prices, and of quantities purchased at those prices, holding other things constant.

A schedule here means a list of prices and quantities.

"Demand" refers to the entire schedule.

Quantity demanded is one entry in the schedule.

The demand curve is a graphical representation of the schedule,

a locus of points with price on the vertical and quantity on the horizontal axis.

By mathematical convention, price is the independent variable.

The demand is the entire curve.

A point on the curve is the "quantity demanded."

Here is a question, regarding demand:

If tuition were eliminated and classes were free, would there be a change in demand to attend SCU?

The answer is, no change in demand. There is a change in quantity demanded.

A shift in demand is a movement of the whole curve.

Can be caused by changes in income, tastes, the prices of other goods, taxes, and expectations of future prices and quantities.

Price as the independent variable on the vertical axis is backwards from usual math convention of independent variable on the horizontal axis.

Alfred Marshall had quantity as independent, and the price for additional goods as the dependent variable on the verticle axis.

But consumers are normally confronted by prices, and decide on quantity. So the convention now is price as independent variable.

Notional demand: desire. Effective demand: desire plus cash, actual purchase at a price.

Demand refers to effective demand.

Individual demand is the quantities of a good which someone desires at various prices at some moment or duration in time.

Market demand: sum of individual demands

Added horizontally for individually-consumed goods, to get total quantity,

vertically for a collective good to get total price.

Major principle: human desires tend to be unlimited.

Implication #1: there is always a demand for something.

Implication #2: there is no such thing as too many goods overall.

The demand for X: the purchase of X at some price during some time.

Demand schedule: for certain prices, certain Qs bought.

We can concisely describe this function as: q = f(p), quantity bought is a function of price.

The law of demand: demand curves never slope up.

Usually, demand curves slope down.

The quantity demanded increases as price decreases.

Ceteris paribus, keeping all else equal.

It is possible that if the price of a good is too low, fewer people will buy it, because they perceive it to be a different type of good - inferior. Suspicious if price lower than normal.

Snob goods might sell better at a higher price becaue it is perceived as a different type of good.

The law of demand pertains to the same physical and mental good at different prices.

What ultimately determines demand is the subjective value of a good, and what makes it a particular good is our subjective perception.

The demand also depends on the expected future price and availability of the good.

You buy more now if you expect the price to go up or if you expect the good to be gone or difficult to get in the future.

Normal assumption: future price equals present price, and the good will be available.

Individual demand can be vertical for addiction.

horizontal demand: buy as much as possible at some price.

applies to markets, not individuals.

In a market with many producers of an identical good, the market demand seen by each firm is horizontal.

Price up, quantity down. Inverse relationship. Why?

Diminishing marginal utility.

"Utility" is the importance we place on goods, or the satisfaction or usefulness we get from goods

With a greater quantity of a good, eventually extra amounts have less and less utility.

Consumers then obtain other goods rather than the same good.

Quantity of goods demanded can be of two types.

For flows, goods in continuous production and consumption, the quantity is an amount per unit of time. q/t.

For example, the demand for oranges is a certain amount per week or month.

The other type of good is a stock, a certain quantity at one moment of time.

For example, the demand for a certain rare stamp is that of a stock. q at time t0.

Supply

A supply schedule is a list of prices for a commodity and the amounts produced at those prices, at some moment or duration in time.

Te supply of a good is the amounts produced at particular prices, or some supply schedule.

A supply curve is a line drawn through the points of a supply schedule in a graph, with the prices on the vertical axis.

The quantity supplied is a point on the supply curve, the amount supplied at some price.

The supply is vertical for goods of fixed supply.

Otherwise, supply curves for a particular production method slopes up.

Law of supply presumes production process not change.

Supply curves slope up, because producers must draw resources away from other uses in order to supply more, and the cost of the resources increases with quantity, since the resources have less

and less of a comparative advantage to the industry to which they are shifted.

As marginal cost increases, profit decreases, and eventually, producers will produce a different good rather than more of the same good.

What is a change in supply? A shift of the schedule or curve.

What causes a change in supply?

Technology. Input prices. Prices of other goods. Expectations. Taxes & subsidies.

Subsidy: reduces the cost, so increases supply.

Taxes: increase the cost, so reduces supply.

Market supply curve from individual curves.

Supply & demand curves. Where they cross, the market clears.

Equilibration: the tendency of markets to exhaust gains from trade.

An equilibrium at a moment in time is a situation in which the gains from trade have become exhausted.

In equilibrium, trade stops.

Individuals who trade are always in disequilibrium, even though the market price is at equilibrium.

Buyer gains, exchanging money for goods.

Seller gains exchanging goods for money.

At equilibrium, q supplied = q demanded.

If price > market clearing, surplus.

Market price falls. Profits fall. Firms reduce output.

If price < market clearing, shortage.

Market price rises. Profits rise. Firms increase output.

Hence, quantities and prices tend to move to equilibrium.

Price obtained by seller = price paid by buyer in a pure market.

But the invisible hand can be blocked and distorted by the visible fist.

Political forces also operate.

Price support, floor: price > marginal market price.

Example: minimum wage.

Result is a labor surplus, or unemployment.

Net wages of all workers are also reduced to pay for unemployment compensation and welfare.

Prices of goods rise as costs get passed on to consumers.

Q: what would be a more effective way to increase the wages of the poor?

Rent control, price ceiling: price < marginal market price.

It's really a rental control of all the factors, land, labor, and capital, of the owner.

Land rent cannot be reduced by legislation. Why?

One can only control the legal rental paid by tenants.

It would be better to call it a control of the legal rental.

The landlord is also a capital lord and a worker lord.

The result is a shortage. Waiting lists.

Can lead to underground or black market if due to controls.

Landlords are better able to discriminate.

Lower profits from capital goods lead to fewer apartments built and reduced maintenace.

Rent controls lead to housing shortages, underground markets, deteriorating structures, a stoppage of construction, big inequalities.

Effect of excise taxes: shifts supply of goods to the left.

Also income, sales taxes, tariffs, taxes on capital goods.

Increases price, reduces quantity, hence employment.

This creates an excess burden, beyond the tax paid, in reduced output and well-being.