MODULE 5 – SUPPLY AND DEMAND: INTRODUCTION AND DEMAND
NOTE: These notes are not meant to be substitutes for reading the textbook—they are a supplement to the textbook, highlighting and elaborating on some of the issues raised by the authors.
(1) One of the first textbooks I used when I began studying economics had the following quotation at the start of the chapter on supply and demand: “You can make even a parrot into a learned economist—all he must learn are the two words “supply” and “demand”—Anonymous”. Section 2 of the textbook is about the “Supply and Demand Model”, easily the most important model in economics. It is used extensively, not only in microeconomics, but also in ...view middle of the document...
Fortunately, many markets in the real world are competitive. We will be studying mainly competitive markets until we get to Module 25.
(3) The demand for any good (or service) in general depends on many factors:
(a) Price of the good itself: Economists often identify the (current or spot) price of the good in question as the foremost determinant of the demand for that product, but recognize there are other factors that affect demand.
(b) Prices of related goods: Two goods are said to be substitutes for each other if one can be consumed in place of the other (such as butter and margarine)—so, a rise in the price of one good leads to an increase in the demand for the other. Two goods are said to be complements for each other if one is consumed with the other (such as bread and butter)—so, a rise in the price of one good leads to a decrease in the demand for the other.
(c) Income: The demand for most goods increases when income increases. Such goods (examples are lattes, travel, brand-name products, and fine-dining) are said to be normal goods. But there are some goods that people buy less (more) of when their income rises (falls), such as hamburger, generics and store-brand products, and fast-food. These are called inferior goods.
(d) Tastes: Tastes can be influenced by advertising, word of mouth, health concerns, and a variety of other influences.
(e) Expectations: If the price of a good is expected to rise in the future, the current demand for the good could increase, and vice versa.
(f) Number of Consumers: Typically, demand for a good increases as the number of consumers increases.
(4) The demand for a good depends on many factors. When we draw a demand curve (for coffee beans, say), the only one of the factors that affects demand that shows up explicitly on the graph is the price of the good itself (on the vertical axis). None of the “other factors” (i.e., other than the current price of the good) that affect demand shows up explicitly on the graph. These other factors are “held equal” or constant when we draw a particular demand curve. Generally, when the price of a good falls, other things equal, the quantity demanded of the good increases, and vice versa. The “other things equal” means that all other factors affecting the demand for the good are being held constant. This inverse or negative relationship between the price and the quantity demanded of a good is called the Law of Demand. Keep in mind that that is a conditional statement (“other things equal”) and that it is only a statement of “general tendency”—there are occasional exceptions.
When the price of a good alone changes, there is a movement along the demand curve. This can expressed as a demand schedule or geometrically as a demand curve—see FIGURE 1. The quantity demanded is the amount that consumers want or desire to purchase of a good at a particular price. When the price of a good falls (other things equal), there is...