Principles of Microeconomics

TOPIC 1: SUPPLY AND DEMAND

Lecture 3
Supply and Demand

Tien-Der Jerry Han

1
Aims of topic 1

Buyers and seller exchange their goods and services in markets

This is the main mechanisms that our society uses to allocate its resources

Develop a basic understanding of how markets work:

● how markets transmit information
● how price provides incentives
● what determines who produces and who consumes

In the process, we’ll:

(a) introduce important concepts and terminology that economists use

(b) begin to develop you ability to explain outcomes and make predictions

While the model we develop is only very simple,

● we will capture some of the main forces in all markets
● useful foundation to build upon 2
Aims of this lecture

In this lecture, we will learn about: SUPPLY AND DEMAND

Supply and demand are the forces that make markets work

Demand is how much buyers can and want to purchase of a good or service

Supply is how much sellers can and want to produce of a good or service

TODAY: look at the determinants of supply and demand

FUTURE: learn how supply and demand determines price

… how knowledge about demand can help businesses set their prices
… how governments can influence prices

Today we: analyse what determines the demand for and the supply of a product

3
Lecture outline

1. Law of demand

2. Causes of shifts in demand

3. Law of supply

4. Causes of shifts in supply

4
Reading

Lipsey and Chrystal, ch. 2, p.22-33

Mankiw and Taylor, ch. 4, p.68-79
Sloman, Wride and Garratt, ch. 2, p. 32-41

Independent: Petrol station sells out at £2.68 per litre as shortages send fuel prices
soaring
https://www.independent.co.uk/news/business/news/petrol-price-litre-london-
b1931209.html?utm_source=pocket_mylist

Economist: Why are British petrol stations running dry?

https://www.economist.com/the-economist-explains/2021/09/27/why-are-british-
petrol-stations-running-dry

5
Assumptions of the behaviour of buyers and sellers

In product markets: buyers = individuals & sellers = firms

In factor markets: buyers = firms & sellers = individuals

Firms
Each firm aims to maximise its profits:
π = TR − TC = price ×quantity − total costs

● Firms have no ability to influence the market price: they are price takers

Individuals
Each individual consumer seeks maximum satisfaction – referred to as utility
Breaking Bad: S3 E11 10:42

● individuals gain utility from consuming goods and services

● the utility determines their maximum willingness to pay

Consumers buy the product if the price is below there maximum willingness to pay
6
The nature of demand

The amount of a product that consumers wish to purchase at a given price is:

the quantity demanded

● This is not the amount that is actually purchased: it’s the desired amount

● The quantity demanded is expressed in terms of a time period

The quantity demanded tends to fall as the price increases

1) INCOME EFFECT
People feel poorer:
They cannot buy as much with their fixed income

2) SUBTITUTION EFFECT
People change their consumption:
They buy similar but rival products or they spend their money on other products
7
 The demand curve

● A change in price means a movement along the demand curve

● Only price changes and other things being equal:
Price in £s

LAW OF DEMAND:
The quantity demanded increases
as the price decreases

Demand curve

Quantity demanded
Interpreting the demand curve

The demand curve shows:

the relationship between quantity demanded and price, ceteris paribus

where ceteris paribus means other things remain equal

1) HORIZONTAL INTERPRETATION
Starting from any given a price:
the demand curve shows what the quantity demanded will be

2) VERTICAL INTERPRETATION
Start with any given quantity:
the demand curve shows what the maximum price that a buyer
is willing to pay for this unit of the product

9
 Shifts in demand
● Changes in other important demand determinants cause shifts in demand
● Changes in other important demand determinants indicate the original
relationship changes
Price in £s

Increase in demand
demand shifts to the right

Decrease in demand
demand shifts to the left
Demand curve

Quantity demanded
Causes of shifts in demand Complements: demand shifts to the left
when the price of a complement
Income increases
Demand is likely to shift to the right ● demand decreases:
when income rises people stop purchasing the complement
● the more affluent people are, the
more they are willing to pay to have
stuff

Normal goods versus inferior goods

Prices of related goods

Substitutes: demand shifts to the right
when the price of a substitute increases
● demand increases: people will switch
away from the more expensive
alternative

24
Causes of shifts in demand

Tastes
Demand shifts to the right if consumers find the product more desirable
● people are willing to pay more for desirable stuff
Tastes are affected by advertising and fashions
https://www.youtube.com/watch?v=M4z90wlwYs8
https://www.youtube.com/watch?v=DaSkMWVlFUU
https://www.buzzfeed.com/augustafalletta/100-years-black-men-trends
https://www.allure.com/story/100-years-of-black-hair-evolution-video

Number of buyers
Demand shifts to the right when there are a greater number of buyers
● more people are willing to buy at a given price

Expectations of the future

Demand will shift depending on consumers expectations of the future
● important factors are: future income, future prices and future supply
24
 Quick Discussion
With the person next to you, consider how the demand for
cigarettes is likely to change due to a:
a) increase in the price of beer
b) advertising campaign illustrating health issues
c) decrease in the price of electronic cigarettes
The nature of supply

The amount of a product that firms wish to supply at a given price is:

the quantity supplied

● This is the amount firms are willing to supply

● The quantity supplied is expressed in terms of a time period

The quantity supplied tends to rise as the price increases

1) SCALE EFFECTS
A firm’s costs rise (or decrease) as it produces more:
Their production methods are less (or more) productive than before

2) ENTRY EFFECTS
High cost firms enter the market:
They can make a profit due to the higher price
14
 The supply curve

● A change in price means a movement along the supply curve

● Only price changes and other things being equal:
Price in £s Supply curve

LAW OF SUPPLY:
The quantity supplied increases as
the price increases

Quantity supplied
Interpreting the supply curve

The supply curve shows:

the relationship between quantity supplied and price, ceteris paribus.

1) HORIZONTAL INTERPRETATION
Starting from any given a price:
the supply curve shows what the quantity supplied will be

2) VERTICAL INTERPRETATION
Start with any given quantity:
the supply curve shows what the minimum price that a seller
is willing to accept for this unit of the product

16
 Shifts in supply

● Changes in other important supply determinants cause a shift in supply

Price in £s Supply curve

Decrease in supply
supply shifts to the left

Increase in supply
supply shifts to the right

Quantity supplied
Causes of shifts in supply

Input prices
Supply is likely to shift to the left when the prices of inputs rise
● the minimum price sellers willing to accept increases

Technology
Supply is likely to shift to the right when there is technological advancement
● more can be produced using fewer resources

Random shocks
Supply is likely to shift to the left when there is an unpredictable shortage
● at a given price, sellers can supply less than before

Number of sellers
Supply is likely to shift to the right when there are more sellers
● more is produced at any given price
24
Summary

The law of demand: quantity demanded decreases as price rises

Demand curve: the relationship between quantity demanded

and price, ceteris paribus

Other important factors: cause shifts in the demand curve

The law of supply: quantity supplied increases as price rises

Supply curve: the relationship between quantity supplied

and price, ceteris paribus

Other important factors: cause shifts in the supply curve

23
Summary

Following this lecture, you should be able to:

(1) explain the relationships between price and quantity demanded, and price and
quantity supplied

(2) draw the relationships as demand and supply curves

(3) illustrate how factors other than price shift demand and supply curves

25