Demand and Supply - International Economics - Lecture Slides, Slides of Economics

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Demand and Supply

Theories and Predictions

• We need to be able to predict the

consequences of

• alternative policies, and
• events that may be outside our control
• The mental tool we use to make such

predictions is called a theory

• A theory is of no use if its predictions are

inaccurate

Assume perfect competition

• The theory of supply and demand assumes that

commodities are traded in perfectly competitive

markets

• A perfectly competitive market is a market in

which

• there are many buyers
• many sellers
• and all sellers sell the exact same product
• As a result, each buyer and seller has a negligible

impact on the market price

DEMAND

Catherine’s Demand Schedule and Demand Curve

Copyright © 2004 South-Western

Price of Ice-Cream Cone

0

1 2 3 4 5 6 7 8 9 10 11 Quantity of Ice-Cream Cones

$3.

12

1. A decrease in price (^) ...
   2. ... increases quantity of cones demanded. docsity.com

Market Demand is the Sum of Individual

Demands

“provided all other factors … are unchanged”

• That’s an important phrase in the wording of the Law of Demand
• The quantity demanded of a consumer good such as ice cream depends on - The price of ice cream - The prices of related goods - Consumers’ incomes - Consumers’ tastes - Consumers’ expectations about future prices and incomes - Number of buyers, etc
• The Law of Demand says that the quantity demanded of a good is inversely related to its price, provided all other factors are unchanged

Why Might Demand Increase?

• How can we explain the difference in Catherine’s behavior in situations A and B?
• Why does she consume more in situation B at every possible price?

Quantity Demanded

Price Situation A Situation B

0.00 12 20

0.50 10 16

1.00 8 12

1.50 6 8

2.00 4 6

2.50 2 4

3.00 0 2

Price

Quantity Demandeddocsity.com

Shifts in the Demand Curve

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

Increase in demand

Decrease in demand

Demand curve, D^3

Demand curve, D^1

Demand curve, D^2

0

Shifts in the Demand Curve

• Consumer Income
  • As income increases the demand for a normal good will increase
  • As income increases the demand for an inferior good will decrease
• Prices of Related Goods
  • When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes
  • When a fall in the price of one good increases the demand for another good, the two goods are called complements

Substitution Effect

• When the price of a good decreases,

consumers substitute that good instead of

other competing (substitute) goods

Clothes Coke Books Movies

1. When the price of Coke decreases…

Pepsi

2. Consumption of Pepsi decreases… 3. Consumption of Coke increases

Income Effect

• A decrease in the price of a commodity is

essentially equivalent to an increase in

consumers’ income

Income Effect

• Consumers respond to a decrease in the price of a commodity as they would to an increase in income
• They increase their consumption of a wide range of goods, including the good that had a price decrease

Clothes Coke Books Movies

1. When the price of Coke decreases… 2. Consumers feel richer… 3. Consumption of Coke and other goods increases

Pepsi

SUPPLY