Macroeconomics

Chapter 3: Where Prices Come From The Interaction of Demand and

Supply

Perfectly competitive market: Market where there are many

buyers and sellers, all the products sold are identical, no barriers
to new firms entering the market
Supply and demand model often successful in predicting changes
in quantities and prices

Demand Side of the Market

Demand is what a consumer wants to buy AND is capable of
buying
Demand Schedules and Demand Curves
o Demand schedules: table that shows the relationship
between the price of a product and the quantity of the
product demanded
o Quantity demanded: Amount of a good or serve that a
consumer is willing and able to purchase at a given price
o Demand curve: Relationship between price and quantity
o Market demand: Represented by demand curve, demand
by all the consumers of a given good or service

Law of demand: Inverse relationship between price and quantity

due to a combination of the substitution effect and the income
effect
o Holding everything else constant except price when price
falls, demand goes up and vice versa
o Substitution effect: change in the quantity demanded of a
good that results from the effect of a change in the price
making the good more or less expensive relative to other
goods that are substitutes
o Income effect: Purchasing power increases as price of
goods fall and income of consumers remains constant (or
increases)

Ceteris paribus condition: Holding everything else constant

Variables that Shift Market Demand

o Income: As income increases, so does demand for a good
(normally)
Normal good: Demand increases for this good when
income increases (whole grain pasta)

Inferior good: Demand decreases for this good as

income increases (instant noodles)
Prices of Related Goods
Substitutes: Goods and services that can be used for
the same purpose
Can buy a substitute in place of a specific good;
when substitute prices go up, demand curve shifts to
the right, and vice versa
EX: tablets drove the demand curve of ereaders to the left
Complements: Goods and services used together
When demand increases for one, demand for
the other increases as well
EX: Smartphones and apps
Tastes
Strong advertising makes consumers more willing to
spend more, and the demand curve shifts to the
right.
When consumer taste increases, demand curve shifts
to the right, and vice versa
Population and demographics
Characteristics of a population with respect to age,
race, and gender that can affect the demand curve.
Expected future prices
If prices are expected to rise, consumers will buy
more of the good now to save money; demand curve
shifts to the right.
Opposite applies if prices are expected to fall
See table 3.1 on page 76

A Change in Demand VS a Change in Quantity Demanded

o Change in demand: shift in the demand curve, that is, a
change in a variable other than price
o Changed in the quantity demanded: Movement along the
demand curve and a change in price

The Supply Side of the Market

Quantity supplied: the amount of a good or service that a firm is
willing and able to supply at a given price
o Ex: holding all other variables constant, when the price of
goods increases, profit increases, and so does quantity
supplied
Supply schedule and Supply Curves

o Supply schedule: table that shows the relationship between

the price of a product and the quantity of the product
supplied
o Supply curve: curve that shows the relationship between
the price of a product and the quantity of the product
supplied
The Law of Supply: Market supply curve should slope upward;
holding everything else constant, increases in price cause
increases in price
Variables that Shift Market Supply
o Prices of Inputs
Input: anything used in the production of a good or
service
As input increases, supply decreases
o Technological change: Positive or negative change in the
ability of a firm to produce a given level of output with a
given quantity of inputs
Positive change = increase in productivity = increase
in quantity supplied (opposite for negative)
o Prices of Substitutes in Production
Substitutes in production: Alternative products that a
firm could produce
Ex: If smartphones are more profitable to make than
tablets, the supply curve for smartphones will shift to
the right
o Number of Firms in the Market
When new firms enter the market, supply curve shifts
to the right because there is another producer of the
good/ service
o Expected Future Prices
If product price is expected to increase in the future,
a firm will hold off on supplying all of its goods at the
moment and wait until the prices go up, supply curve
will shift to the left
If input prices are expected to drop, a firm may wait
to produce more in an effort to save money
o See graph 3.2 on page 81

A change in supply versus a change in the quantity supplied

(similar to demand)
o Change in supply: Shift of the supply curve when a variable
other than price changes

o Change in quantity supplied: movement along the supply

curve as a result of a change in product price
Market Equilibrium: Putting Demand and Supply Together
Market equilibrium: Point at which quantity demanded equals
quantity supplied
Competitive market equilibrium: Market equilibrium with many
buyers
At any other price of quantity, no other economic unit will make
a different decision both firms and consumers are happy

How markets eliminate surpluses and shortages

o When quantity supplied is greater than demand, a surplus
occurs. This can happen when the price of a good, set by a
firm, is above the equilibrium point
With goods piling up, firms must slash prices to
increases sales, which will push the market towards
equilibrium the market will only reach equilibrium
when the price of the product set by the firm is the
equilibrium price.
o When quantity supplied is less than the demand, a
shortage occurs. This can happen if price set by a firm is
below the equilibrium price.
With a shortage of goods, firms will increase prices
which will push the market back to equilibrium the
market will only reach equilibrium of the price set by
firms is the equilibrium price.
o At a competitive equilibrium, all consumers willing
to pay the market price will be able to buy as much
of the product as they want, and all firms willing to
accept the market price will be able to sell as much
of the product as they want. AS a result, there will
be no reason for the price to change unless either
the demand curve or supply curve shifts
o Demand and supply go hand in hand

The Effect of Demand and Supply Shifts on Equilibrium

The effect of shifts in demand AND supply on equilibrium
o See figure 3.11 and table 3.3 on page 88 (below)

Shifts in a curve versus movements along a curve

Changes in price do not shift curves
For demand or supply to increase or decrease, the entire curve
must shift due to another variable