Supply and Demand

Note: The original VNote structure and wording are preserved. Only clear errors or statistical/institutional definitions that have changed are corrected minimally.

1. Demand

1.1. What It Is

• Demand is the quantity of a good that consumers are willing and able to buy during a given period at a given price level.
  • Willing to buy: desire, or potential demand
  • Able to buy: money
  • Demand = desire + money
    • If only desire is satisfied, it is potential demand.
    • If both are satisfied, it is effective demand.
    • The benefit of distinguishing effective demand from potential demand is to understand actual market demand.
      • For example, China has a large population but effective demand may be smaller, while the United States has a smaller population but effective demand may be larger.

1.2. Factors Affecting Demand

1.2.1. The Price of the Good Itself

• Price rises, quantity demanded falls.

1.2.2. Income Level

• Income rises, demand rises – normal goods.
• Income rises, demand falls – inferior goods.

1.2.3. Degree of Preference

1.2.4. Prices of Related Goods

• Price of good A rises, demand for B falls – complements -> firms are in a cooperative relationship.
• Price of good A rises, demand for B rises – substitutes -> firms are in a competitive relationship.
• Price of good A rises, demand for B is unchanged – independent goods.

1.2.5. Expectations About the Future

• Better future expectations, demand rises.
• Worse future expectations, demand falls.

1.3. Effect of Price on Demand

1.3.1. Law of Demand

• Among the factors affecting demand, consider only the price of the good itself.
• Verbal description
  • Other things equal, the quantity demanded of a good changes inversely with the good’s own price.
• Demand schedule
  • 
• Demand curve
  • 
  • It represents quantity demanded during a given period.
• Demand function
  • 

1.3.1.1. Market Demand

• Market demand = sum of individual demands.
• Therefore market demand also follows the law of demand.

1.3.2. Exceptions to the Law of Demand

• Price unchanged while demand keeps increasing
  • 
  • For example, scarce materials such as gold.
• Demand does not change regardless of how high the price is
  • 
  • Necessities such as salt and medicine.
• Price rises and demand rises
  • 
  • Non-necessities such as luxury goods.
• Price rises and demand may fall or rise
  • 

1.4. Effects of Other Factors on Demand

• Change in quantity demanded: change caused by the good’s own price – movement along the curve.
• Change in demand: change caused by non-price factors – shift of the curve.
• 

2. Supply

2.1. What It Is

• Supply is the quantity of a good that producers are willing and able to provide during a given period at a given price level.
  • A given period
  • Willing to sell: willingness to sell, related to price
  • Able to sell: output
• Supply = willingness to sell + output -> price + output
  • When both conditions are met, it is effective supply (realized supply).
  • When only one is met, it is potential supply (unrealized supply).
  • The purpose of distinguishing effective and potential supply
    • Measure producers’ actual income.

2.2. Factors Affecting Supply

• The price of the good itself
  • Price rises, output rises.
• Product cost
  • Cost rises, output falls.
• Technology level
  • Technology improves, output rises.
  • Productivity = (labor + capital + land) * technology
• Prices of related goods
  • Prices of related goods rise, output falls.
• Producers’ objectives
  • Mainly the following three:
    • Profit maximization
    • Total output maximization
    • Average output maximization
• Future expectations
  • Better economic expectations, output rises.

2.3. Effect of Price on Supply

2.3.1. Law of Supply

• Verbal description
  • Other things equal, the quantity supplied of a good changes in the same direction as the good’s own price.
• Supply schedule
  • 
• Supply curve
  • 
  • It is defined over a period, not a single point in time.
• Supply function
  • Supply = f(price, prices of other goods, cost, technology)

2.3.1.1. Market Supply

• Market supply = sum of individual supplies.
• Therefore market supply also follows the law of supply.

2.3.2. Exceptions to the Law of Supply

• Price unchanged while supply keeps increasing
  • 
  • Beverages
  • Some public products/services: subway, bus, tap water, etc.
• Price keeps rising while supply remains unchanged
  • 
  • Antiques, land, etc.
• Lower price, greater supply
  • 
  • Assembly-line work
• Price rises, supply may rise or fall
  • 
  • Wages

2.4. Effects of Other Factors on Supply

• Change in quantity supplied: change caused by the good’s own price – movement along the curve.
• Change in supply: change caused by non-price factors – shift of the curve.
  • 

3. Market Equilibrium

• Verbal description
  • A market formed by demand and supply mainly has three states:
    • Excess supply
    • Equilibrium
      • When demand equals supply, the market is in equilibrium. The corresponding price is the equilibrium price, and the corresponding quantity is the equilibrium quantity.
    • Excess demand
• Table method
  • 
• Graphical method
  • 
    • E is the equilibrium point.
    • K-L above E is excess supply.
    • M-N below E is excess demand.
• Formula method
  • 

3.1. Changes in Market Equilibrium

• A change in demand alone causes equilibrium price and equilibrium quantity to move in the same direction.
  • Demand increases -> equilibrium price rises, equilibrium quantity rises.
  • Demand decreases -> equilibrium price falls, equilibrium quantity falls.
• A change in supply alone causes equilibrium price to move in the opposite direction and equilibrium quantity in the same direction.
  • Supply increases -> equilibrium price falls, equilibrium quantity rises.
  • Supply decreases -> equilibrium price rises, equilibrium quantity falls.
• Simultaneous changes in demand and supply produce more complex equilibrium changes.
  • Supply increases, demand falls -> equilibrium price falls, equilibrium quantity is indeterminate.
  • Supply decreases, demand rises -> equilibrium price rises, equilibrium quantity is indeterminate.
  • Both increase -> equilibrium price is indeterminate, equilibrium quantity rises.
  • Both decrease -> equilibrium price is indeterminate, equilibrium quantity falls.

3.2. Price Floors and Price Ceilings

• Price floor: a minimum price above the equilibrium price.
• Price ceiling: a maximum price below the equilibrium price.

3.3. Government Taxes

• Tax on producers -> production cost rises -> supply curve shifts left.

3.4. Government Subsidies

• Subsidy to producers -> production cost falls -> supply curve shifts right.