Demand

Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity
demanded is the amount of a product people are willing to buy at a certain price; the relationship
between price and quantity demanded is known as the demand relationship.

The Law of Demand

The law of demand states that, if all other factors remain equal, the higher the price of a good, the
less people will demand that good. In other words, the higher the price, the lower the quantity
demanded. The amount of a good that buyers purchase at a higher price is less because as the price
of a good goes up, so does the opportunity cost of buying that good. As a result, people will
naturally avoid buying a product that will force them to forgo the consumption of something else
they value more. The chart below shows that the curve is a downward slope.

A, B and C are points on the

demand curve. Each point on the
curve reflects a direct correlation
between quantity demanded (Q)
and price (P). So, at point A, the
quantity demanded will be Q1 and
the price will be P1, and so on. The
demand relationship curve
illustrates the negative relationship
between price and quantity
demanded. The higher the price of
a good the lower the quantity
demanded (A), and the lower the
price, the more the good will be in
demand (C).

Reasons why observe law of demand:

1. Substitution effect: tendency of people to substitute in favor of cheaper commodities
2. Real-income effect: change in purchasing power that occurs when the price of a good
changes

Determinants of Demand
The major nonprice determinants of demand are:

1. Income
2. Tastes and preferences
3. Prices of substitute goods, and the price of complementary goods
4. Consumers' expectations about future prices and incomes that can be checked
5. Number of potential consumers

Substitutes: a change in the price of one causes a shift in demand for the other in the same direction
(e.g. butter and margarine)
Complements: a change in the price of one good causes a shift in demand for the other in the
opposite direction (e.g., stereo amplifiers and speakers, nuts and bolts)
Change in Demand—results from change in a non-price determinant of demand (curve moves)
Change in Quantity demanded—results from change in price (move along curve)
Supply
Supply represents how much the market can offer. The quantity supplied refers to the amount of
a certain good producers are willing to supply when receiving a certain price. The correlation
between price and how much of a good or service is supplied to the market is known as the supply
relationship.

The Law of Supply

Like the law of demand, the law of supply demonstrates the quantities that will be sold at a certain
price. But unlike the law of demand, the supply relationship shows an upward slope. This means
that the higher the price, the higher the quantity supplied. Producers supply more at a higher price
because selling a higher quantity at higher price increases revenue.

A, B and C are points on the

supply curve. Each point on the
curve reflects a direct correlation
between quantities supplied (Q)
and price (P). At point B, the
quantity supplied will be Q2 and
the price will be P2, and so on.

Reasons why observe supply law:

1. higher prices increase incentives for increasing production

2. the law of increasing costs

Non-Price Determinants of Supply

1. The prices of inputs used to produce the product (lower prices, curve shifts right)
2. Technology (improvements shift curve right)
3. Taxes and subsidies (taxes behave as a cost, shift left, subsidies reduce costs, shift right)
4. Price Expectations (e.g., farmers withhold crops in expectation of higher prices)
5. Number of Firms (more firms shift to the right)
Supply and Demand
Equilibrium
When supply and demand are equal (i.e. when the supply function and demand function intersect)
the economy is said to be at equilibrium. At this point, the allocation of goods is at its most
efficient because the amount of goods being supplied is exactly the same as the amount of goods
being demanded. Thus, everyone (individuals, firms, or countries) is satisfied with the current
economic condition. At the given price, suppliers are selling all the goods that they have produced
and consumers are getting all the goods that they are demanding.

As you can see on the chart,

equilibrium occurs at the intersection
of the demand and supply curve, which
indicates no allocative inefficiency. At
this point, the price of the goods will be
P* and the quantity will be Q*. These
figures are referred to as equilibrium
price and quantity.

In the real market place equilibrium

can only ever be reached in theory, so
the prices of goods and services are
constantly changing in relation to
fluctuations in demand and supply.

Disequilibrium

Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*.

a. Excess Supply
If the price is set too high, excess supply will be created within the economy and there will be
allocative inefficiency.

At price P1 the quantity of goods

that the producers wish to supply
is indicated by Q2. At P1,
however, the quantity that the
consumers want to consume is at
Q1, a quantity much less than Q2.
Because Q2 is greater than Q1,
too much is being produced and
too little is being consumed. The
suppliers are trying to produce
more goods, which they hope to
sell to increase profits, but those
consuming the goods will find the
product less attractive and
purchase less because the price is
too high.
b. Excess Demand
Excess demand is created when price is set below the equilibrium price. Because the price is so
low, too many consumers want the good while producers are not making enough of it.

In this situation, at price P1, the

quantity of goods demanded by
consumers at this price is Q2.
Conversely, the quantity of goods
that producers are willing to
produce at this price is Q1. Thus,
there are too few goods being
produced to satisfy the wants
(demand) of the consumers.
However, as consumers have to
compete with one other to buy the
good at this price, the demand will
push the price up, making
suppliers want to supply more and
bringing the price closer to its
equilibrium.

Shifts vs. Movement

For economics, the "movements" and "shifts" in relation to the supply and demand curves
represent very different market phenomena:

Movements
A movement refers to a change along a curve.

On the demand curve, a

movement denotes a change in
both price and quantity
demanded from one point to
another on the curve. The
movement implies that the
demand relationship remains
consistent. Therefore, a
movement along the demand
curve will occur when the price
of the good changes and the
quantity demanded changes in
accordance to the original
demand relationship. In other
words, a movement occurs when
a change in the quantity
demanded is caused only by a
change in price, and vice versa.
 Like a movement along the demand
curve, a movement along the supply
curve means that the supply
relationship remains consistent.
Therefore, a movement along the
supply curve will occur when the
price of the good changes and the
quantity supplied changes in
accordance to the original supply
relationship. In other words, a
movement occurs when a change in
quantity supplied is caused only by a
change in price, and vice versa

Shifts
A shift in a demand or supply curve occurs when a good's quantity demanded or supplied changes
even though price remains the same.

For instance, if the price for a bottle of beer

was $2 and the quantity of beer demanded
increased from Q1 to Q2, then there would be
a shift in the demand for beer. Shifts in the
demand curve imply that the original demand
relationship has changed, meaning that
quantity demand is affected by a factor other
than price. A shift in the demand relationship
would occur if, for instance, beer suddenly
became the only type of alcohol available for
consumption.

Conversely, if the price for a bottle of beer

was $2 and the quantity supplied decreased
from Q1 to Q2, then there would be a shift
in the supply of beer. Like a shift in the
demand curve, a shift in the supply curve
implies that the original supply curve has
changed, meaning that the quantity
supplied is affected by a factor other than
price. A shift in the supply curve would
occur if, for instance, a natural disaster
caused a mass shortage of hops; beer
manufacturers would be forced to supply
less beer for the same price.
Price floor
A price floor is a government- or group-imposed price control or limit on how low a price can be
charged for a product. A price floor must be greater than the equilibrium price in order to be
effective. A price floor is the lowest legal price a commodity can be sold at. Price floors are used
by the government to prevent prices from being too low. The most common price floor is the
minimum wage- the minimum price that can be paid for labor. Price floors are also used often in
agriculture to try to protect farmers.

Effectiveness of price floors

An ineffective, non-binding price floor,

below equilibrium price.

A price floor can be set below the free-

market equilibrium price. In the first
graph at right, the dashed green line
represents a price floor set below the
free-market price. In this case, the floor
has no practical effect. The
government has mandated a minimum
price, but the market already bears a
higher price.

An effective, binding price floor, causing

a surplus (supply exceeds demand).

By contrast, in the second graph, the

dashed green line represents a price
floor set above the free-market price.
In this case, the price floor has a
measurable impact on the market. It
ensures prices stay high so that product
can continue to be made.

Effect on the market

A price floor set above the market equilibrium price has several side-effects. Consumers find they
must now pay a higher price for the same product. As a result, they reduce their purchases or drop
out of the market entirely. Meanwhile, suppliers find they are guaranteed a new, higher price than
they were charging before. As a result, they increase production. Taken together, these effects
mean there is now an excess supply (known as a "surplus") of the product in the market to maintain
the price floor over the long term.
Minimum wage

A historical (and current) example of a price floor is minimum wage laws; in this case, employees
are the suppliers of labor and the company is the consumer. When the minimum wage is set higher
than the equilibrium market price for unskilled labor, unemployment is created (more people are
looking for jobs than there are jobs available). A minimum wage above the equilibrium wage
would induce employers to hire fewer workers as well as allow more people to enter the labor
market, the result is a surplus in the amount of labor available. The equilibrium wage for a worker
would be dependent upon the worker's skill sets along with market conditions.

A few crazy things start to happen when a price floor is set. First of all, the price floor has raised
the price above what it was at equilibrium, so the demanders (consumers) aren't willing to buy as
much quantity. The demanders will purchase the quantity where the quantity demanded is equal
to the price floor, or where the demand curve intersects the price floor line. On the other hand,
since the price is higher than what it would be at equilibrium, the suppliers (producers) are willing
to supply more than the equilibrium quantity. They will supply where their marginal cost is equal
to the price floor, or where the supply curve intersects the price floor line.

As you might have guessed, this creates a problem. There is less quantity demanded (consumed)
than quantity supplied (produced). This is called a surplus. If the surplus is allowed to be in the
market then the price would actually drop below the equilibrium. In order to prevent this, the
government must step in. The government has a few options:

• They can buy up the entire surplus. For a while the US government bought grain surpluses in the
US and then gave all the grain to Africa. This might have been nice for African consumers, but it
destroyed African farmers.

• They can strictly enforce the price floor and let the surplus go to waste. This means that the
suppliers that are able to sell their goods are better off while those who can't sell theirs (because of
lack of demand) will be worse off. Minimum wage laws, for example, mean that some workers
who are willing to work at a lower wage don't get to work at all. Such workers make up a portion
of the unemployed (this is called "structural unemployment").

• The government can control how much is produced. To prevent too many suppliers from
producing, the government can give out production rights or pay people not to produce. Giving out
production rights will lead to lobbying for the lucrative rights or even bribery. If the government
pays people not to produce, then suddenly more producers will show up and ask to be paid.

• They can also subsidize consumption. To get demanders to purchase more of the surplus, the
government can pay part of the costs. This would obviously get expensive really fast.

In the end, a price floor hurts society more than it helps. It may help farmers or the few workers
that get to work for minimum wage, but it only helps those people by hurting everyone else. Price
floors cause a deadweight welfare loss.