Introduction to Economics: Supply and Demand Concepts

Part I: Introduction to Economics

4 Units
Unit 1: What is Economics?
Unit 2: Thinking like an Economist
Unit 3:
Supply and Demand
Unit 4: ElasticityThe Basic Market Model
Our first step is building the workhorse
of economics: the supply & demand
model.
This is done in two steps:
Unit 3: Supply, demand and competitive markets
Unit 4: ElasticityUnit 3
Supply, Demand, and
Competitive Markets
(Mankiw & Taylor, Ch 3)

Preview of Unit 3

Here we meet our first model, the market model called «perfect
competition»
Why do we start from here?

1. Because it is the most intuitive
2. Because it played a huge role in the history of economics
3. Because it is applicable in many situations
4. Because it is crucial from both the microeconomic and the
   macroeconomic perspectives

Market Model Framework

We build a simple framework to describe a perfectly competitive
È ESPRESSA INTERMINIDI
OFFERTA
market, which is cast in terms of a supply curve and a demand curve.
SUPPLY CURVE
DEMAND CURVE
Supply and demand are meant to describe rational selling and
ACQUISTO
purchasing programmes by sellers and buyers (rational: based on
opportunity costs, marginal principle etc.)
PRODOTTO/MERCE
Within this setup, the market price of a commodity can be looked at as
what makes selling and purchasing programmes consistent with each
other.
COERENTI/CONFORMi
We thus obtain a model which can be used to predict and interpret the
working of the market

Introduction

1. We already know the distinction between Macroeconomics and
   Microeconomics
2. Market models belong to Microeconomics, as they focus on the
   interaction among agents within markets
   I POTES.
3. Basic assumptions (perfect information, perfectly defined property
   rights, rational behaviour)

Defining a Market

First question: what is a market?
· «Locus» where people meet to buy and sell
· Set of people meeting in order to buy and sell
· Abstract definition
At the end of a day, to have a market we need a set of
agents (buyers and sellers) and a commodity (bought
and sold)
AGENTS and COMMODITY

Market Types and Criteria

Second question: how do we distinguish between different market
«types»?
Three criteria:
The commodity being traded (homogenous vs differentiated)
20
The way agents (buyers and seller) interact (structural vs
strategic)
3
Whether there are obstacles to the free entry of traders in the
market

Basic Market Models

Using these criteria, we identify 4 basic market models:

1. perfect competition
2. monopoly
3. CONCORRENZA MONOPOLISTICA
   monopolistic competition
4. oligopoly

Perfectly Competitive Markets

We focus on (the general features of)
Perfectly competitive markets

• product is homogeneous
• interaction is structural
  HOMOGENEUS
  STRUCTURAL
  3) there is free entry
  FREE ENTRY

Supply And Demand

Supply and demand are the way we describe the
agents' choices on PCMkts
Supply and demand determine prices in a market
economy
SUPPLY AND DEMAND
DETERMINE PRICES

Behavior in Markets

The terms supply and demand are meant to describe the behaviour of
sellers and buyers as they interact with one another in markets.
A PC market is meant to describe a market in which competition works at
its strongest.
COMPETITION WORKS AT ITS STRONGEST.
Hence

• Product is homogeneous (law of one price)
• Interaction is structural ('many' agents, each with no impact on price)
• There is free entry (potential competition
  3
  ACQUIRENTI DI PREZZI
  Hence, agents act as price takers, which is best applied to situations
  where buyers and sellers are very many.
  2

Demand

Quantity demanded is the amount of a good that buyers are willing
and able to purchase.
AFFERMAZIONE
Law of Demand is the (empirical) claim that, other things equal, the
quantity demanded of a commodity falls when its price rises.
LAW OF DEMAND
Note:
Buyers vs consumers
Preferences, income and prices of other commodities

Demand Schedule and Curve

PROGRAMMA
The Demand Schedule (usually represented by a Demand Curve, or
Demand Function) shows the relationship between the price of the
commodity and the quantity demanded.
RELATIONSHIP BETWEEN
PRICE OF THE COMMODITY AND
THE
QUANTITY DEMANDED
Here is where the rationality assumption bites:
A demand schedule is a rational purchasing plan
PIANO RAZIONALE D'ACQUISTO

Demand Schedule Example

Example of a Demand Schedule
Price of milk per litre (€)
Quantity of milk demanded
(litres per month)
0.00
20
0.10
18
0.20
16
0.30
14
0.40
12
0.50
10
0.60
8
0.70
6
0.80
4
0.90
2
FROM MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 @ CENGAGE EMEA 2017

Demand Curve Visualization

The corresponding Demand Curve
Price of milk per
litre (€)
1.00
0.90
0.80
0.70
1. A decrease in
price ...
0.60
¥ 0.50
0.40
0.30
0.20
0.10
0
2
4
6
8
10
12
14
16
18
20
>
Quantity of milk
demanded (litres)
2. ... increases
quantity of milk
demanded
FROM MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 @ CENGAGE EMEA 2017

Market vs Individual Demand

Market Demand vs Individual Demand:
Market demand refers to the sum of all individual demands for a
particular commodity or service.
Graphically, individual demand curves are summed horizontally to
obtain the market demand curve.
Observe that Q is a function of p, but the latter is on the vertical
axis

Demand Shifts vs Movements

Demand Shifts vs Movements along the Demand Curve
MANTENENDO. COSTANTE GLI ALTRI FATTORI CHE INFLUENZANO LA DOMANDA
Holding constant other factors affecting demand (income, preferences,
prices of other goods) one can study the effect of a change in price on
demand. A change in own price implies a movement along the demand
curve.
CHANGE IN PRICE: MOVEMENT ALONG THE D. CURVE
By contrast, a shift in the demand curve is caused by factors affecting
demand other than a change in price (such as, indeed, income,
OLTRE
AL
preferences, or the prices of other goods)
SHIFT IN THE O.C.

• OTHER FACTORS TOO
• INCOME
• PREFERENCES
• PRICES OF OTHER GOODS

Movement Along the Demand Curve

Movement Along the Demand Curve
Let the price of milk fall: we expect more milk will be demanded.
EFFETTO DEL REDDITO

• The income effect. If incomes remain constant, a fall in the price of
  milk means that consumers can now afford to buy more with their
  income.
  IF. INCOME CONSTANT = MORE MILK AFFORDABLE
• The substitution effect. Milk is lower in price compared to similar
  products: some consumers will choose to substitute the more
  expensive drinks with the now cheaper milk.
  SUBSTITUTE WITH
  SAME CHEAPER PRODUCTS

Demand Curve Movement Example

Movement along the Demand Curve
Price of milk
B
€1.20
A tax raising the price
of milk results in a
movement
along
the
demand curve.
A
€0.60
D
0
4
8
Quantity of milk
FOROM MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 @ CENGAGE EMEA
2017

Shifts in the Demand Curve

Shifts in the Demand Curve
... that is: shifts caused by factors other than own price.

1. Prices of related goods
   INCREASE ON PRICE X
   - INCREASE ON D. y
   • Substitutes: two goods for which an increase in the price of one leads
     to an increase in the demand for the other.
   • Complements: two goods for which an increase in the price of one
     leads to a decrease in the demand for the other.
     -

Income and Demand Shifts

Shifts in the Demand Curve
2. Income

• Higher income means that one has more to spend, so one might spend more
  on some - and probably most - goods.
  . However, higher income may also be associated to a fall in consumption for
  some commodities
  FALL IN CONSUMPTION FOR SOME COMMODITIES
  If the demand for a commodity falls when income falls or rises as income
  rises, this is called a normal commodity.
  NORMAL COMMO DITY
  DV IV
  DA IT
  If the demand for a good rises when income falls, this is called an inferior
  commodity.
  INFERIOR COMMODITY
  DI IV

Demand Curve Shift Illustration

Shifts in the Demand Curve
Price of milk
Increase
in demand
Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
Quantity of milk
0
FROM MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 @ CENGAGE EMEA 2017

Normal Commodity Demand Shift

Shifts in the Demand Curve
Price of milk
€ 1.20
Normal commodity;
increasing income shifts
out the demand curve
1.00
Increase
in demand
0.80
0.60
0.40
NORMAL
COMMODITY
0.20
D2
2
D
1
Quantity of
milk
0 1 2 3 4 5 6 7 8 9 10 11 12
FROM MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 @ CENGAGE EMEA 2017

Inferior Commodity Demand Shift

Shifts in the Demand Curve
Price inferior
good
€ 1.50
Inferior commodity;
increasing income shifts back
the demand curve
1.00
DV
Decrease
in demand
0.50
INFERIOR
COMMODITY
D2
2
D
1
0 1 2 3 4 5 6 7 8 9 10 11 12
FROM MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 @ CENGAGE EMEA 2017
Quantity of
inferior
good

Supply

OFFERTA
Quantity supplied is the amount of a commodity sellers are willing and
able to sell.
Law of supply is the empirical claim that, other things equal, the quantity
supplied of a commodity rises when its price rises.
Q1 PM
Note
Sellers vs firms
Role of technology

Supply Schedule and Curve

The supply schedule (usually represented by the supply curve, or
supply function) shows the relationship between the price of the
commodity and the quantity supplied. QUANTITÀ OFFERTA
Here is where the rationality assumption bites:
The supply schedule is a rational selling plan
SELLING PLAN
7
PURCHASING PLAN

Supply Schedule Example

Example of a Demand Schedule
Price of milk per litre (€)
Quantity of milk supplied
(litres per month)
0.00
0
0.10
0
0.20
2
0.30
4
0.40
6
0.50
8
0.60
10
0.70
12
0.80
14
0.90
16
1.00
18
FROM MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331
@ CENGAGE EMEA 2017

Supply Curve Visualization

The corresponding Supply Curve
Price of milk per
litre (€)
Richard's supply
+
1.00
S (Richard)
0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0
2
4
6
£
8
10
12
14
16
18
20
Quantity of milk
supplied (litres)
FROM MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331 @ CENGAGE EMEA 2017

Market vs Individual Supply

Market Supply vs Individual Supply:
Market supply refers to the sum of all individual supplies for a
particular commodity or service.
Graphically, individual supply curves are summed horizontally to
obtain the market supply curve.
P
Observe that Q is a function of p, but the latter is on the vertical
axis
P ON VERTICAL
AXIS

Individual to Market Supply

From individual to market supply
Price of milk per
litre (€)
Richard +
Megan =
Market
0
0
0
0
0,1
0
1
1
0,2
2
2
4
0,3
4
3
7
0,4
6
4
10
0,5
8
5
13
0,6
10
6
16
0,7
12
7
19
FROM MANKIW AND TAYLOR, ECONOMICS 4TH EDITION 9781473725331
@ CENGAGE EMEA 2017