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Demand and Supply

Topic 1

Demand and supply

1. Demand 2. Supply 3. Market Equilibrium 4. Consumer & Producer Surplus

Demand

A relationship between price and quantity demanded in a given time period, ceteris paribus.

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Demand curve

Law of demand

An inverse relationship exists between the price of a good and the quantity demanded in a given time period, ceteris paribus. Reasons:

substitution effect income effect

Determinants of demand

tastes and preferences prices of related goods and services income number of consumers expectations of future prices and income

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Supply

the relationship that exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.

Law of supply

A direct relationship exists between the price of a good and the quantity supplied in a given time period, ceteris paribus.

Reason for law of supply

The law of supply is the result of the law of increasing cost.

As the quantity of a good produced rises, the marginal opportunity cost rises. Sellers will only produce and sell an additional unit of a good if the price rises above the marginal opportunity cost of producing the additional unit.

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Determinants of supply

the price of resources, technology and productivity, the expectations of producers, the number of producers, and the prices of related goods and services

note that this involves a relationship in production, not in consumption

Market equilibrium

4. 1 Consumer Surplus

the difference between what the consumers are willing to pay (shown on the demand curve) and what they actually pay (the market price) In other words, Consumer surplus is the area between the Demand curve and the Price line

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Consumer surplus

P1

Q1
fig

Q
Copyright 2001 Pearson Education Australia

Consumer surplus
P

P1

Total consumer expenditure

Q1
fig

Q
Copyright 2001 Pearson Education Australia

Consumer surplus
P

P1

Total consumer surplus

Total consumer expenditure

Q1
fig

Q
Copyright 2001 Pearson Education Australia

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Consumer Surplus

CS is the area between the demand curve and the market price line. It measures how much the consumer gains from buying goods in the market

4.2 Producer surplus

the amount producers receive (market price) above the minimum price required to make them supply the good (shown on the supply curve) Producer surplus is the area between the Price line and the Supply curve

Producer surplus
S
Total Producer surplus

P
1

Market price

Producer Surplus

Q1
fig

Q
Copyright 2001 Pearson Education Australia

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4.3 CS and PS Economic efficiency

CS and PS are an important tool for measuring the performance of an economic system or for assessing the impact of alternative government policies in that system.