ECON528 – Orientation

All goods and services are subject to scarcity at some level. Scarcity means that society must develop some allocation mechanism – rules to determine who gets what. Most countries use market based allocation systems. In markets, prices act as rationing devices, encouraging or discouraging production and encouraging or discouraging consumption in such a way as to find an equilibrium allocation of resources.

Law of demand: If the price of something goes up, people are going to buy less of it.

  • The law of demand states that a higher price leads to a lower quantity demanded and that a lower price leads to a higher quantity demanded.
  • Demand curves and demand schedules are tools used to summarize the relationship between demand and price.
  • A demand schedule is a table that shows the quantity demanded at each price.
  • A demand curve is a graph that shows the quantity demanded at each price.

The difference between demand and quantity demanded

In economic terminology, demand is not the same as quantity demanded. When economists talk about demand, they mean the relationship between a range of prices and the quantities demanded at those prices, as illustrated by a demand curve or a demand schedule. When economists talk about quantity demanded, they mean only a certain point on the demand curve, or one quantity on the demand schedule. In short, demand refers to the curve and quantity demanded refers to a specific point on the curve.

What factors change demand?

Price isn’t the only factor that affects quantity demanded.

  • Demand curves can shift: Changes in factors like average income and preferences can cause an entire demand curve to shift right or left. This causes a higher or lower quantity to be demanded at a given price.
  • Ceteris paribus assumption: Demand curves relate the prices and quantities demanded assuming no other factors change. This is called the ceteris paribus assumption.

What factors affect demand?

We defined demand as the amount of some product a consumer is willing and able to purchase at each price. That suggests at least two factors in addition to price that affect demand. Willingness to purchase suggests a desire, based on what economists call tastes and preferences. If you neither need nor want something, you will not buy it. Ability to purchase suggests that income is important.

How does income affect demand?

Say we have an initial demand curve for a certain kind of car. Now imagine that the economy expands in a way that raises the incomes of many people, making cars more affordable. This will cause the demand curve to shift.
As a result of the higher income levels, the demand curve shifts to the right. People have more money on average, so they are more likely to buy a car at a given price, increasing the quantity demanded.
A decrease in incomes would have the opposite effect, causing the demand curve to shift to the left. People have less money on average, so they are less likely to buy a car at a given price, decreasing the quantity demanded.

Normal and inferior goods

A product whose demand rises when income rises, and vice versa, is called a normal good. A few exceptions to this pattern do exist, though. As incomes rise, many people will buy fewer generic brand groceries and more name brand groceries. They are less likely to buy used cars and more likely to buy new cars. They will be less likely to rent an apartment and more likely to own a home, and so on. A product whose demand falls when income rises, and vice versa, is called an inferior good. In other words, when income increases, the demand curve shifts to the left.

Other factors that shift demand curves

Changing tastes or preferences

Changes in the composition of the population

Related goods: The demand for a product can also be affected by changes in the prices of related goods such as substitutes or complements. A substitute is a good or service that can be used in place of another good or service. As electronic resources, like this one, become more available, you would expect to see a decrease in demand for traditional printed books. A lower price for a substitute decreases demand for the other product. Other goods are complements for each other, meaning that the goods are often used together, because consumption of one good tends to enhance consumption of the other.

Changes in expectations about future prices or other factors that affect demand: it is also true that expectations about the future price (or expectations about tastes and preferences, income, and so on) can affect demand.

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Law of supply: If the price of something goes up, companies are willing (and able) to produce more of it.

  • The law of supply states that a higher price leads to a higher quantity supplied and a lower price leads to a lower quantity supplied.
  • Supply curves and supply schedules are tools used to summarize the relationship between supply and price.
  • A supply schedule is a table that shows the quantity supplied at each price.
  • A supply curve is a graph that shows the quantity supplied at each price.

The difference between supply and quantity supplied

In economic terminology, supply is not the same as quantity supplied. When economists refer to supply, they mean the relationship between a range of prices and the quantities supplied at those prices, a relationship that can be illustrated with a supply curve or a supply schedule. When economists refer to quantity supplied, they mean only a certain point on the supply curve, or one quantity on the supply schedule. In short, supply refers to the curve and quantity supplied refers to a specific point on the curve.

What factors change supply?

Price isn’t the only thing that affects the quantity supplied.
  • Supply curves can shift: Changes in production cost and related factors can cause an entire supply curve to shift right or left. This causes a higher or lower quantity to be supplied at a given price.
  • The ceteris paribus assumption: Supply curves relate the prices and quantities supplied assuming no other factors change. This is called the ceteris paribus assumption.

 

How production costs affect supply

Say we have an initial supply curve for a certain kind of car. Now imagine that the price of steel, an important ingredient in manufacturing cars, rises, so that producing a car has become more expensive.
As a result of the higher manufacturing costs, the supply curve shifts to the left. Firms will profit less per car, so they are motivated to make fewer cars at a given price, decreasing the quantity supplied.
A decrease in costs would have the opposite effect, causing the supply curve to shift to the right. Firms will profit more per car, so they are motivated to make more cars at a given price, increasing the quantity supplied.

Other factors that affect supply

Natural conditions: A drought decreases the supply of agricultural products, which means that at any given price, a lower quantity will be supplied. Conversely, especially good weather would shift the supply curve to the right.

New technology: When a firm discovers a new technology that allows the firm to produce at a lower cost, the supply curve will shift to the right as well.

Government policies: Government policies can affect the cost of production and the supply curve through taxes, regulations, and subsidies. Taxes are treated as costs by businesses. Higher costs decrease supply for the reasons discussed above. Other examples of policy that can affect cost are the wide array of government regulations that require firms to spend money to provide a cleaner environment or a safer workplace; complying with regulations increases costs.

A government subsidy, on the other hand, is the opposite of a tax. A subsidy occurs when the government pays a firm directly or reduces the firm’s taxes if the firm carries out certain actions. From the firm’s perspective, taxes or regulations are an additional cost of production that shifts supply to the left, leading the firm to produce a lower quantity at every given price. Government subsidies reduce the cost of production and increase supply at every given price, shifting supply to the right.
supply

Market equilibrium: The actual price you see in the world is a balancing act between supply and demand.

  • Supply and demand curves intersect at the equilibrium price. This is the price at which the market will operate.
The equilibrium price is the only price where the plans of consumers and the plans of producers agree — that is, where the amount of the product consumers want to buy (quantity demanded) is equal to the amount producers want to sell (quantity supplied). This common quantity is called the equilibrium quantity. At any other price, the quantity demanded does not equal the quantity supplied, so the market is not in equilibrium at that price. If a market is not at equilibrium, then economic pressures arise to move the market toward the equilibrium price and the equilibrium quantity.

Fixed Income Assets = Treasury Bonds = Bonds = Sovereign Bond

A government bond is a bond issued by a national government, generally with a promise to pay periodic interest payments and to repay the face value on the maturity date.