Chapter 3 Notes on Econ 1A

- the prices and quantities of goods and services are determined by interactions in the market

-demand curve graphs the quantity of a good that buyers wish to buy at each price

-why demand curve is downward sloping?

-buyer’s reaction to a price change
-substitution effect
-the change in quantity demanded because buyers switch to or from
substitutable goods when the prices changes
-income effect
-the change in quantity demanded (Qd) because change in price changes
the buyer’s purchasing power)
-difference in buyer’s reservation prices
-consumers are different in terms of how much they are willing to pay for the
goods

-buyer’s reservation prices – the largest dollar amount the buyer is willing to pay for the goods

-seller’s reservation price – the smallest dollar amount the seller would be willing to charge for
an additional unit of the good

-interpretations of demand curves

-horizontal interpretation
-start from the vertical axis (P) to the horizontal axis (Q)
-how much of the good is demanded at a given price?
-vertical interpretation
-start from the horizontal axis to the vertical axis
-how much the buyer wants to pay at a given quantity?
-the reservation price of the marginal buyer at a given quantity

-interpretation of supply curves

-horizontal interpretation
-at a certain level of price, how many products sellers wish to sell
-vertical interpretation
-the seller’s reservation price at a given level of Qs

-when the market is in equilibrium, no incentive to move away from the equilibrium

-Changes in demand
-when there is an increase in demand, the demand curve shifts to the right
-when there is a decrease in demand, the demand curve shifts to the left
-6 factors that shift demand curve
-change in price of a complementary good
-2 goods are “complements” if a price of one good decreases, demand for the
other good increases (or price of one good increases, demand for the other good
decreases)

-change in price of a substitutable good

-two goods are “substitutes” if increase in price of one good, demand for the good
decreases (demand decrease, price decreases, and quantity decreases)

-change in buyer’s income

-normal good – increase in buyer’s income causes demand for normal good to
increase
-(Equilibrium Price increases and Equilibrium Quantity
increases)
-inferior good – increase in buyer’s income causes demand for inferior good to
decrease

-change in buyer’s preference or taste

-demand increases which causes price and quantity to increase

-change in population of potential buyers

-demand increases the price and quantity increases

-an expectation of price change in future

-decrease in demand causes decrease in prices and quantity

-changes in supply
- when there is an increase in supply, the supply curve shifts to the right
- when there is a decrease in supply, the supply curve shifts to the left
-5 factors that shift the supply curve
-change in the cost of inputs used for production (capital or labor)
-wage of workers increase causes costs to increase which causes decrease in
supply
-causes price of goods to increase and quantity of goods to decrease

-improvement in technology (less costly to produce)

-causes supply to increase which causes price to decrease, and quantity to increase

-change in weather (agriculture)

-if there is sunny weather for oranges then the supply increases which causes the
price to decrease and the quantity to increase

-change in the number of suppliers

-if the number of suppliers increases it causes the supply curve to shift to the right
-causes the equilibrium price to decrease and the equilibrium quantity to
increase

-an expectation of price change in future

-due to a bad weather, bad crops of wheat are expected
-suppliers may withhold sale of wheat because they expect an increase in
price due to shortage of wheat
-supply decreases which causes equilibrium price to increase and
equilibrium quantity to decrease

-what if both supply and demand curves shift simultaneously?

-if increase in supply is relatively bigger than decrease in demand
-equilibrium price decreases, and equilibrium quantity increases
-if decrease in demand is relatively bigger than increase in supply
-equilibrium price decreases and equilibrium quantity decreases