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Demand, supply and market equilibrium Basic decision-making units in market (the circular flow)

Demand, supply and market equilibrium Basic decision-making units in market (the circular flow). Household demand in product market Household’s decision about quantity demanded (number of units per period of time) depends on: - Price of product (p)

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Demand, supply and market equilibrium Basic decision-making units in market (the circular flow)

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  1. Demand, supply and market equilibrium • Basic decision-making units in market (the circular flow)

  2. Household demand in product market • Household’s decision about quantity demanded (number of units per period of time) depends on: - Price of product (p) - Income of household (normal vs. inferior goods) (y) - Household’s wealth (w) - Prices of other products (substitutes vs. complementary goods) (op) - Household’s tastes and preferences (pref) - Expectations about future income, wealth, and prices (exp)

  3. Household demand curve issues • Household demand curve: A graph illustrating how much of a product a household would be willing to buy at different prices. p • Discussion: • Ceteris paribus or all else equal- Law of demand- Dem curve intersects q axis (time limitations and diminishing marginal utility)- Dem curve intersects p axis (limited income and wealth)- Change in income D (y0, w0, op0, pref0, exp0) 0 q

  4. From household demand to market demand • Market demand: The sum of the quantities of a good demanded per period by all the households buying in that market.

  5. Firm supply in product markets • Firms engage in production to maximize profits. Therefore, firm’s decision about the quantity supplied (number of units per period of time) depends on: - Price of product (p) - Cost of producing the product:price of inputs (e.g. wage (w) and interest rate (r)), technology used (tech), short run limitations - Prices of other products (op)

  6. Firm supply curve issues • Firm supply curve: A graph illustrating how much of a product a firm would be willing to sell at different prices. p Discussion: - Law of supply- Change in wages- Short run vs. long run supply curve S (w0, r0, tech0, op0) 0 q

  7. From firm supply to market supply • Market supply: The sum of what is supplied each period by all producers of a single product.

  8. Market equilibrium • Market equilibrium: The condition that exist when quantity supplied and quantity demanded are equal. At equilibrium there is no tendency for price to change. p Example:S: qs = -10 + pD: qd = 20 – p peq=15 , qeq=5 S equilibrium point peq D 0 qeq q

  9. Stability of market equilibrium • Economists like equilibriums, but we love those that are stable!!! Stable equilibrium: The system always returns to it after small disturbances. Unstable equilibrium: The system moves away from the equilibrium after small disturbances

  10. Stability of market equilibrium The inherent forces of the market move the system to its equilibrium!!! p S excess supply p0 equilibrium point p1 excess demand D 0 q

  11. p Example: Increase in income Changes in Equilibrium S eq. point 1 eq. point 0 D1 D0 0 q

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