Tutorial 3: Demand and Supply
This tutorial is divided into five parts (see
Page Links at right). It explores how buyers (Demand) and
sellers (Supply), in the context of a market, interact to
determine the equilibrium price and quantity of a good or
service (Equilibrium). It also discovers how changes in
factors underlying demand and supply lead to changes in
equilibrium price and quantity (Comparative statics). Finally,
we explore the intended and unintended consequences of government-set
price controls on a market (Controls).
Market Demand
In Tutorial 2
we learned that the maximum price a buyer is willing to
pay for one unit of a good or service, rather than do without,
is called his reservation price. As a group, buyers'
reservation prices for a given quantity of a good vary due
to differences in the strength of their preference for the
good, their knowledge of the price of substitute or complementary
goods, their disposable income, and their expectations about
what will happen to their income or the price of the good
in the near future.
This indicates that the quantity of a good demanded
by buyers in a market varies with market price, all these
other influences held constant. As market price rises, fewer
buyers will have a reservation price high enough to make
the purchase worthwhile. That's because as price rises,
substitutes for the good start to look more attractive.
As price falls more buyers will have a reservation price
low enough to make the purchase worthwhile. That's because
as price falls substitute uses for this good start
to look more attractive.
We can use mathematics notation to write a shorthand
expression of this relationship as:
QD = f (Price | P-PINE),
where |
QD = |
Quantity of the good demanded in this
market during a given time period |
|
Price = |
The market price of the good |
|
| = |
"given" or "holding
these variables constant" |
|
P = |
Preferences of buyers in this market |
|
P = |
Price of substitutes |
|
|
Price of complements |
|
I = |
Income (good is normal) |
|
|
Income (good is inferior) |
|
N = |
Number of buyers in this market |
|
E = |
Expectations buyers have of future
changes in the price of the good or in their disposable
income. |
A linear equation describing market demand for a good might
be written as:
QD(Price | PPINE) = a - b1*Price + b2*Pref -
b3*Pc + b4*Ps + b5*In - b6*Ii + b7*N + b8*E(Price) + b9*E(Inc)
The sign of the intercept term, a, is positive.
This indicates that if all the variables were set to zero,
the consumer would still buy a positive amount of the good.
The sign on coefficients b2, b4, b5, b7,b8 and
b9 are all positive. This indicates that an increase in
the value of any one of these variables (Preferences, Price
of substitute good, Income--normal good, Number of buyers,
or Expected change in Price and Expected change in Income)
will increase the quantity demanded at a given price, ceteris
paribus.
The sign on coefficients b1 and b6 are both
negative. This indicates that an increase in the value of
either of these variables (Price or Inc--inferior good)
will decrease the quantity demanded at a given price, ceteris
paribus.
If we hold the P-PINE variables
constant and only allow Price to vary, we can write the
equation for demand as:
QD(Price | PPINE) = b0 - b1*Price,
where b0 = b2*Pref - b3*Pc + b4*Ps + b5*Inormal
- b6*Iinferior + b7*N + b8*E(Price) + b9*E(Inc).
Let b0 = 400 and b1 = 2. The resulting demand
equation is
QD(Price) = 400 - 2*Price.
The inverse form
of this equation1 is depicted
graphically as a downward-sloping line in Price/Quantity
space:
This demand curve (D1) depicts the Price
(in $ per unit) of a good buyers are willing to pay for
a given Quantity (in units per time period), everything
else (e.g., P-PINE) held constant.
| Now it's time to
"do the thing".
Click on the following link
to download the Demand
and Supply Workbook. Work through Warmup
Questions 1 - 5 to improve your understanding
of how changes in P-PINE shift the demand
curve.
Return here when you have finished.
Need help
downloading the Excel file? |
|
Now we turn our attention to the supply side of a market...
Continues... 
|
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Demand