Author: John Bouman

Price and Quantity Changes The law of demand states that buyers of a good will purchase more of the good if its price is lower, and vice versa. If the price of apples decreases from $1.79 per pound to $1.59 per pound, ceteris paribus, consumers will buy more apples. Ceteris Paribus The law of demand assumes that no other changes take place. This assumption is called “ceteris paribus.” If we don’t make this assumption, then we may notice that the price of apples decreases while fewer apples are purchased. One explanation for this may be that the price of oranges, a substitute product, has decreased more than the price of apples, so that consumers will substitute oranges for apples. Does this violate the law of demand? The answer is no. The law of demand assumes that no other changes take place, so we assume that the price of oranges stays the same. If we had not changed anything else (ceteris paribus), then we would have noticed an increase in the quantity purchased of apples as a result of a decrease in its price. Substitution and Income Effects There are two primary reasons why people purchase more of a product as its price decreases. One is the “substitution effect.” The substitution effect states that as the price of a product decreases, it becomes cheaper than competing products (assuming that prices of the...

Graphing the Demand Curve We can graph demand data in a diagram. The two variables we consider are the price of the product (P) and the amount of the product purchased during a certain period of time (Q). Economists measure the price of the product on the vertical axis and the quantity on the horizontal one. A demand schedule and a corresponding demand curve represent buyers’ willingness and ability to purchase the product. For demand to exist,  buyers cannot merely desire the product, but they must also be able to afford it. In the diagram below, two points are plotted for a hypothetical product. At a price of $7 per product, 13 units are sold. At a price of $14 per product, only 6 units are sold. Other points can be plotted and a line or curve can be connected through these points to arrive at the demand curve. A demand curve usually extends from the upper left to the lower right. It is “downward sloping.” The above diagram shows that on demand curve D, consumers buy 13 units at a price of $7 (point A) and 6 units at a price of $14 (point B). Video Explanation For a video explanation of how to graph a demand curve, please watch: Demand, Utils, Total Utility, and Marginal Utility The willingness of buyers to purchase a product depends on the...

Price and Quantity Changes The law of supply states that, ceteris paribus, producers offer more of a product at higher than at lower prices. If the product price is high, the supplier can make greater profits by selling more (assuming the cost of production is constant and there is sufficient demand). A video game, for which the demand is high and therefore the price as well, will be supplied at greater quantities because the higher price makes firms willing and able to supply more. Income and Substitution Effects When firms can get a higher price for their product, and they are still able to sell approximately the same amount, their income or revenue increases. This is the income effect of changing prices. The other effect is the “substitution effect.” The supplier’s substitution effect states that as the market price of a product increases, other competing products, ceteris paribus, will become less attractive to produce. Suppliers will substitute the higher priced product for the less expensive product (and vice versa). If the market price for Grover, the Sesame Street stuffed animal, increases in price, and Big Bird does not increase in price, then suppliers will want to make more Grovers. They are more attractive and more profitable to make compared to the Big Bird stuffed...

  Graphing the Supply Curve A supply curve slopes upward from the bottom left to the upper right of the diagram. At higher prices, firms are willing and able to sell more than at lower prices. We say that there is a direct relationship between price and quantity supplied. The above diagram shows that on supply curve S, suppliers supply 6 units of this product when the price is $7 (point A) and 11 units when the price is $14 (point B). An Individual Firm’s Supply Curve for Gasoline Below is an example of a hypothetical supplier’s supply schedule for gasoline. The supplier is willing and able to sell the quantities at the respective prices. Price per Gallon Total Number of Gallons Supplied Per Month (Quantity Supplied) $5.00 3,500 $4.50 3,000 $4.00 2,500 $3.50 2,000 $3.00 1,500 $2.50 1,000 A graph of this individual supplier’s demand schedule for gasoline looks like this: The Market Supply Curve for Gasoline A supply curve for the entire market of this product is simply the sum of every individual supplier’s supply schedule. For example, if the market for gasoline consists of 10 suppliers, then the market supply schedule looks as follows (for simplicity, we assume that every supplier’s supply schedule is identical to the individual supplier in the previous paragraph; compared to the table above the numbers in the quantity column are multiplied...

  The Market Price and Quantity In a free and competitive market without government price controls, the equilibrium, or market, price and quantity occur at the intersection of the supply and demand curves. At this price, consumers are willing and able to buy the same amount that businesses are willing and able to sell. If the price is below this equilibrium intersection point, a shortage results. If the price is above the point, a surplus results. In the graph above, the market is at equilibrium at a price of $11 and a quantity of 9. If the price were set at $7, a shortage of 7 products results. At $7 the quantity demanded is 13 (from $7 go straight over to the demand curve) and the quantity supplied is 6 (from $7 go straight over to the supply curve). Similarly, if the price were set at $14, a surplus of 5 units (11 minus 6) results. Video Explanation For a video explanation of the equilibrium price and quantity, please watch: Below are some supply and demand applications, in which we study what happens when the government, instead of the free market, determines the price. The Case of Rent Control Rent control is an example of a price set below the equilibrium point. This is called a price ceiling. In the graph below, the equilibrium (market) price of a rental...