Macroeconomics 201 Lecture #3: Supply, Demand, and Equilibrium
Because we only want to know the relationship between price and quantity demanded, we must hold all other factors constant or unchanging. This includes incomes, tastes or preferences, price and availability of related goods
(complements and substitutes), and expectations about all of the above. If we don’t hold these things constant, then we won’t know for sure if a change in quantity demanded was due to a change in price or due to one of these other factors (income affects ability, tastes affect willingness).
Because we only want to know the relationship between price and quantity supplied, we must hold all other factors constant or unchanging. This includes costs of production (determined by both input prices and technology), the number of sellers, and expectations of future prices and the previous factors. If we don’t hold these things constant, then we won’t know for sure if a change in quantity supplied was due to a change in price or due to one of these other factors.
Market surplus or excess supply
Excess demand means that too many buyers are chasing too few goods, so buyers are competing with one another for the goods that are in relatively low supply. In order to make sure that they can get a hold of some of the product, buyers will offer to pay a little bit more for the good. As they bid up the price, sellers will respond to the higher offer by increasing their supply, while some buyers will respond to the higher price by withdrawing some of their demand (less willing and able to buy at the higher price). As long as qs < qd, buyers will continue to bid up prices, stimulating supply and causing demand to contract, until p = p* and qs = qd.
If there were a market surplus, firms with excess inventories competing with one another for the relatively low demand will slash prices to capture some of the limited demand. As they cut prices, buyers will increase their willingness and ability to buy while some sellers’ willingness and ability to supply will fall at the lower prices. As long as qs > qd, firms will continue to slash prices, stimulating demand and causing supply to contract, until p = p* and qs = qd.
Own price elasticity of demand is the sensitivity or responsiveness of the demand for good x to a change in the price of good x. The factors that determine how elastic or inelastic demand will be for a good are:
demand will be elastic, as a small price change will cause people to switch to a substitute. If there are little or no substitutes, demand will be inelastic, as even a substantial price change means people have no alternative.
Firms care about own price elasticity of demand because they want to know what will happen to total revenue when there is a price change.
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