Please note that this basic version of the lecture is provided as a convenience for the student, and may be missing interactive materials throughout. Students are still responsible for reviewing the missing materials – including audio, video, and interactive widgets – that are found in the full lecture.
SUPPLY AND DEMAND: GET YOUR
OUTPUT IN ORDER
Another essential component of good managerial decision making is having a thorough understanding of the relationship between prices and output. For that, supply and demand curves are helpful. Demand is the quantity of a good or service that a consumer is willing and able to purchase at a specific point in time and at a specific price. The demand curve reflects an inverse relationship between the price of the product and the quantity demanded of the product. A movement along this curve results from a change in the price of the product. As the price of an iPhone falls, for instance, demand increases for the cheaper product. In economic terms, this is referred to as a change in the quantity demanded (see Figure 1).
Figure 1. Change in the quantity demanded.
A change in demand, or more easily remembered as a shift in demand, results from a change in the forces that drive demand. These include the number of buyers in the market, consumer tastes and preferences, consumer income, the price of related goods, and consumer expectations. Figure 2 shows a positive shift in the demand curve due to favorable changes in the factors that determine demand, except the price of the product. The quantity demanded increases at given prices. The curve can also shift in the opposite direction as the forces of demand cause the quantity to decrease.
Figure 2. Positive shift in demand.
Ceteris paribus means “all other factors being constant or equal.” There are many factors that aﬀect demand for a product.
Consequently, it is diﬃcult, if not impossible, to graph these factors on one graph, hence the assumption of all other factors being constant, so that we are able to isolate price and quantity demanded or quantity supplied. The end results are in Figures 1 and 2. Think about the market for Christmas trees. Between Thanksgiving and Christmas, the number of buyers for Christmas trees increases rapidly. As Christmas Day approaches, the number of buyers falls oﬀ. Come December 26, buyers are so scarce that it is a common sight to see trees left sitting on the sidewalk to be taken for free.
Strong customer preferences dictate that a shift in demand will happen, in this case to the left, as the quantity demanded declines over time, regardless of a shift in price. Sure, the seller can charge less and get more people to buy, but at some point, preferences trump price. The demand curve shifts.
On the other side of the equation is supply. Supply is the quantity of goods and services that producers are willing and able to sell at a specific price and at a specific point in time. The supply curve reflects a direct relationship between the price of the product and the quantity supplied. A movement along this supply curve results from a change in the price to produce the product.
When smart phones first hit the market at a high price, for example, competitors rushed in to supply the market, and stores were eventually flooded with copycat phones. In economic terms, this is referred to as a change in quantity supplied (see Figure 3).
Figure 3. Change in quantity supplied.
A change in supply, or more easily remembered as a shift in supply, results from a change in the forces that drive supply. These include the number of sellers, producer expectations, technology advancements, and the price of other goods. Figure 4 illustrates a positive shift in supply.
Figure 4. Positive shift in supply.
Let’s use the Christmas tree example again. As the Christmas season heats up, more and more suppliers of Christmas trees enter the market, shifting the supply curve to the right. As Christmas Day approaches, suppliers begin to leave the market, shifting the supply curve to the left. The supply curve shifts right and left based on consumer expectations.
Keep this in mind: Price and quantity are determined by the intersection of the demand and supply curves (see Figure 5). When demand equals supply, market equilibrium exists.
Figure 5. Intersection of supply and demand curves. A market surplus or shortage can exist at times when markets are in disequilibrium. A surplus reflects excess supply, meaning suppliers produce more goods than consumers are willing to buy at a given price. Car dealers with excess inventory, for example, are willing to accept lower prices because they are motivated to move cars oﬀ the lots before the end of the month.
A shortage reflects a demand for products greater than what has been supplied at a given price. A shortage implies that consumers are demanding more than suppliers are willing to supply. Consumers will therefore pay more to get the goods. A return to market equilibrium will bring things back to a just-right state of neither too much nor too little supply.
The concept of surplus and shortage will be revisited in later lectures when we discuss government-imposed floors and ceilings on prices, and supply as tools to implement various public policy objectives.
The interplay of costs, prices, and output is a dynamic, multidimensional process. As we will see in subsequent lectures, a good understanding of the impact of these forces on your company and its markets can give you an edge over competitors.