To all the dedicated followers of our Junior Economist:
It is a great pleasure to announce the launch of our Curriculum Series on the Junior Economist. In the past few months, our team of writers and editors have produced a plethora of articles ranging from leadership and personal development advice, to editorials on political and financial news, to recaps of our latest event successes.
Our goal with the Curriculum Series is to provide readers with a student perspective on the basics of business, often highlighting many of the same values and principles discussed at our events. Through this initiative we hope to spread the outreach and impact that our Junior Economist provides to students from across Ontario.
We look forward to hearing your feedback.
Robert Di Marco
Supply, Demand, and Market
Supply, Demand, and Market
Supply and demand is one of the most important concepts in economics. In simple terms, demand refers to the quantity of a product or service that is wanted by consumers, whereas supply refers to the quantity of a product or service that the market can offer.
In this article, we will explore the roles of supply and demand, their relationship, and how the two forces drive the way people allocate resources in the economy.
Demand refers to the relationship between the price of a good and the quantity of the good that consumers are willing to buy at each price. In this relationship, the price is the independent variable. The dependent variable is the quantity demanded, which refers to the amount of the product consumers are willing to buy at each price.
The Law of Demand
The law of demand states that the higher the price of a good, the fewer people will want that good. More formally, as price increases, quantity demanded decreases. When working with this law, we assume ceteris paribus—that all other factors affecting price and quantity demanded are held constant. The relationship between price and quantity demanded is displayed in the demand curve, as illustrated in Figure 1.1.
To draw the demand curve, place price on the vertical axis and quantity demanded on the horizontal axis. Note that, unlike in typical mathematics, the independent variable is on the y-axis instead of the x-axis. This may be a bit confusing at first, but it is accepted as a convention in economics. If you have drawn the model correctly, the demand curve should have a negative slope.
The demand curve’s negative slope is indicative of the law of demand; as the price of a good goes up, the quantity demanded goes down, and vice versa. This is an example of a change in quantity demanded, which is represented by a movement along the demand curve.
For instance, as the price of apples drops from $3.00 per kilogram to $2.00 per kilogram at your local grocery store, you might go from buying 4 apples per month to 6 kg of apples per month. This change in quantity demanded is represented by a movement from one point on the demand curve to another, as shown in Figure 1.2.
Market demand refers to the sum of all consumers’ purchases, or quantity demanded, at each given price. While you purchase 6 kilograms of apples per month at a price of $2, your neighbour might purchase 10 kilograms per month at the same price. When considering what both of you are able or willing to pay at $2, the total quantity demanded is 16 kilograms of apples per month. In this case, the market demand is therefore 16 kilograms of apples per month for apples priced at $2 per kg. As we repeat this procedure of summing the quantities demanded at every possible price, the resulting market demand curve will shift outwards.
Supply refers to the relationship between the price of a good and the quantity of the good that businesses are willing to sell for each price. In this relationship, the price is again the independent variable; however, the dependent variable is now quantity supplied. Quantity supplied refers to the amount of a product businesses are willing to supply at each price. As with market demand, market supply is the sum of all producers’ quantities supplied at each price.
The Law of Supply
The law of supply states that, as the price of a good increases, the quantity supplied increases as well. We must also assume ceteris paribus when working with the law of supply. The relationship between price and quantity supplied is shown in Figure 2.1.
The supply curve’s axes are identical to the axes for the demand curve. Unlike the law of demand, however, the law of supply shows a positive slope. This is because businesses want to sell more of their products when prices are high, since selling high quantities of a good at high prices results in increased revenue.
As with the demand curve, a change in a product’s price causes a change in quantity supplied. However, in the case of supply, an increase in price causes an increase in quantity supplied. This is represented by a movement along the supply curve.
For instance, as the price of apples drops from $3.00 per kilogram to $2.00 per kilogram, businesses might go from selling 9 million kilograms of apples per year to selling 16 million kilograms per year. This movement along the graph is shown in Figure 2.2.
3. Supply and Demand Relationship
In the marketplace, supply and demand work behind the scenes to coordinate the decisions of buyers and sellers. Quantities demanded and supplied are driven to a point of stability by changes in price. This point of stability is called the market equilibrium, where the supply and demand curves intersect.
The market is said to be at equilibrium when supply and demand are equal. At this point, the allocation of goods is at optimal efficiency, because the amount of goods being supplied is the same as the number of goods being demanded by consumers.
Whenever the market is out of equilibrium, changes in price compel the market to right itself and achieve equilibrium. If the price of a good is too high, the quantity supplied exceeds the quantity demanded, resulting in a surplus of goods. If the price is too low, the quantity demanded exceeds the quantity supplied, resulting in a shortage of goods. Both these conditions force the market back to equilibrium.
Surplus of Goods
A surplus of a product forces its market price down towards an equilibrium price. Since the good’s quantity supplied exceeds its quantity demanded, this means that suppliers are selling way more than consumers are buying. In response, some suppliers cut their prices and others scale down production. As suppliers cut prices, the market price falls towards its equilibrium. The falling price decreases the surplus because it increases the good’s quantity demanded and decreases its quantity supplied—until quantity demanded is equal to quantity supplied. At that point, there is no longer a surplus. The forces moving the price stop operating and the price comes to rest at its equilibrium.
Shortage of Goods
A shortage of a product forces its market price up towards an equilibrium price. Since the good’s quantity demanded exceeds its quantity supplied, this means that suppliers are not selling enough to satisfy the buyers. Hence, suppliers aren’t earning an optimal amount of income, as they are not selling to all the consumers who want to purchase their goods. In response, some suppliers raise their prices whereas others increase their output. As suppliers push the price up, the price rises towards its equilibrium. The rising price reduces the shortage because it decreases the good’s quantity demanded and increases its quantity supplied—until quantity demanded is equal to quantity supplied. At that point, there is no longer a shortage. The forces moving the price stop operating and the price comes to rest at its equilibrium.
Basic Economic Models and Foundations
Basic Economic models
We can define the term economics as the transfer of wealth within a defined society. In Economics, we can place the most commonly seen and used economic models into perspective in a way so that they contrast and provide distinct properties from one another—distinct enough so that we understand their respective outcomes, sacrifices (and there are always sacrifices), and shortcomings. In the study of theoretical economics (emphasis on THEORETICAL), many assumptions that do not nessasaility reflect real world values are introduced, assumptions such there are only two different products in competition, or that consumers have unlimited and unrestricted access to marketing information, or that anything and everything is rational and equal—ceteris paribus.
Scarcity is the situation in which available resources, or factors of production, are finite, whereas wants for such resources, are infinite. There are not enough resources to produce everything everyone wants, so economics deals with the plans and methods to make sure what we do have is allocated to highest efficiency. Resources can also be known as factors of production, and can include things like human labour, machinery, and factories, or “gifts of nature”, such as agricultural land, and metals underground. By studying economics, we are trying to find out:
What to produce
How to produce
For whom to produce
Four factors of production
Economists group factors of production under four categories:
Capital (different from accounting capital)
The word capital has several meanings amongst different studies. In Geography, it might mean the most important city or town of a country. In law, it might mean execution as a punishment. In accounting, it might mean assets needed by a company to provide goods or services, as measured in terms of money value. In economics, capital is, in the most general sense, resources that can produce a future seam fo benefits. This may be physical capital (four factors of production), human capital (skills, abilities, and knowledge of the people), natural capital, or financial capital.
Opportunity cost is defined as the value of the next best alternative that must be given up in order to to obtain something else. For Example, when a consumer spends $100 on shoes, that consumer is giving up the opportunity to spend that $100 on something else, such as books. That lost opportunity is the opportunity cost.
Productions possibilities model
One of the most basic models in economics, the productions possibilities model/curve (PPC) is the curve depicting all maximum output possibilities for two goods, given a set of inputs consisting of resources and other factors.
Depending on the costs of resources each respective resource requires for production, the curve varies accordingly. Looking at the chart above and suing the classic example of guns and butter, we see that should we produce more butter, we must decrease the amount of guns we can produce, making the two quantities meet at point C, and vice versa, at point B. If the amount of guns produced where to equal that of the butter produced, the two quantities would meet a more or less central point, point D, in this case. The condition of scarcity would thus not allow the economy to produce outside of the PPC, because it does not have enough resources.
It is important to know that this is all theoretical. For this model to exist, two conditions must be met:
All Resources must be fully employed
All resources must be used to maximum efficiently
In reality though, it is nearly impossible for any economy to produce on its PPC, and will most likely do so at a point such as A, as there are a multitude of factors such as resource waste that would prevent maximum efficiency.
The above diagram, where the PPC (yes, it's still a curve even though its straight) is straight, meaning that the change from one produced produced to another is a constant change. For example, in the second diagram, for every 10 butter we produce, we are giving up 25 guns that we could’ve used the resources to produce. On the other hand, for the first diagram, because the PPC is curved, a 10 butter increase might mean only a 1 gun decrease near the top of the curve, but at the bottom, a 10 butter increase could mean a 35 gun decrease. The change isn’t constant.