SAD - Supply and Demand Overview
Supply and Demand Overview
Introduction
Understanding the basic workings of demand and supply and their role in equilibrating the market is essential in microeconomic analysis. In this module, you will explore the role of demand and supply in establishing a market clearing price and producing a socially optimal outcome in a competitive market. In addition, you will analyze the resulting inefficiencies in markets when outside forces act to impede the natural market mechanisms.
Essential Questions
- How does price act as an incentive to consumers, according to the Law of Demand?
- How does price act as an incentive to suppliers, according to the Law of Supply?
- What is the underlying difference between a "change in demand/change in supply" and a "change in quantity demanded/change in quantity supplied?"
- What are the determinants of demand and supply and how do changes impact the market equilibrium?
- How is a consumer brought into equilibrium through maximizing utility given a budget constraint? How does a competitive, free market maximize total welfare to society?
- What are consumer and producer surplus? What is meant by Pareto efficiency?
- How is total welfare in a market impacted by operating in a position other than Pareto efficiency? How do price ceilings, price floors, and quotas impact the allocative efficiency of a market?
Key Terms
Click here to download the key terms document for this module. Links to an external site.
Law of Demand – states that price and quantity demanded move in opposite directions
Income Effect – due to a change in price, this is the change in quantity demanded that results from a change in the consumer’s purchasing power (or real income).
Substitution Effect – this effect explains the change in quantity demanded resulting from a change in the price of one good relative to the price of other goods
Demand Schedule – a demand curve is a graphical representation of the information in a demand schedule.
Demand Curve – a graphical representation of the information in a demand schedule.
Utility – the happiness, benefit, satisfaction, or enjoyment from the consumption of goods and services.
Marginal Utility – the change in an individual’s total utility from the consumption of an additional unit of good or service
Law of Diminishing Marginal Utility – the instance wherein a given time period, as consumption of an item increases, the additional (marginal) utility from that item falls
Consumer Equilibrium – the combination of goods and services at which the marginal utility per dollar spent on the last unit of each good is equal.
Normal Good – a good for which income and demand are positively related
Inferior Goods – a good for which income and demand are negatively related
Complements – two goods that provide more utility when consumed together than when consumed separately
Substitutes – two goods that can be used in place of one another because they provide virtually the same utility
Law of Supply – states that the price and quantity supplied are positively related
Supply Schedule – a table showing quantity supplied for a good at various prices
Supply Curve – a graphical representation of information on the supply schedule
Market Clearing Price (Equilibrium Price) – the price at which quantity demanded equals quantity supplied and there is no shortage or surplus in the market
Market Equilibrium – exists at only the price where the quantity supplied equals the quantity demanded. OR, it is the only quantity where the price consumers are willing to pay is exactly equal to the price producers are willing to accept.
Shortage – a situation in which, at the going market price, the quantity demanded exceeds the quantity supplied.
Surplus – a situation in which, at the going market price, the quantity supplied exceeds the quantity demanded.
Price Ceiling – a type of price control that establishes a legal maximum price, above which the product cannot be sold.
Price Floor - a type of price control that establishes a legal minimum price, below which the product cannot be sold.
Consumer Surplus – considered the ‘unpaid benefit’ a consumer receives on units purchased of a good. It is the difference between a buyer’s willingness to pay and the price actually paid.
Producer Surplus – the difference between the price received and the marginal cost of producing the good
Total Welfare – the sum of consumer and producer surplus
Deadweight Loss – the lost net benefit to society caused by a movement from the competitive market equilibrium.
Module Standards Links to an external site.
National Technology Education Standards Links to an external site.
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