Economics Study

The Concept of Equilibrium

noreply@blogger.com (seo webdesigner) — Sat, 16 Feb 2008 18:09:00 +0000

Both demand and supply functions independently serve important functions. However, it is important to bring them together in an attempt to establish equilibrium. The concept of equilibrium, though analytical in nature, is quite simple in practice. It can be defined as a point of equality or agreement between buyers and sellers. Since both demand and supply quantities are shown in the scheduled forms these indicate mutual willingness of consumers and producers to purchase or sell respectively, varying quantities at varying prices. The schedules do not yet explain actual market price at which deals take place. This can be possible only when the quantities demanded and supplied are exactly equal at some uniform price. So long as this has not been achieved, some buyers or sellers are yet dissatisfied and may attempt to raise or lower the price. In this sense equilibrium is a point of complete satisfaction of the given behavior of buying and selling and hence an act of fulfillment of a given economic activity.
Let’s present and illustrate the establishment of equilibrium with the help of demand and supply functions in our earlier examples (in the sections given above). We begin with two equations:
qd = 10 - 3P and qs = 2P
By definition, demand and supply must be equal (qd = qs) for the condition of equilibrium.
qd = 10 - 3P = qs = 2 P or 10 - 3P = 2P
On solving this we find equilibrium price:
On substituting the value of price in demand and supply function we get,
qd = 10 - 3P qd = 10 - 3 (2) = 10 - 6 = 4
qs = 2P qs = 2 (2) = 4
Hence equilibrium price is 2, at which both quantity demanded and supplied are equal to 4. The algebraic proof (Figure 7) of the equilibrium can also be presented geometrically.
Figure 9
In the figure, AB and OS are the demand and supply curves respectively. The two curves intersect at point E which is an equilibrium point at which price P = 2 and quantity demanded and supplied are both equal (q = 4). At any other price higher than P such as P1, the quantity supplied S1 exceeds the quantity demanded d1 (S1 > d1) and hence at this stage, some sellers remain dissatisfied. On the other hand at any lower price such as P2, quantity demanded d2 exceeds quantity supplied S1 (d2 > S1) and this time some buyers remain dissatisfied. Therefore only at the point of intersection between demand and supply curves can equilibrium be attained. In other words, equilibrium price represents that price at which buyers are willing to buy the good and sellers are willing to sell it. This is the point of satisfaction for both the groups.

Elasticity of Demand and Supply

noreply@blogger.com (seo webdesigner) — Sat, 16 Feb 2008 18:07:00 +0000

(A) Price Elasticity
i) Elasticity of Demand: Elasticity of demand can be classified into two major divisions: one the highly elastic, unitary elastic and the highly inelastic type and two, the extreme cases of the perfectly elastic and the perfectly inelastic type.
a) Highly elastic, Unitary elastic and highly inelastic: The laws of demand and supply are no doubt an important part of economic analysis. But the knowledge about demand and supply relations serves only a limited purpose. This is in view of the fact that both demand and supply laws are applicable to all kinds of goods. However, an actual rise or fall in the quantity demanded or supplied with a small variation in the price may considerably differ for different goods such as food, automobiles, film shows, garments, hardware materials, machines, land etc. In other words it is important to know the extent of rise or fall in the demand with a given change in the price for each individual good. This is exactly the purpose served by the concept of price elasticity of demand; this concept is advanced and subtle in nature. It was first developed by Alfred Marshall; he has defined elasticity as follows:
Elasticity of demand is the degree of responsiveness with which quantity demanded changes for a given change in price.
In other words it is a proportional change in the quantity demanded to a proportional change in price.
Price Elasticity of demand is then the ratio of the proportional change in the quantity demanded to the proportional change in price.
Proportional change in quantity can be expressed as where q1 is the initial and q2 is the new quantity demanded.
Proportional change in price is similarly where P1 is initial and P2 is the new price.
Elasticity ratio e is therefore,
If symbols q and P are used for small variations in quantity and price respectively then,

Note that Dq / Dp is in the limit derivative or marginal change and p/q is the reciprocal of average change, therefore
Let’s illustrate this. In our demand schedule example above, when price changes from 2 to 3 units, the quantity demanded changes from 4 to 1 units. Substituting these values we have:
Note that the elasticity ratio 3/2 is more than one and has a negative sign. Both these are important features. Numerical values explain the extent or degree of change in demand while the sign of the ratio explains the direction of change. Since the law of demand is based on the inverse relation between price and quantity, the elasticity of demand is always stated with a negative sign.
The numerical value of elasticity can be equal to 1 (that is called ‘unit’) more than one or less than one. In case of unit elastic demand (e = 1) both price and quantity (demanded) changes occur in the same proportion. If the value of elasticity exceeds one (e > 1) then the percentage or proportional change in quantity demanded is greater than that in price and the good is said to be price elastic or highly responsive to a change in price. If the value of elasticity is less than one (e < 1) then the proportional change in quantity is smaller than that in price and the demand for the good is said to be price inelastic or not very responsive to a change in price. The information about the value of elasticity therefore serves an important purpose in classification of various goods as elastic or inelastic in demand. This helps in several practical and policy applications such as taxation, foreign trade, monopoly, price determination etc.
There are four methods of measurement of elasticity of demand. These are percentage, proportion, outlay and geometric or point elasticity methods. The one mentioned last (point elasticity method) is the most accurate and can be explained conveniently with a given demand curve:

Supply Schedule, Function and Law

noreply@blogger.com (seo webdesigner) — Sat, 16 Feb 2008 18:06:00 +0000

(A) Supply Schedule: Just as goods are demanded by consumers, they are supplied by manufacturers or sellers. At any point of time quantity supplied by them is a function of the market price. Several such prices can be related to the relevant quantities supplied: this would give the supply schedule. In the given schedule, as price of the goods rises (from zero to 3) the quantity supplied also rises (from zero to 6 units).
Supply Schedule
qs
P
0
0
2
1
4
2
6
3
(B) Supply Function: Supply is a direct function of the price and it rises or falls with the price. This is because the law of supply is based on the behavior of the cost of production. Assuming that manufacturers begin at the point where cost of production is minimal any further production and supply of goods can be possible only at an increasing additional or marginal cost per unit. Hence they can afford to supply more only at a rising price. Further, logically any seller would be willing to sell more goods if the price were to rise. The quantity supplied at the given range of prices as above can be presented in the form of an algebraic function:
qs = 2P
With the help of the function we can find the quantity supplied at any randomly chosen prices. For instance, when P = 3, qs = 6 or when P = 2, qs = 4 etc.
(C) Law of Supply: The law of supply can be stated as follows:
"Ceteris paribus, the quantity of a good supplied will rise (expand) with every rise in its price and the quantity of a good supplied will fall (contract) with every fall in its price."
In a functional form this can be stated as : qs = f (P) [T, R, P] const.
The quantity of a commodity supplied is thus a function of its own price. There exists a direct relationship between the quantity supplied and the price of a commodity. It is subject to the condition that other things should remain constant. In this case ‘other things’ include mainly two things. These are technical conditions or methods of production (T) and the prices and quantities of the resources supplied (RP). With improved technical conditions, supply can be increased at the same old price, since the cost of production can now be reduced. Similarly with an enhanced supply of resources and a reduction in the prices of resources such as land, labor, raw materials etc. an increasing quantity of the commodity can be supplied at a constant or even falling price.
Figure 4
Figure 4 is the graphical representation (the supply curve) of the supply schedule. It begins at the point of origin where both quantity supplied and price are zero in value, and then it continuously rises upwards. This upward sloping curve indicates the positive relationship between supply and price: there is a rise in the quantity supplied with every successive rise in the price.
(D) Expansion or contraction and increase or decrease: Changes in the quantity supplied as a result of movement along the same supply curve has been described by Marshall as rise and fall or expansion and contraction of quantity supplied of the commodity. But if the supply curve shifts left or right of the original curve, the changes in supply of the good are known as increase or decrease.
Figure 5
In figure 5 we notice such a shift in the supply curve. On the original supply curve (OS) the quantity of goods supplied at price OP is Oq but when the supply curve shifts towards its left (i.e. S1 S1) then at the same price OP, the quantity supplied decreases to Oq1. If we begin with S1 S1 as the original supply curve, OS would represent a shift of the supply curve towards the right. In this case, quantity supplied increases at a given price.
The supply curve undergoes a shift in it with a change in the technical conditions or the price and supply conditions of the inputs (resources). With improved techniques or methods of production, the degree of the efficiency with which some or all resources can be utilized will increase. This results in a favorable change in the cost of production. Similarly with improved supplies and reduced prices of the inputs, the cost of production tends to fall and an increased supply of a commodity becomes possible at a given market price.

Demand Schedule, Function and Law

noreply@blogger.com (seo webdesigner) — Sat, 16 Feb 2008 18:04:00 +0000

D(demand)
qd
Schedule
P
10
0
8
1
4
2
1
3
0
4
(A) Demand Schedule : The various quantities demanded of a particular commodity are presented here in a schedule. At arbitrarily chosen prices, the quantity of a commodity an individual consumer is expected to demand, is explained by the schedule. Since quantity demanded (qd) depends on the relevant prices of goods, the two can be expressed in the form of an algebraic function as well. The schedule shows that as price goes on rising (from zero to 4) the quantity demanded goes on falling (from 10 to zero).
The scheduled information has been presented in the form of a demand curve in Figure 2 (below). In the figure, the units of quantity of the goods have been measured along the horizontal axis (OX) and the respective prices have been shown along the vertical axis (OY). The curve intersects OY axis at point A which shows highest price at which quantity demanded is zero. On the contrary the curve intersects OX axis at point B showing largest quantity demanded where price is zero. Both OA and OB are said to be intercept quantities when one of the variables assumes zero value. Note that demand curve is sloping downward. This follows the law of demand (given below). But the demand curve of such a shape is obvious from the fact that quantities demanded and price in the demand schedule hold an inverse relationship.
Quantity Demanded qdFigure 2
(B) Demand Function: The price-demand relationship shown above can be expressed in the form of a demand function as follows:
qd = 10 - 3P
On substitution of any scheduled value of P we get the relevant value of the quantity demanded. Thus when P = 1 then qd =10 - 3 (1) = 7 or when P = 3, then qd = 10 - 3 (3) = 1 etc.
(C) Law of demand: The law of demand explains the inverse relation between quantity and price in general. It can be stated as follows:
"Ceteris Paribus (other things remaining equal), the quantity of a good demanded will rise (expand) with every fall in its price and the quantity of a good demanded will fall (contract) with every rise in its price."
In a functional form this can be stated as,
qd = f (P) [ Y, Ps, N, Z ]const.
This explains that qd, the quantity of a good demanded functionally depends on its price P. However, the quantity demanded is also causally related to other factors such as income of an individual (Y), prices of substitutes (Ps), number of members in the family (N) and the tastes of the consumer (Z). In order to satisfy price-demand relation, the effect of these other variables has been restrained by assuming them to be constant.
Initially, the law of demand was based on the principle of diminishing marginal utility (DMU). But in that case it was implied that utility is cardinally or absolutely measurable. There were other practical difficulties in the DMU approach as well. Therefore recently attempts have been made to place the law of demand on the empirical and realistic basis. One such attempt is in the form of Indifference Curve (IC) analysis. Under the IC approach it is enough to measure utility in ordinal or relative terms.
(D) Rise or Fall and Increase or Decrease in demand: On a given demand curve as we move downwards from point A in the direction of B, the quantity demanded goes on rising with every successive fall in price. On the contrary, moving from point B to A shows a fall in the quantity demanded with every successive rise in the price. Marshall has called this process rise and fall or expansion and contraction in the demand. Therefore, in this case the price of the quantity (and the change in it) plays an important part. Here, a change in the quantity demanded is indicated with movement along the demand curve (up or down accordingly). This change is subject to the ceteris paribus condition.
On the other hand, other factors are also likely to alter the quantity demanded. This can be expressed by a shift in the curve. Such an upward shift in the demand curve (Figure 3) has been shown by a new and higher demand curve (A1B1) in the figure.
Figure 3
At a given price OP on the original demand curve (AB), the quantity demanded is Oq but on the new demand curve (A1B1) it has increased to Oq1. On the other hand, if we begin with the A1B1 demand curve as the initial demand curve and consider demand to have reduced (to AB) then the quantity demanded reduces from Oq1 to Oq. Such a change in the demand, arising out of a shift in the demand curve is known as an increase (if it is towards the right of the original demand curve) and a decrease (if it is towards the left of the original demand curve) in the demand, respectively.
The demand curve may shift and quantity demanded may increase or decrease, due to changes in a number of factors (apart from price), say the income (Y) of a consumer (when he becomes richer or poorer). A similar effect can be noticed with a rise or fall in the price of substitute (Ps) goods. For instance, tea and coffee or soaps of different brands are substitutes of each other. Therefore a rise in price of pasta may result in a reduction in the consumption of pasta and simultaneously an increase in the consumption of bread to that extent and vice versa. Or the demand curve may shift and quantity demanded may increase at the old price if there is a sudden increase in the number of members in a family (N), (say because of the unexpected arrival of guests). Finally, a shift in the demand curve may also be the result of the change in the tastes of a consumer. A cigarette or liquor consumer may become addicted because of which his demand for such goods will rise remarkably even at the old price.
There is an important difference between the change in the quantity demanded of a particular commodity and change in the demand for that commodity. While the former is influenced by the single factor: price, the latter is influenced by various other factors apart from price. A change in the quantity demanded is represented by a movement along the demand curve, while a change in the demand is represented by a shift of the curve (towards the left in case of a decrease and towards the right in case of an increase).

Fundamental Concepts

noreply@blogger.com (seo webdesigner) — Thu, 14 Feb 2008 18:08:00 +0000

Demand and supply are basic concepts in economic analysis. This is because economics is fundamentally concerned with ends and means. The quantities of various goods demanded are expected to bring satisfaction of different wants or ends, the supply of these goods is conditioned by the availability or scarcity of resources which act as the means of production. Both the terms ‘demand’ and ‘supply’ have technical implications. By demand, we mean the quantity of any commodity that ‘buyers are willing and have the ability to buy.’ Both the conditions must be satisfied together before goods can be demanded. One who smokes wishes to purchase cigarettes but he must have enough money or resources to do so. Similarly, a quantity of a commodity is said to be supplied only when a seller is willing to sell it at the market price.

The two concepts of demand and supply are, however, relative in nature and conveniently interchangeable. For example, a person may visit a distant wholesale market and purchase 50 small cans of beer at a somewhat lower price than what he would have paid in the local market. Therefore 50 cans of beer can be said to be his demand for the commodity. On his way home he meets a friend B who requests for 10 cans of beer at a particular price. If the bargain is acceptable, A will sell 10 cans to B, which will consist of his (that is A’s) ‘supply’ and the remaining 40 cans will then be his demand. Later on if a close relative of A (say C) requests him to part with 5 cans of beer on a ‘no profit no loss’ basis, then that becomes a further part of his ‘supply’ and his demand is reduced to 35 cans of beer. Similarly a shopkeeper who begins with 200 cans of beer (which is his supply) may retain 10 cans for himself and for his family members (this is known as self-consumption). In that case, his supply is reduced to 190 cans and demand would be 10 cans.
Finally demand and supply are mutually opposing concepts, in the sense that demand is an inverse (falling) function of the price, while supply is a direct (rising) function of the price. This is explained in the following sections.

Positive Economic Theory and Analysis

noreply@blogger.com (seo webdesigner) — Thu, 14 Feb 2008 18:03:00 +0000

It will be noticed that value judgments and normative elements are unavoidable in economic discussions. Yet economists and researchers take the effort of preserving and developing the scientific content of the subject matter. There is a standard theoretical model generally used and improved upon in most analytical work. This model emerges out of neo-classical techniques introduced at the beginning of this century. Professor Danie M. Hausman in his recent book Inexact and Separate Science of Economics has brought out several basic features of this theoretical model. The important features are :

(A) Marginal Approach: The standard theoretical model used in economics is also called a marginal method or approach. This is because all optimizing decisions are taken ’at the margin’ under this method. Margin or marginal change means infinitesimally small changes in an economic entity under consideration, such as utility, cost, factor services, wage rate, quantity demanded or supplied, etc. Such a small or marginal change is in fact a mathematical tool used in calculus. In mathematics, the first derivative of any algebraic function is known as ’the rate of change.’ In economics, marginal value or quality serves exactly the same purpose. This can be illustrated as:

In each case marginal value indicates the rate of change. With a small variation in the quantity of x, the marginal utility changes at the rate of 2, or with a small change in the quantity of x, marginal revenue changes at the rate of 0.75. In both these examples, the sign of the marginal values is positive. Therefore both marginal utility and marginal revenue tend to increase with every increase in the quantity of x. This however need not always be the case. In the present case, the functions are said to be rising. But there may be falling functions as well, such as that of the cost of production in the initial stages. In that case, value of the marginal cost may be negative. In fact, productive activity normally and beneficially occurs on the falling phase of the average cost curve. This will get clearer as we proceed.

(B)Ceteris Paribus (restrictive) clause : The marginal method of economic analysis deals with the rate of small changes. Moreover, these are instant and isolated changes. We need to concentrate on the effect of such changes on concerned individuals. But actually, economic activity is highly complex and consists of interdependent factors. Therefore such isolated changes can be examined only under highly restricted conditions. We have to make a heroic assumption about the constancy or absence of change in all other related factors or causes. For instance, an individual’s demand for a commodity depends on several conditions such as the price of the commodity (P), prices of its substitutes (Ps), income of the individual (Y), the number of members in his family (N) and the tastes of that individual (Z). Such a relation can be expressed in a functional form as :

d = f (P, Ps, Y, N, Z).
This explains that ’d’, the quantity of a commodity demanded, functionally depends upon five different factors. In other words, any change in any one of these factors can result in a change in the quantity demanded. However, the marginal approach is partial in nature. It attempts to concentrate on any one of these factors at a time, in analyzing its effect. The rest of the factors are assumed to be constant. This is the implication of the Ceteris Paribus a condition which means ’other things remaining equal.’ If we want to concentrate on the isolated effect of changes in the price of the same good (P) on the quantity demanded, then this can be written as :
d = f (P) [Ps, Y, N, Z]const.
Here the second bracket, i.e. […], serves as a Ceteris Paribus assumption in explaining the price-demand relation.

Positive Economic Theory and Analysis

noreply@blogger.com (seo webdesigner) — Thu, 14 Feb 2008 17:59:00 +0000

It will be noticed that value judgments and normative elements are unavoidable in economic discussions. Yet economists and researchers take the effort of preserving and developing the scientific content of the subject matter. There is a standard theoretical model generally used and improved upon in most analytical work. This model emerges out of neo-classical techniques introduced at the beginning of this century. Professor Danie M. Hausman in his recent book Inexact and Separate Science of Economics has brought out several basic features of this theoretical model. The important features are :

(A) Marginal Approach: The standard theoretical model used in economics is also called a marginal method or approach. This is because all optimizing decisions are taken ’at the margin’ under this method. Margin or marginal change means infinitesimally small changes in an economic entity under consideration, such as utility, cost, factor services, wage rate, quantity demanded or supplied, etc. Such a small or marginal change is in fact a mathematical tool used in calculus. In mathematics, the first derivative of any algebraic function is known as ’the rate of change.’ In economics, marginal value or quality serves exactly the same purpose. This can be illustrated as:
In each case marginal value indicates the rate of change. With a small variation in the quantity of x, the marginal utility changes at the rate of 2, or with a small change in the quantity of x, marginal revenue changes at the rate of 0.75. In both these examples, the sign of the marginal values is positive. Therefore both marginal utility and marginal revenue tend to increase with every increase in the quantity of x. This however need not always be the case. In the present case, the functions are said to be rising. But there may be falling functions as well, such as that of the cost of production in the initial stages. In that case, value of the marginal cost may be negative. In fact, productive activity normally and beneficially occurs on the falling phase of the average cost curve. This will get clearer as we proceed.

(B)Ceteris Paribus (restrictive) clause : The marginal method of economic analysis deals with the rate of small changes. Moreover, these are instant and isolated changes. We need to concentrate on the effect of such changes on concerned individuals. But actually, economic activity is highly complex and consists of interdependent factors. Therefore such isolated changes can be examined only under highly restricted conditions. We have to make a heroic assumption about the constancy or absence of change in all other related factors or causes. For instance, an individual’s demand for a commodity depends on several conditions such as the price of the commodity (P), prices of its substitutes (Ps), income of the individual (Y), the number of members in his family (N) and the tastes of that individual (Z). Such a relation can be expressed in a functional form as :
d = f (P, Ps, Y, N, Z).
This explains that ’d’, the quantity of a commodity demanded, functionally depends upon five different factors. In other words, any change in any one of these factors can result in a change in the quantity demanded. However, the marginal approach is partial in nature. It attempts to concentrate on any one of these factors at a time, in analyzing its effect. The rest of the factors are assumed to be constant. This is the implication of the Ceteris Paribus a condition which means ’other things remaining equal.’ If we want to concentrate on the isolated effect of changes in the price of the same good (P) on the quantity demanded, then this can be written as :
d = f (P) [Ps, Y, N, Z]const.
Here the second bracket, i.e. […], serves as a Ceteris Paribus assumption in explaining the price-demand relation.

Macro and Microeconomics

noreply@blogger.com (seo webdesigner) — Thu, 14 Feb 2008 17:49:00 +0000

These are two branches or rather methods of exposition of the science of economics. The distinction between them can best be explained by comparing their main features. As the terms suggest, macroeconomics deals with the market on a large-scale and its aggregate problems, while microeconomics concerns markets on a small-scale and individual aspects of the problems. There are six distinct aspects of the two approaches that are shown as in the following table:

Microeconomics
Macroeconomics
(a)
Units of the study
Individual consumers, producers workers, traders, etc.
Aggregate units such as state National or International economy.
(b)
Activities
Optimization and maximization of personal gains and profits.
Long term growth, maintenance of high levels of production and employment.
(c)
Origin
Micro activities emerge on the demand side of consumer’s choices.
Problems of long-term growth depend upon the supply of productive resources
(d)
Conditions
This approach is functional under static conditions and small time intervals.
This approach is functional under dynamic conditions and complex long run changes.
(e)
Methods
It is concerned with small adjustments, for which the application of a marginal method is suitable.
It deals with complex, dynamic changes inviting the use of advanced mathematical techniques.
(f)
Levels
Micro adjustments in resource A allocation are made in response to changes in relative prices of goods and services. The aggregate level of income or total economic activities is considered to be constant.
Macro approach attempts to find the conditions of long-term expansions in output as a whole, assuming relative prices as constant (or significant).

This distinction between micro and macroeconomics as presented above is only a matter of theoretical convenience. The two approaches are complementary and not competitive; one cannot consider these to be watertight compartments. Moreover, the distinction is to be understood as relative in nature. The problems of a city municipal corporation are macro in nature as compared to those of individual citizens, but a city unit is micro as compared to the state, and the state unit is micro as compared to the nation and the national unit can be considered micro in the context of the global economy. Again all economic problems and activities, whether micro or macro are ultimately connected with making a choice and optimization. They emerge out of and are concerned with human behavior.

What is Supply and Demand?

noreply@blogger.com (seo webdesigner) — Thu, 14 Feb 2008 17:33:00 +0000

Supply and demand is considered a basic economic concept, as well as a vital part of a free market economy. Supply is the amount of something, such as a product or service, that a market has available. Demand is the amount of the product or service that buyers want to purchase. The relationship between supply and demand has a good deal of influence on the price of goods and services.
Understanding the law of demand is an important part of deciphering the relationship between supply and demand. According to the law of demand, price has a significant effect on demand. Essentially, higher prices translate into less demand for a product or service. When the price of an item or service is high, an individual must consider that buying the item may prevent him from being able to afford the purchase of another, more valuable item. As such, the opportunity cost of that item is too high and demand for it may be low.
The law of supply is also vital to understanding the relationship between supply and demand. According to the law of supply, higher quantities of a product or service are supplied at a higher price. Those who produce goods and offer services are willing to supply more at higher prices because selling their wares at higher prices provides increased revenues.
To understand the relationship between supply and demand, consider a unique gift item that is priced at 99 US Dollars (USD). The company that makes the gift item has analyzes past sales and determines that demand for this particular item will be low if it is priced higher than 99 USD. The company decides to produce and release just 100 gift items because its analysis predicts that the opportunity cost is too high to provide for high demand. However, if 200 people demand the gift item, the price will rise along with the demand. Since higher prices lead to increased supply, more of the gift item will be produced and offered.
The supply and demand relationship affects price in a different manner when a company has produced too much of an item. For example, if the gift company increases production to create 500 gift items, but the demand stays at 200, the supply outstrips the demand and the price will not rise. By contrast, the company may actually lower the price in an attempt to attract consumers who considered the gift item attractive, but thought the opportunity cost was too high.
It is possible for supply and demand to be equal. In order for this to happen, the amount of supplied products or services must equal the demand for those products and services. If this relationship between supply and demand is attained, the economy is balanced in a state of equilibrium.

The Demand Curve

noreply@blogger.com (seo webdesigner) — Tue, 15 Jan 2008 14:27:00 +0000

The quantity demanded of a good usually is a strong function of its price. Suppose an experiment is run to determine the quantity demanded of a particular product at different price levels, holding everything else constant. Presenting the data in tabular form would result in a demand schedule, an example of which is shown below.

Demand Schedule

Price	Quantity Demanded
5	10
4	17
3	26
2	38
1	53

The demand curve for this example is obtained by plotting the data:

Demand Curve

By convention, the demand curve displays quantity demanded as the independent variable (the x axis) and price as the dependent variable (the y axis).

The law of demand states that quantity demanded moves in the opposite direction of price (all other things held constant), and this effect is observed in the downward slope of the demand curve.

For basic analysis, the demand curve often is approximated as a straight line. A demand function can be written to describe the demand curve. Demand functions for a straight-line demand curve take the following form:

Quantity = a - (b x Price)

where a and b are constants that must be determined for each particular demand curve.

When price changes, the result is a change in quantity demanded as one moves along the demand curve.

Shifts in the Demand Curve

When there is a change in an influencing factor other than price, there may be a shift in the demand curve to the left or to the right, as the quantity demanded increases or decreases at a given price. For example, if there is a positive news report about the product, the quantity demanded at each price may increase, as demonstrated by the demand curve shifting to the right:

Demand Curve Shift

A number of factors may influence the demand for a product, and changes in one or more of those factors may cause a shift in the demand curve. Some of these demand-shifting factors are:

Customer preference
Prices of related goods
- Complements - an increase in the price of a complement reduces demand, shifting the demand curve to the left.
- Substitutes - an increase in the price of a substitute product increases demand, shifting the demand curve to the right.
Income - an increase in income shifts the demand curve of normal goods to the right.
Number of potential buyers - an increase in population or market size shifts the demand curve to the right.
Expectations of a price change - a news report predicting higher prices in the future can increase the current demand as customers increase the quantity they purchase in anticipation of the price change.