Model Of Supply And Demand

Demand What factors influence households decisions to consume a certain good? Continuing with the specific case of bread, our model-building methodology suggests that we should assemble the shortest possible list of factors that might affect the amount of bread that people want to consume during a given period of time. Price We expect that as the price goes up, the quantity demanded goes down. Asbread becomes more expensive, households turn to other goods, perhaps buying more muffins or sweet rolls instead. The notion that price and quantity demanded normally are inversely related is called the Law of Demand. Income Changes in income modify people’s consumption opportunities. It is hard to say in advance, however, what effect such changes have upon consumption of a given good. Onepossibility is that as incomes go up, people use some of their additional income to purchase more bread. On the other hand, as incomes increase, people may consume less bread, perhaps spending their money on cake instead. If an increase in income increases demand (other things being the same), the good is called a normal good. If an increase in income decreases demand (other things being the same) thegood is called an inferior good. Prices of Related Goods Suppose the price of crackers goes up. If people can substitute bread for crackers, this increase in the price of crackers increases the amount of bread people wish to consume. Now suppose the price of butter goes up. If people tend to consume bread and butter together, this tends to decrease the amount of bread consumed. Goods like bread andcrackers are called substitutes; goods like bread and butter are called complements. Tastes The extent to which people “like” a good also affects the amount they demand. Presumably, less bread is demanded by people concerned with weight problems than buy those who are skinny. We have just completed a verbal model that suggests that a wide variety of things can affect demand. For purposes ofconstructing a graphical version of the model, it is useful to focus on the relationship between the quantity of a commodity demanded and its price. Suppose that we hold constant income, the prices of related goods, and tastes. We can imagine varying the price of bread and seeing how the quantity demanded changes under the assumption that the other relevant variables stay at their fixed values. Ademand schedule (or demand curve) is the relation between the market price of a good and the quantity demanded of that good during a given time period, other things being the same. (Economists often use the Latin ceteris paribus for “other things being the same.”) In particular applications, one must always specify just what period of time is being considered, because generally different quantities ofa commodity are demanded over a day, a month, a year, and so on. A hypothetical demand schedule for bread is represented graphically by curve D in Figure 1. The horizontal axis measures the number of loaves of bread, and the price per loaf is measured on the vertical axis. Thus, for example, if the price is U$1.30 per loaf,

households are willing to consume 2 million loaves; when the price isonly $0.80, they are willing to consume 5 million loaves. The downward slope of the demand schedule reflects the reasonable assumption that when the price goes up, the quantity demanded goes down, and vice versa.

Figure 1 A Demand Curve
Price Per loaf

Figure 2
Price Per loaf

Shifting a Demand Curve

$1.30 1.20 1.10 1.00

$1.30 1.20 1.10 1.00

0.90 0.80 D

0.90 D’ 0.80 D

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Millions of loaves per year Schedule D shows the quantity of bread that people are willing to buy at each price, other things being the same. It is called the demand curve for bread.

Millions of loaves per year When the price of muffins increases, there will be a tendency to purchase more bread. This is reflected in an outward...