Module 1: Market and Market Failure Overview - Chapter 1 Notes

1. What is Demand?
 Demand defined in economics as a functional relationship between the price of a good or service and the
quantity demanded by consumers in a given period of time, all else held constant. (The Latin phrase
ceteris paribus is often used in place of “all else held constant.”)
 Demand incorporates a consumer’s willingness and ability to purchase a product.

2. What is a functional relationship?

 A functional relationship means that demand focuses not just on the current price of the good and the
quantity demanded at that price, but also on the relationship between different prices and the quantities
that would be demanded at those prices.

3. What is the book definition of a Function relationship?

 A relationship between variables, usually expressed in an equation using symbols for the variables,
where the value of one variable, the independent variable, determines the value of the other, the
dependent variable.

4. What are the 9 Nonprice Factors Influencing Demand?

 Tastes and Preferences - Consumers must first desire or have tastes and preferences for a good.
i.For example, in the aftermath of the September 11, 2001, terrorist attacks on New York and
Washington, D.C., the tastes and preferences of U.S. consumers for airline travel changed
dramatically. People were simply afraid to fly and did not purchase airline tickets regardless of the
price charged.

 Income - The level of a person’s income also affects demand, because demand incorporates both
willingness and ability to pay for the good. If the demand for a good varies directly with income, that
good is called a normal good.

 Normal Goods – A good for which consumers will have a greater demand as their incomes increase, all
else held constant, and a smaller demand if their incomes decrease, other factors held constant.
i. This definition means that, all else held constant, an increase in an individual’s income will
increase the demand for a normal good, and a decrease in that income will decrease the demand
for that good.

 Inferior Goods – A good for which consumers will have a smaller demand as their incomes increase, all
else held constant, and a greater demand if their incomes decrease, other factors held constant.

 Prices of Related Goods – There are two major categories of goods or products whose prices influence
the demand for a particular good: substitute goods and complementary goods.

 Substitute Goods – Two goods, X and Y, are substitutes if an increase in the price of good Y causes
consumers to increase their demand for good X or if a decrease in the price of good Y causes consumers
to decrease their demand for good X.

 Complementary Goods – Two goods, X and Y, are complementary if an increase in the price of good Y
causes consumers to decrease their demand for good X or if a decrease in the price of good Y causes
consumers to increase their demand for good X.

Page 1 of 12
 Future Expectations – Expectations about future prices also play a role in influencing current demand
for a product. If consumers expect prices to be lower in the future, they may have less current demand
than if they did not have those expectations.

 Number of Consumers – Finally, the number of consumers in the marketplace influences the demand for
a product. A firm’s marketing strategy is typically based on finding new groups of consumers who will
purchase the product. In many cases, a country’s exports may be the source of this increased demand.

5. What is the formula for Demand?

QXD = f(PX, T, I, PY, PZ, EXC,NC,…)
where
QXD = quantity demanded of good X
PX = price of good X
T = variables representing an individual’s tastes and preferences
I = income
PY, PZ = prices of goods Y and Z, which are related to the consumption of good X
EXC = consumer expectations about future prices
NC = number of consumers
How the formula works:
The quantity demanded of good X is a function (f) of the variables inside the parentheses. An ellipsis is
placed after the last variable to signify that many other variables may also influence the demand for a
specific product. These may include variables under the control of a manager, such as the size of the
advertising budget, and variables not under anyone’s control, such as the weather.

6. What is Individual demand function?

 The function that shows, in symbolic or mathematical terms, the variables that influence the quantity
demanded of a particular product by an individual consumer.

7. What is Market demand function?

 The function that shows, in symbolic or mathematical terms, the variables that influence the quantity
demanded of a particular product by all consumers in the market and that is thus affected by the number
of consumers in the market.

8. What is the Demand curve?

 The graphical relationship between the price of a good and the quantity consumers demand, with all
other factors influencing demand held constant.

9. What are Demand shifters?

The variables in a demand function that are held constant when defining a given demand curve, but that
would shift the demand curve if their values changed.

Page 2 of 12
10. What is a Negative (inverse) relationship?
 A relationship between two variables, graphed as a downward sloping line, where an increase in the
value of one variable causes a decrease in the value of the other variable.

11. Draw a Demand Curve for a Product:

Demand curves are generally downward sloping, showing a negative or inverse relationship between the price of a good
and the quantity demanded at that price, all else held constant. Thus, in Figure 2.1, when the price falls from P1 to P2, the
quantity demanded is expected to increase from Q1 to Q2, if nothing else changes. This is represented by the movement from
point A to point B in Figure 2.1. Likewise, an increase in the price of the good results in a decrease in quantity demanded, all
else held constant. Most demand curves that show real-world behavior exhibit this

12. What is the Change in quantity demanded?

 The change in quantity consumers purchase when the price of the good changes, all other factors held
constant, pictured as a movement along a given demand curve.
 A change in quantity demanded refers to a movement along a fixed demand curve that's caused by a
change in price.

Page 3 of 12
13. What is a Change in Demand and when does it occur?
 The change in quantity purchased when one or more of the demand shifters change, pictured as a shift
of the entire demand curve.
 It occurs when one or more of the variables held constant in defining a given demand curve changes.

 A change in demand refers to a shift in the demand curve -- that's caused by one of the shifters:
income, preferences, changes in the price of related goods and so on.

Page 4 of 12
14. Draw a Change in quantity demanded:

15. Draw a Change in demand:

Good Example: Change in Demand vs. Change in Quantity Demanded

 https://www.youtube.com/watch?v=9jLlOPqHxLs&ab_channel=MarginalRevolutionUniversity

16. Explain Individual Versus Market Demand Curves: REVIEW Book Page 26
 The shift in the market demand curve as more individuals enter the market is illustrated in Figure 2.3,
which shows how a market demand curve is derived from individual demand curves. In this figure,
demand curve DA represents the demand for individual A. If individual A is the only person in the market,
this demand curve is also the market demand curve. However, if individual B enters the market with
demand curve DB, then we have to construct a new market demand curve. As shown in Figure 2.3,
individual B has a larger demand for the product than individual A. The demand curve for B lies to the
right of the demand curve for A, indicating that individual B will demand a larger quantity of the product
at every price level.

17. What is Horizontal summation of individual demand curves?

 Horizontal summation of individual demand curves The process of deriving a market demand curve by
adding the quantity demanded by each individual at every price to determine the market demand at
every price.

Page 5 of 12
18. What is a Linear demand function?
 A mathematical demand function graphed as a straight-line demand curve in which all the terms are
either added or subtracted and no terms have exponents other than 1.
 The graph of a linear demand function has a constant slope. This linear relationship is used both because
it simplifies the analysis and because many economists believe that this form of demand function best
represents individuals’ behavior, at least within a given range of prices. However, not all demand
functions are linear

19. Review Book Page 27.

20. What is Supply?

 The functional relationship between the price of a good or service and the quantity supplied by
producers in a given time period, all else held constant.

21. What are Nonprice Factors Influencing Supply?

Although supply focuses on the influence of price on the quantity of a good or service supplied, many other
factors influence producer supply decisions. These factors generally relate to the cost of production.

22. List and explain the what are the Nonprice Factors Influencing Supply?
1. State of Technology – The state of technology, or the body of knowledge about how to combine the
inputs of production, affects what output producers will supply because technology influences how the
good or service is actually produced, which, in turn, affects the costs of production.
i. For example, the discussion of the copper industry noted that a change in mining technology
allowed companies to produce copper at a lower cost, keeping more of them in business. This
change in technology contributed to a decrease in mining costs of 30 percent between the 1980s
and the 1990s

2. Input Prices – Input prices are the prices of all the inputs or factors of production— labor, capital, land,
and raw materials—used to produce the given product. These input prices affect the costs of production
and, therefore, the prices at which producers are willing to supply different amounts of output.
i. For broiler chickens, feed costs represent 70–75 percent of the costs of growing a chicken to
a marketable size. Thus, changes in feed costs are so important that market analysts often use them
as a proxy to forecast broiler prices and returns to broiler processors

3. Prices of Goods Related in Production – The prices of other goods related in production can also affect
the supply of a particular good. Two goods are substitutes in production if the same inputs can be used
to produce either of the goods, such as land for different agricultural crops.
i. Companies use the same type of rigs to drill for oil and natural gas. Therefore, they allocate
equipment according to the price and profitability of each fuel. Given that the price of oil increased
significantly between 2010 and 2011 from unrest in Northern Africa and the Middle East, the
number of land rigs in the U.S. drilling for natural gas decreased 8 percent while oil rigs increased
81 percent.

Page 6 of 12
4. Future Expectations – Future expectations can play a role on the supply side of the market as well. If
producers expect prices to increase in the future, they may supply less output now than without those
expectations. The opposite could happen if producers expect prices to decrease in the future.
i. Expectations may not always be correct. Given the high demand and lumber prices in summer
2004, lumber manufacturers expected that demand would start to drop as interest rates rose.
When this did not happen, prices continued to climb

5. Number of Producers – Finally, the number of producers influences the total supply of a product at any
given price. The number of producers may increase because of perceived profitability in a given industry
or because of changes in laws or regulations such as trade barriers.
i. For example, the lumber market was reported to be exceedingly strong in January 1999,
largely due to demand from the booming U.S. housing market. However, quotas on the amount of
wood that Canada could ship into the United States also played a role in keeping the price of
lumber high in the United States in January of that year.

23. What is the Supply Function Formula?

QXS = f (PX, TX, PI, PA, PB, EXP,NP,N)

where
QXS = quantity supplied of good X
PX = price of good X
TX = state of technology
PI = prices of the inputs of production
PA, PB = prices of goods A and B, which are related in production to good X
EXP = producer expectations about future prices
NP = number of producers

24. What is Individual supply function?

The function that shows, in symbolic or mathematical terms, the variables that influence the quantity
supplied of a particular product by an individual producer.

25. What is Market Supply Function?

 The function that shows, in symbolic or mathematical terms, the variables that influence the quantity
supplied of a particular product by all producers in the market and that is thus affected by the number of
producers in the market.

26. What is a Supply Curve?

 The graphical relationship between the price of a good and the quantity supplied, with all other factors
influencing supply held constant.

Page 7 of 12
27. What are Supply shifters?
 The other variables in a supply Function that are held constant when defining a given supply curve, but
that would cause that supply curve to shift if their values changed.

28. What is a Positive (direct) relationship?

 A relationship between two variables, graphed as an upward sloping line, where an increase in the value
of one variable causes an increase in the value of the other variable.

29. What is a Linear supply function?

A mathematical supply function, which graphs as a straight-line supply curve, in which all terms are either
added or subtracted and no terms have exponents other than 1.

30. What is Change in quantity supplied?

 The change in amount of a good supplied when the price of the good changes, all other factors held
constant, pictured as a movement along a given supply curve.

31. Draw a Graph with Change in quantity supplied and Explain?

The supply curve shifts from S1 to S2 because one or more of

the factors from Equation 2.4 held constant in supply curve
S1 changes. The increase in supply, or the rightward shift of
the supply curve in Figure 2.5, shows that producers are
willing to supply a larger quantity of output at any given
price. Thus, the quantity supplied at price P1 increases from
Q1 to Q2.

32. What is Change in supply?

The change in the amount of a good supplied when one or more of the supply shifters change, pictured as a
shift of the entire supply curve.

33. What is Change (Increase) in Supply? Draw a Graph:

A change in supply occurs when one or more of the factors held constant in defining a given supply curve
changes.

Page 8 of 12
34. What is the difference between a change in quantity supplied and a change in supply?
 This distinction between a change in quantity supplied and a change in supply is analogous to the
distinction between a change in quantity demanded and a change in demand. We use the same
framework—the relationship between two variables (price and quantity), all else held constant—on both
the demand and the supply sides of the market.

35. What cause the Supply Curve to move?

 Any increase in the price of inputs increases the costs of production and causes the supply curve of the
product to shift to the left.

 The effect of a change in the price of a related good on the supply of a given good depends on whether
the related good is a substitute or complement in production. An increase in the price of a substitute
good causes the supply curve for the given good to shift to the left. A decrease in the price of a
substitute good causes an increase in the supply of the given good.

 The opposite set of relationships holds for goods that are complements in production. If the price of the
complementary good increases, the supply of the given good increases.

 Producer expectations of lower prices cause the supply curve of a good to shift to the right. The supply
increases in anticipation of lower prices in the future. The opposite holds if producers expect prices to
increase. There would be a smaller current supply than without those expectations.

 Finally, an increase in the number of producers results in a rightward shift of the supply curve, while a
decrease results in a leftward shift of the supply curve. A given supply curve shows how prices induce the
current number of producers to change the quantity supplied. Any change in the number of producers in
the market is represented by a shift of the entire curve.

36. Review the Mathematical Example of a Supply Function: - Book Page: 32/33

37. List the Factors Influencing Market Demand and Supply?

Factors Influencing Market Demand and Supply
DEMAND SUPPLY
Price of the product Price of the product
Consumer tastes and preferences State of technology
Consumer income: Input prices
Normal goods Prices of goods related in production
Inferior goods Substitute goods
Price of goods related in consumption: Complementary goods
Substitute goods Future expectations
Complementary goods Number of producers
Future expectations
Number of consumers

38. What is Equilibrium price?

 The price that actually exists in the market or toward which the market is moving where the quantity
demanded by consumers equals the quantity supplied by producers.
 In a competitive market, the interaction of demand and supply determines the equilibrium price, the
price that will actually exist in the market or toward which the market is moving.
Page 9 of 12
39. What is Equilibrium quantity (QE)? Draw a Graph:
 The quantity of a good, determined by the
equilibrium price, where the amount of output that
consumers demand is equal to the amount that
producers want to supply.

 This quantity is called the equilibrium quantity (QE).

At any other price, there will be an imbalance
between quantity demanded and quantity supplied.
Forces will be set in motion to push the price back
toward equilibrium, assuming no market
impediments or governmental policies exist that
would prevent equilibrium from being reached.

40. What happens in Lower-Than-Equilibrium Prices? Draw a Graph:

 A Lower-Than-Equilibrium Price – A shortage of a good
results when the market price, P1, is below the
equilibrium price, PE.

 Suppose P1 is the actual market price in Figure 2.7. As you

see in the figure, price P1 is lower than the equilibrium
price, PE. You can also see that the quantity of the good
demanded by consumers at price P1 is greater than the
quantity producers are willing to supply. This creates a
shortage of the good, shown in Figure 2.7 as the amount
of the good between QD and QS. At the lower-than-
equilibrium price, P1, consumers demand more of the
good than producers are willing to supply at that price.
Because there is an imbalance between quantity demanded and quantity supplied at this price, the
situation is not stable. Some individuals are willing to pay more than price P1, so they will start to bid the
price up. A higher price will cause producers to supply a larger quantity. This adjustment process will
continue until the equilibrium price has been reached and quantity demanded is equal to quantity
supplied.

41. What happens in Higher-Than-Equilibrium Price? Draw a Graph:

 A surplus of a good results when the market price, P2, is
above the equilibrium price, PE.
 At price P2, the quantity supplied, QS, is greater than
the quantity demanded, QD, at that price. This above-
equilibrium price creates a surplus of the good and sets
into motion forces that will cause the price to fall. As
the price falls, the quantity demanded increases and the
quantity supplied decreases until a balance between
quantity demanded and quantity supplied is restored at
the equilibrium price. Thus, the existence of either
shortages or surpluses of goods is an indication that a
market is not in equilibrium.
42. Mathematical Example of Equilibrium – Review Book Page 37:
Page 10 of 12
43. When do the Changes in Equilibrium Prices and Quantities occur?
 Changes in equilibrium prices and quantities occur when market forces cause either the demand or the
supply curve for a product to shift or both curves shift. These shifts occur when one or more of the actors
held constant behind a given demand or supply curve change. Much economic analysis focuses on
examining the changes in equilibrium prices and quantities that result from shifts in demand and supply.

44. What happens to the Equilibrium when there is a Change in Demand? Draw a Graph:
 Change in Demand – A change in demand, represented by a shift of the demand curve, results in a
movement along the supply curve.

 Change in Demand Figure 2.9 shows the effect of a change in demand in a competitive market. The
original equilibrium price, P0, and quantity, Q0, arise from the intersection of demand curve D0 and
supply curve S0. An increase in demand is shown by the rightward or outward shift of the demand
curve from D0 to D1. This increase in demand could result from a change in one or more of the
following nonprice variables: tastes and preferences, income, prices of related goods, expectations,
or number of consumers in the market, as we discussed earlier in the chapter. This increase in
demand results in a new higher equilibrium price, P1, and a new larger equilibrium quantity, Q1, or in
the movement from point A to point B in Figure
2.9. This change represents a movement along the
supply curve or a change in quantity supplied.
Thus, a change in demand (a shift of the curve on
one side of the market) results in a change in
quantity supplied (movement along the curve on
the other side of the market).
 The opposite result occurs for a decrease in
demand. In this case, the demand curve shifts
from D0 to D2 in Figure 2.9, and the equilibrium
price and quantity fall to P2 and Q2. This change in
demand also causes a change in quantity supplied,
or a movement along the supply curve from point
A to point C.

45. What happens to the Equilibrium when there is a Change in Supply? Draw a Graph:
 Change in Supply Figure 2.10 shows the effect of a change in supply on equilibrium price and quantity.
Starting with the original demand and supply curves, D0 and S0, and the original equilibrium price and
quantity, P0 and Q0, an increase in supply is represented by the rightward or outward shift of the supply curve
from S0 to S1. As we discussed earlier in the chapter, this shift could result from a change in technology, input
prices, prices of goods related in production, expectations, or number of suppliers. The result of this increase in
supply is a new lower equilibrium price, P1, and a larger equilibrium quantity, Q1. This change in supply results in a
movement along the demand curve or a change in quantity demanded from point A to point B. Figure 2.10 also
shows the result of a decrease in supply. In this case, the supply curve shifts leftward or inward from S0 to S2. This
results in a new higher equilibrium price, P2, and a smaller equilibrium quantity, Q2. This decrease in supply results
in a decrease in quantity demanded or a movement along the demand curve from point A to point C.

Page 11 of 12
46. What happens if there are Changes on Both Sides of the Market? Draw Graphs – Book page 40
Changes on Both Sides of the Market As in the copper case discussed at the beginning of this chapter, most
outcomes result from changes on both sides of the market. The trends in equilibrium prices and quantities will depend
on the size of the shifts of the curves and the responsiveness of either quantity demanded or quantity supplied to
changes in prices.

47. Mathematical Example of an Equilibrium Change – Book review page 40

48.
49.
50.
51.
52.
53.
54.
55.
56.
57.
58.
59.
60.

Page 12 of 12