Supply And Demand

1.1 Law of Demand

The law of demand states that if all factors remain equal, the higher the price of a good the less people will demand. In other words the higher the price the lower the quantity demanded. The amount of a good that buyers purchase at a high price is less because as the price goes up, so too does the opportunity cost for buying that product.

People will avoid buying a higher priced good if it forces them to forgo the consumption of something else they value more.

Both points are on the demand curve. Each point reflects a direct correlation between quantity and Price. It shows that the higher the price the lower the quantity demand quantity.

The Law of Demand implies the following with respect to a demand curve (all of these say exactly the same thing):

• The demand curve is downward sloping

• The demand curve has a negative slope

• The demand curve shows an inverse relationship between price and quantity demanded

1.2 Eight Market Equilibrium Changes

Change 1: Demand Increase

Change 2: Demand Decrease

Change 3: Supply Decrease

Change 4: Supply Increase

Change 5: Demand and Supply Increase

Change 6: Demand and Supply Decrease

Change 7: Demand Increase and Supply Decrease

Change 8: Demand Decrease and Supply Increase

1.3 Long Run Equilibrium in perfect competition

In long run equilibrium in perfect competition, P=MC=AC=AR

Profits and losses are inconsistent with long run equilibrium. Profits create incentives for new firms to enter the industry, where as losses causes’ new firms to exit the industry. Therefore zero profit conditions define the long run equilibrium. Zero profits are not the absence of profits, just the absence of supernormal profits. Normal profits are accounted for in the costs along with Fixed and variable costs.

Figure 1 shows how with all the variables being equal, along run equilibrium is reached.

Figure 1.

The point at which all curves meet is the point at which long run equilibrium is determined. If the price cure did not interchange, with all the other curves, then it will show a supernormal profit or loss.

Figure 2 shows us how if price decreases there is a loss and firms will exit the industry

Figure 2:

As you can see the shades area, there is a loss incurred due to the price falling. If the price was to increase too much there would be a supernormal profit as illustrated in figure 3. This will cause firms to enter the industry.

Figure 3

The shaded area is the supernormal profit. This is why it is imperative that the price either increases or decreases the correct amount to create the long term equilibrium.

1.4