Elasticity of supply and demand:
I. Supply and Demand
i. Demand curve tells you what: It’s a plot of people’s marginal value. It tells you people’s plans about whether they shall purchase a guitar or not at various prices.
ii. Supply curve is a plot a producer’s marginal opportunity cost of production.
iii. The actions of buyers and sellers on the supply-demand curve are completely independent of one another. When I go out to buy a guitar, I have no impact on the price of guitar. When you’re jack who make guitar, you have no impact on people’s reference on guitar. Our buying and selling actions are independent of one another.
iv. Price is where supply and demand curve intersects. At that equilibrium point, something really interesting happens. The number of guitars demanded by the market is 1000, and the number of guitars sellers wish to produce at that market is also 1000. When you have this outcome this doesn’t mean more people wouldn’t like guitar. Just I tell you how much people want a guitar at that price; it doesn’t mean anything about how much people really like to have a guitar. Remember, demand curve captures both the willingness and ability to pay. The same thing, it doesn’t mean more than 1000 people wouldn’t like to sell guitars. It only means at the price of 500, only 1000 can be profitably sold.
II. Ask yourself two questions when thinking about changes in supply and demand:
i. How does each half of the market respond? Buyers and sellers
People respond to incentives, when price goes up, producers try to produce more, and the quantity supplied (not supply) will increase. The new equilibrium is enough to cover the new opportunity cost since it cost more to make more. How would demanders respond? Quantity demanded will fall.
i. Whose plans are satisfied after those changes? Buyers and sellers
This question means if you have a particular goal, given the rules that you face, can you meet your goal. I don’t mean whether you are happy or not, I only mean can you meet the goal. For demanders, the answer is yes. At a price of $700, buyers want 800 guitars and they get them. There’re certainly enough guitars to satisfy demander’s requirement at that price. It only means when the price is $700, the requirement of demanders can be satisfied. For sellers, the answer is no. They are able to sell 2000. At the price of $700, the quantity supplied is going to exceed quantity demanded. There will be a surplus (at a particular price, the quantity supplied exceed quantity demanded) of guitar.
What shall we do? Producers cut prices. What happens when you cut prices:
i. It gives an incentive for other people to stop selling guitar. Quantity supplied will fall down. (sellers change their behavior)
*when somebody says price is “too high”, in economics, it doesn’t mean the absolute number is so huge. It only means the price is above the equilibrium.
ii. When the price is so low, quantity demanded will increase.
Buyers and sellers don't compete in a market, buyers compete against buyers and sellers compete against sellers. Being at equilibrium is not inherently good. It doesn’t mean anything saying “too high” or “too low”
A high price signifies that the good is relatively scarce. As prices are increasing, a shortage is being alleviated.
A low price signifies that the good is relatively not scarce. Scarcity talks about the relative abundance of a good, not its absolute abundance.
Equilibrium - At a price where neither buyers nor sellers have an incentive to change their behavior.
Two Types of Equilibrium:
1) Market Clearing ("good"): Quantity demanded = Quantity supplied
2) Non-Market clearing ("not good")
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