Chapter 2.

1: Demand
The terms “supply” and “demand” refers to the behavior of people as they interact
with one another in competitive markets.
- market: a group of buyers and sellers of a particular good or service
- competitive market: a market with many buyers and sellers, each has a negligible
effect on the market price
- perfect competitive market: a market with 2 characteristics:
+ all goods exactly the same
+ buyers and sellers so numerous that no one can affect the market price, each is a
“price taker”
- ceteris paribus means all other things remaining equal

I, Some definitions
1, Demand (D)
- the amount of the good or service that buyers are willing and able to purchase at
various prices during a period of time, ceteris paribus

2, Quantity demanded (QD)

- the amount of the good or service that buyers are willing and able to purchase at an
defined price during a period of time, ceteris paribus

3, Individual demand
- the demand of an individual or a single buyer

4, Market demand
- the sum of all the individual demands for a particular good or service
- The market quantity demanded is the sum of the quantities demanded by all buyers at
each price

II, Law of demand

- The claim that, when the price of a good or service rises, the quantity demanded of
the good or service falls, and when the price falls, the quantity demanded rises, ceteris
paribus
- The reason of the contra-variant relationship between price and quantity demanded is
demand always be limited by the ability to purchase

III, Tools
1, Demand schedule
- a table that shows the relationship between the price of a good or service and the
quantity demanded
2, Demand curve
- a graph of the demand schedule, illustrates how the quantity demanded of the good or
service changes as its price varies
- because a lower price increases the quantity demanded, the demand curve slopes
downward

3, Demand function
- express the relationship between quantity demanded and factors that are related
- We can represent a demand function as follows
QD = f(xi)
xi: factors related to quantity demanded
1
If xi is price (P) then QD = aP+b and the inverse demand function is P= QD + d =
a
cQD+d

QD = f(Px, Py, I, T, E, N)
in which
Px: The price of the good or service itself
Py: The prices of related goods and services
I: The income of the buyers
T: The tastes of the consumers
E: The expectations in the future
N: The number of consumers

IV, Shifts in the Demand Curve vs Movements along the Demand Curve
- Any change in edogenous variable (price) merely moves from one point (A) of the
demand curve to another (B or C) (changes in quantity demanded)
- Any change in exogenous variable (income, prices of related goods, tastes,
expectations, number of buyers,..) causes a shift in the demand curve (changes in
demand)

V, Factors affecting demand

1, Prices of related goods and services
a) Substitute goods
- Two goods are substitutes if a fall in the price of one good reduces the demand for
another good
- Substitutes are often pairs of good that are used in place of each other
Ex:
+ An increase in the price of pizza increases demand for hamburgers, shifting
hamburger demand curve to the right.
+ CD and digital music
+ Milo and Ovaltine
b) Complement goods
- Two goods are complements if a fall in the price of one good raises the demand for
another good
- Complements are often pairs of goods that are used together
Ex:
+ Computers and software. If price of computers rises, people buy fewer computers,
and therefore less software. Software demand curve shifts left.
+ Pencils and erasers.
+ Gaming portals and DVD of Games.

2, Income
- Demand for a normal good is positively related to income.
An increase in income causes increase in quantity demanded at each price, shifting
the D curve to the right
- Demand for an inferior good is negatively related to income. An increase in income
shifts D curves for inferior good to the left
- A good which is a normal good for a person could be an inferior good for the others
Ex: For college student, street clothes is normal good but inferior good for office
workers
- A good which is a normal good when income is low could be an inferior good when
income significantly rises
- An Engel curve describes how buyer’s expenditure on a particular good or service
varies with their income

3, Tastes
Anything that causes a shift in tastes toward a good will increase demand for that good
and shift its D curve to the right
Ex: People who interested in manga or anime also tend to lisen to Japanese music and
watch Japanese drama and eat Japanese foods

4, Expectations
- Buyers expectations about the future may affect their demand for a good or service
today
Ex
+ If Ha expect to earn a higher income next month, she may choose to save less now
and spend more of her current income buying comics
+ If Ha expect the price of clothes to fall next week, she may be less willing to buy a
dress at today’s price

5, Number of buyers
- An increase in the number of buyers causes an increase in quantity demanded at each
price, and market demand would increase, which shifts the demand curve to the right.
Chapter 2.2: Supply
I, Some definitions
1, Supply (S)
- the quantity of the good or service that sellers are willing to sell and able to sell at
various price levels in a certain time, ceteris paribus

2, Quantity supplied (QS)

- the quantity of the good or service that sellers are willing to sell and able to sell at a
price level in a certain time, ceteris paribus

3, Individual supply
- the supply of an individual or a single seller

4, Market supply
- the sum of all the individuals supply for a particular good or service
- The market quantity supplied is the sum of the quantities supplied by all sellers at
each price

II, Law of supply

- the claim that, when the price of a good rises, the quantity supplied of the good also
rises, and when the price falls, the quantity supplied falls as well, ceteris patibus
- the reason of the positive relationship between price and quantity supplied is when
the price of a good or service rises, it gives an incentive to producers to produce more
because they want to make more profit

III, Tools to demonstrate supply

1, Supply schedule
- a table that shows the relationship between the price of a good and the quantity
supplied

2, Supply curve
- a graph of the direct relationship between the quantity supplied of the good or service
and its price in a given period of time, ceteris paribus
- because a higher price increases the quantity supplied, the supply curve slopes
upward
- Market supply curve: the horizontal sum of individuals supply curves and is formed
by adding the quantities supplied by each individual at each price

3, Supply equation
QS = n + mP: direct supply equation
P = k + hQS: inverse supply equation
in which h<0, m<0 to express the positive relationship between quantity supplied and
price

4, Supply function
- express the relationship between quantity supplied and factors that are related
- We can represent a supply function as follows
QS = f(Px, Pi, Te, G, E, N)
in which
Px: The price of the good or service itself
Pi: The prices of input factors
Te: Technology
E: The expectations of producers
G: Government policies
N: The number of producers

IV, Shifts in the Supply Curve vs Movements along the Supply Curve
- Any change in endogenous variable (price) moves from one point (A) of the supply
curve to another (B or C) (changes in quantity supplied)
- Any change in exogenous variable (technology, prices of input factors, government
policies, expectations of producers, number of producers,..) causes a shift in the supply
curve to the left or right(changes in supply)

V, Factors affecting supply

1, Input prices (wages, prices of raw materials,…)
- input prices are the price of the resources needed to produce a good or service
- the supply of a good is negative related to the price of the input prices:
+ a fall in input prices makes production more profitable at each output price, so
firms supply a larger quantity at each price
=> The Supply curve shifts to the right
+ a rise in input prices makes production less profitable at each output price, so
firms supply a less quantity at each price
=> The Supply curve shifts to the left
Ex: Ha makes cakes with fresh strawberries.
i) If the price of strawberries increases, Ha’s costs increase. She can’t afford to
produce as many strawberry cakes, and her supply curve shifts to the left
ii) If the price of strawberries decreases, her costs decrease. She is willing and
able to increase the quantity she can supply at every price, and the curve shifts to the
right

2, Government policies
- Government policies can affect the cost of production both positively and negatively
through taxes, regulations, and subsidies:
+ When the tax rate is high, firms have to pay more for taxes, then supply of a product
would decrease, the Supply curve shifts to the left, vice versa
Ex: Excise taxes are placed on items such as alcohol and tobacco decrease the supply of
these items
+ A subsidy is a government payment that partially covers the cost of an economic
activity and its purpose is to encourage or protect that activity
+ The regulation is the act of controlling business behavior through a set of rules or
laws
Ex: Worker safety regulations might decrease supply by increasing a business’s
production costs or increase supply by reducing the amount of labor lost to on-the-job
injuries

3, Technology
- A better and advanced technology increases the productivity of a product, which
results in the increase in the supply of the product, the Supply curve shifts to the right ,
vice versa
Ex: Increased automation, including the use of industrial robots, has led to increased
supplies of automobiles, computers, and many other products.

4, Expectations of sellers
- Sellers expectations about the future may affect their supply for a good or service
today
+ If a firm expects the price of a good to rise in the future, it will put some of its
production into the storage and supply less to the market today

5, Number of sellers
- An increase in the number of sellers causes an increase in quantity supplied at each
price, and market supply would increase, which shifts the supply curve to the right.
 Chapter 2.3: Surplus and Shortage
I, Surplus and Shortage
1, Surplus
- Surplus or “excess supply” is a situation in which quantity supplied is greater than
quantity demanded at a price level above the equilibrium price
- Assume that the price level P1 is greater than equilibrium price PE. According to law
of demand, when the price increases from PE to P1, the quantity demanded decreases
from QE to QD1, and the quantity supplied increases from QE to QS1 due to law of
supply. So, at this price level, consumer wants to buy an amount of QD1 while seller
wants to sell QS1. There is a surplus, which is the difference between QS1 and QD1. This
surplus depends on the slope of supply curve and demand curve, and the difference
between equilibrium price and market price.

2, Shortage
- Shortage or “excess demand” is a situation in which quantity supplied is less than
quantity demanded at a price level below the equilibrium price
- Assume that the price level P2 is less than equilibrium price PE. According to law of
demand, when the price decreases from PE to P2, the quantity demanded increases from
QE to QD2, and the quantity supplied decreases from QE to QS2 due to law of supply. So,
at this price level, consumer wants to buy an amount of QD2 while seller wants to sell
QS2. There is a shortage, which is the difference between QD2 and QS2. This shortage
depends on the slope of supply curve and demand curve, and the difference between
equilibrium price and market price.

3, Market's self-regulatory mechanism

- The “Invisible Hand” mechanism: Whenever a surplus or a shortage occurs, both
consumer and seller will adjust their behaviors followed each self-interest. As a result,
the market reaches the equilibrium.
- Law of supply and demand: The claim that the price of any good adjusts to bring the
quantity supplied and the quantity demanded for that good into balance
- When a surplus occurs, producers won't be able to sell all their goods. This will
induce them to lower their price to make their product more appealing. In response to
the lower price, consumers will increase their quantity demanded, moving the market
toward the equilibrium. In this situation, excess supply has exerted downward pressure
on the price of the product.
- When a shortage occurs, there not enough goods available for consumers to buy as
much of a good as they would like. In response to the demand of the consumers,
producers will raise both the price of their product and the quantity they are willing to
supply. The increase in price will be too much for some consumers and they will no
longer demand the product, which causes the quantity demanded to fall, moving the
market toward the equilibrium. In this situation, excess demand has exerted upward
pressure on the price of the product.
II, Consumer surplus and Producer surplus
1, Consumer surplus
a) Willingness to pay (WTP)
- the maximum amount that a consumer will spend on one unit of a good or service
b) Consumer surplus (CS)
- A measure of the welfare that people gain from consuming goods and services
- According to Alfred Marshall, consumer surplus is defined as the difference between
the maximum amount that consumers are willing and able to pay for a good or service
and the total amount that they actually do pay.
CS = WTP – P
- Market consumer surplus is the sum of all the consumers surplus for a particular
good or service
- In the graph, consumer surplus is indicated by the area under the demand curve and
above the market price.

2, Producer surplus
a) Willingness to sell (WTS)
- is the minimum price that a producer is willing to sell
b) Producer surplus (PS)
- A measure of the welfare that firms gain from selling goods and services
- Producer surplus is defined as the difference between the market price and the
minimum amount that producers are willing and able to supply a good or service
PS = P – WTS
- Market producer surplus is the sum of all the producers surplus for a particular good
or service
- In the graph, consumer surplus is indicated by the area above the supply curve and
under the market price.

3, Total surplus
- A measure of the net welfare that society gains after the exchange of goods and
services.
- Total surplus is defined as the sum of consumer surplus and producer surplus
TS = CS + PS
Chapter 5: Theory of Firms Behavior