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MODULE 5 – SUPPLY AND DEMAND: INTRODUCTION AND DEMAND

NOTE: These notes are not meant to be substitutes for reading the textbook—they are a supplement to the textbook, highlighting and elaborating on some of the issues raised by the authors.

(1) One of the first textbooks I used when I began studying economics had the following quotation at the start of the chapter on supply and demand: “You can make even a parrot into a learned economist—all he must learn are the two words “supply” and “demand”—Anonymous”. Section 2 of the textbook is about the “Supply and Demand Model”, easily the most important model in economics. It is used extensively, not only in microeconomics, but also in macroeconomics. Make sure you understand this section—it will help you better understand the world around you. And, if you plan to take more courses in economics after this, you will encounter this model over and over again.

(2) Strictly speaking, the supply and demand model should only be used to study perfectly competitive markets. These are markets where there are a large number of buyers and sellers (each of them so small as to have no effect on market price), firms sell identical products, everyone has full information about the price and quality of goods, and the costs of trading are low. Think of the markets for tomatoes or most such agricultural products. As a counter-example, think of airlines: there are only a few airlines (even more so, when you look at particular routes) and they have the power to be able to set their own prices. On the other hand, Farmer A cannot raise the price at which he sells tomatoes above the market price. If he tries to do so, consumers will desert him and buy their tomatoes from Farmer B or some other producer. In a perfectly competitive market, each producer is a price-taker—they take the market price as given, because each one of them individually is “too small” to affect market price on their own. Fortunately, many markets in...