Understanding Supply and Demand in Economics
Demand
The demand for a commodity is made up of the amount of that good the consumer will want to buy on the market. The demand function tells us, for each possible price of the goods, the amount of this consumer demand.
Shifts in the Demand Curve When Income Changes
- Normal Goods: With variations in income, the quantity demanded changes in the same direction. It stands to reason that the more income a consumer has, the greater the amount of that good they will want to purchase. Olive oil could be considered a normal good.
- Inferior Goods: With variations in income, the quantity demanded varies in the opposite direction. These are low-quality goods. As consumers get more income, they are replaced by others of higher quality. Sunflower oil would be an inferior good.
- Neutral Goods: Given variations in income, the consumer does not adjust the amount demanded because its consumption does not affect income. Drugs are neutral goods.
Shifts in the Demand Curve When the Price of Other Goods Changes
- Complementary Goods: When two goods must be used together to satisfy a need. For example, contact lenses and lens cleaner.
- Substitute Goods: When meeting a need, the consumer has to choose one of them. For example, a pen and a pencil.
- Independent Goods: When the consumption of goods does not affect the consumption of other goods. For example, lenses and a pen.
Elasticity of Demand
The elasticity of demand for goods, with respect to price, measures the percentage change in the quantity demanded of that good when its price varies by a certain percentage.
- Elastic Demand Curve: A demand curve is elastic when the percentage change in quantity demanded is greater than the percentage change in price, which means that the quantity demanded is very sensitive to price changes. The numerical value is greater than 1.
- Inelastic Demand Curve: It is inelastic if the percentage change in quantity demanded is smaller than the percentage change in price; that is, the quantity demanded is not very sensitive to changes in price. The numerical value is less than 1.
- Completely Elastic Demand Curve: The numerical value of elasticity is infinite, which means that the sensitivity to price is so high that the consumer is only willing to purchase quantities of a good at one price.
- Completely Inelastic Demand Curve: There is no change in quantity demanded if the price varies. The numerical value is zero.
- Unit Elastic Demand Curve: This occurs when the percentage change in quantity demanded equals the percentage change in price.
Production
Production is defined as the process by which productive factors (inputs) become finished products (outputs).
- Inputs: The resources (land, labor, and capital) that the company uses in production. They are divided into:
- Variable Inputs: Those whose consumption varies depending on production (raw materials, packaging, etc.).
- Fixed Inputs: Their use does not depend on the amount of product obtained (machinery, facilities, etc.).
- Technology Used: The body of knowledge on ways and methods to produce goods and services. Technological progress occurs when new techniques can obtain a higher production volume with the same number of factors used or when you can get the same volume of output with less use of units of inputs.
- Outputs: The goods and services that can be devoted to consumption or production of other goods.
Analysis of Production in the Short Term
In the short term, if a company wants to produce more product, it must modify the units of variable factors used.
Analysis of Production in the Long Term
In the long term, an employer can change all factors of production to change the volume of production. All factors of production can vary; for example, we could hire more workers, use more yards of fabric, buy more machines, etc. The production function tells us how much production we get for the different units of output.
Average productivity is the ratio between the amount of product obtained and the amount used as a productive factor.
Short-Term Variable Costs
These are incurred to acquire variable factors of production and, therefore, depend on the level of production. As production varies, the quantities of variable input will change, causing an increase in variable cost. This is reflected in its function, which relates the amount of product obtained with the variable cost required to obtain it.
Short-Term Fixed Costs
These originate in the purchase of fixed productive factors and are independent of the number of units produced.
Supply
The supply of goods that a company is constituted by the amount of good it will want to bring to market. The elasticity of supply measures the percentage change that occurs in the quantity supplied of a good to a percentage change in price.