A Bit of Economics — Part 3

{Read part 2 here.}

In ordinary speech we do not distinguish between “demand” and “quantity demanded.” We just say something like, “The demand for apples has gone up” to mean that more apples are being bought by people. But in economics, there is a clear and important distinction. When we say “demand has increased” we mean the relationship between prices and quantities has changed, and that people are willing to buy more than before at various prices.

In economics, demand and supply simply designates the relationship between quantities and prices. We demand specific quantities, not abstract relationships. So when we say “the quantity demanded” we are talking not about some abstract function but quantity of stuff.

If someone were to say, “the quantity demanded has gone up”, we could conclude that the price has fallen because we know that quantity demanded increases when the price falls. But that’s only true in case the demand — the relationship between prices and quantities — has not changed.

But the demand could change. If the demand increased, then it could happen that even as the price has increased, the quantity demanded has also increased.

Let’s take an example. Masks were going at $1 a pop in January 2020, and at that price, the quantity sold was 10 million masks a month. If in January 2020, producers had increased the price (for some reason that we will go into later) to $2 a pop, the quantity sold could have dropped to 6 million. The old story about higher prices leading to lower quantities being sold.

But in March 2020, masks were selling at $3 a pop, and the quantity being sold was 50 million masks a month. Price went up 3x and quantity demanded went up 5x. What happened was that the demand function itself shifted because people wanted more masks. The price rose because of that and that price rise induced producers to produce more masks.

Graphically, the old equilibrium was (p1, q1) and the new equilibrium is (p2, q2) due to the increase in demand, where p2 > p1, and q2 > q1. In this scenario, the supply S did not change; only the demand moved up from D1 to D2. Due to this change in demand, the quantity demanded and supplied went up, and to the price went up to induce the increase in supply. If the price had continued to to be p1, then suppliers would have supplied on q1 — which would have fallen short of the quantity demanded (which would fall on demand function D2, not D1.)

Suppose the government had mandated that masks could not be sold at more than $1 a pop, producers would not have produced the quantity demanded at that price, and it would have led to shortages, which would then have led to a black market in masks, etc., etc.

This brings up to the next bit: the function of prices.

{Read part 4 here.}

 

Author: Atanu Dey

Economist.

2 thoughts on “A Bit of Economics — Part 3”

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