Tuesday, August 6, 2013

What is a supply and demand diagram, anyway?



Here is the process for how you construct a supply and demand diagram in the information transfer model. You start with a 3D surface (think x,y,zQd,Qs,P) defined by 
P=1κQdQs

and perform two projections into the (Qd,P) and (Qs,P) planes. You keep the line that "varies". For example, in the (Qs,P) plane, the supply curve doesn't vary with the quantity supplied because it is the set of points on the surface where Qs=const that includes the equilibrium point where the curves cross. This means the red supply curve appears as a vertical line, but the demand curve falls with increasing quantity supplied. The opposite goes for the projection in the (Qd,P) plane: here the demand curves are constant versus demand while the supply curves vary with the quantity demanded.

The dashed line represents a shift in the demand curve (it appears as a vertical line shifted to the right in the (Qd,P) plane).

Not all supply and demand diagrams look like the basic one. For example, sometimes you project both curves into the same plane (e.g. here). However, I think this is a good way to get a handle on the various ones that appear out there.

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Also, try to avoid the use of dollar signs as they interfere with my setup of mathjax. I left it set up that way because I think this is funny for an economics blog. You can use € or £ instead.

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