Demand
Supply
The Market: Demand and Supply
Specialization and Trade: Markets
In a market economy people can trade what they have (or have produced)
for economic resources or goods they would like to have. Places,
institutions, or mechanisms at or through which these trades take palace
are called markets.
Money as a medium of exchange, standard of value, and store of vale facilitates trade.
The opportunity to trade allows people to specialize, resulting in greater efficiency in production.
The Circular Flow Model
The Resource Market: The market in which sellers (households) and buyers
(firms) of resources meet
The goods (or products) market: The market in which the buyers (households)
and the sellers (firms) of goods meet
As a result of the interactions between buyers and sellers the prices of resources as well as the prices of goods are determined in these two markets.
What producers pay to households for their resources (land, labor and capital) would constitute households' incomes, on the one hand, and the firms' costs of production, on the other hand.
What households spend on goods and services (households' expenditures) woulld become the firms' revenue.
The Role of Price in the Market
Price is in essence the means of communication in the market.
By offering higher prices buyers signal their desire to buy more of a good
or a resource to sellers. Sellers, on the other hand, communicate the information
about the cost of a good or a resource to buyers through price.
If too much of a good is produced and offered to the market, the price of that good will go down, signaling the producers to cut back on production. Conversely, if not enough of a good is produced, its price will go up, encouraging producers to produce more.
Individual Markets
A market economy functions through a vast network of individual markets
bringing together buyers and sellers of various goods and services as well
as resources; e.g., the corner grocery store, the McDonald's restaurant,
the New York Stock Exchange, The Chicago Board of Trade
In each market it is the interaction of demand and supply that determines the price.
Demand
Demand and its Determinants: A General Definition
Demand is the quantity of a good or resource that buyers (or demanders)
are willing and able to buy under a given set of conditions over a given
period of time.
Conditions: The conditions under which the demand for a good (or a resource) is determined are characterized by factors such as price, income, taste, prices of related goods, expected prices, number of buyers, etc.
Note: In most of our discussion of supply and demand we deal with only products markets.
Demand and Price
Demand and Price, Ceteris Paribus: A Narrower (More Specific) Definition
Demand is a schedule or a curve showing the various amounts of a good
or a service consumers (buyers) are willing and able to buy at various
possible prices, ceteris paribus, over a specified period of time.
Price Quantity Demanded
$ 5 10
4
20
3
35
2
55
1
80
Law
of Demand
Other things unchanged, as price rises, the quantity demanded decreases,
and as price falls, the quantity demanded increases; the relationship between
price and the quantity demanded is negative.
The Reasons Behind the Law of Demand
1. The price a consumer pays for a good is, in fact, the opportunity
cost of having it; the money spent on a good could be spent on some thing
else. The higher the price of a good, the more of other goods the consumer
would have to forego to buy that good.
2. The principle of diminishing marginal utility: In any given period of time the more of a good a person consumes, the less satisfaction he/she derives from each additional unit of that good; a consumer will buy an additional unit of a good if the price (of the additional unit) is reduced.
3. Income and substitution effects: The higher the price of a good the lower the purchasing power of the money income of the consumer; this is referred to as the income effect of a price change. As the price of a good goes up the consumer substitutes that good with cheaper goods; this is called the substitution effect of a price change.
The Demand Curve
The demand curve is a line or a curve showing the relationship between
price and quantity demanded; it is a curve plotted in a two-dimensional
space with price measured along the vertical axis and the quantity demanded
measured along the horizontal axis.
A demand curve shows the relationship between price and quantity demanded
only; all (other) factors affecting demand are assumed to remain unchanged
along a demand curve.
Individual
Demand and Market Demand
An individual demand curve reflects the quantities of a good a consumer
is willing and able to purchase at a range of possible prices, ceteris
paribus, during a given period of time. A market demand (curve) is the
(horizontal) sum of individual demands.
Demand (Curve) versus Quantity Demanded
By demand or demand curve we mean a range of quantities corresponding
to various prices reflected along a line or a curve. By quantity demanded
we mean a specific quantity demanded corresponding to a specific price.
A change in price (ceteris paribus) results in a change in quantity demanded ( a movement along the curve), not a change in demand.
A change in demand (curve) results from changes in factors other than price. Such changes cause shifts of the demand curve.
Changes in income, taste, prices of related goods (substitutes or complementary goods), expected prices, number of buyers, etc. will result in changes in demand or shifts of the demand curve.
Note: Normally, an increase in income
will result in an increase in demand or a shift of the
demand curve to the right. In fact, those goods for which demand is positively
related to income we call normal goods. There are, however some
goods
for which demand is negatively related to income; the demand for these
goods
would go down in reaction to an increase in income. These
goods are called
inferior goods. At certain income levels a good like potatoes may
become an
inferior good. A consumer may substitute a more expensive good like beef
for
potatoes in reaction to an income increase.
A Challenge: With the above discussion in mind, think about the income
effect
of
a price change mentioned earlier in connection with our discussion
about the slope of the demand curve.
Supply
A General Definition: Supply is the quantity of a good or resource
that sellers (or suppliers) are willing and able to offer to the market
for sale under a given set of conditions over a specific period of
time.
Determinants of Supply: Factors affecting supply of a good include price, prices of inputs, technology, prices of related goods, taxes, expectations, number of firms, etc.
Supply and Price: A Narrower Definition
Supply (or a supply curve) is a schedule or curve showing the quantities
of
a product a firm (or firms) is (are) willing and able to produce and offer
to the market for sale at a range of possible prices, ceteris paribus,
over a certain period of time.
Price Quantity Supplied
$ 5 60
4
50
3
35
2
20
1
5
Law of Supply
Other things remaining constant, as the price of a good rises, the
corresponding quantity supplied increases, and as the price falls the quantity
supplied decreases; the relationship between price and the quantity supplied
is positive.
The Reason Behind the Law of Supply: As more and more of a good is produced, beyond some production level, the costs of producing additional units begin to rise. In order for a firm to produce more of that good it has to charge (or be offered) higher prices.
Supply
Curve
The supply curve is a line or a curve showing the relationship between
price and quantity supplied; it is a curve plotted in a two-dimensional
space with price measured along the vertical axis and the quantity supplied
measured along the horizontal axis.
A supply curve shows the relationship between price and quantity supplied
only; all (other) factors affecting supply are assumed to remain unchanged
along a supply curve.
Individual Supply and Market Supply
An individual supply curve reflects the quantities of a good a
producer (a firm) is willing and able to produce and offer for sale
at a range of possible prices, ceteris paribus, during a given period of
time. A market supply (curve) is the (horizontal) sum of individual supply
curves.
Supply (Curve) versus Quantity Supplied
By Supply or supply curve we mean a range of quantities corresponding
to various prices reflected along a line or a curve. By quantity supplied
we mean a specific quantity supplied corresponding to a specific price.
A change in price (ceteris paribus) results in a change in quantity supplied ( a movement along the curve), not a change in supply.
A change in supply (or the supply curve) is caused by changes in factors other than price. Such changes cause shifts of the supply curve.
Changes in resource prices, technology, prices of related goods (substitutes or accompanying products), expectations, number of firms, etc. will result in changes in (market) supply or shifts of the supply curve.
Market
Equilibrium
What do economists mean by "equilibrium?"
Market equilibrium is a condition under which the quantity supplied
is equal to the quantity demanded; when a market is in equilibrium, there
is no tendency for change.
The equilibrium price is the price at which the quantity demanded is equal to the quantity supplied.
Shortages occur when price is below the equilibrium price; shortages cause the price to rise.
Surpluses occur when price is above the equilibrium price;
surpluses cause the price to fall.
Changes in the Market Equilibrium
Changes (shifts) in the market supply and demand result in changes
in the market equilibrium.
Recalling the factors that cause changes (shifts) in the marker supply and demand, consider the following changes:
An increase in demand
A decrease in demand
An increase in supply
A decrease in supply
An increase in demand along with an increase in supply
An increase in demand along with a decrease in supply
A decrease in demand along with an increase in supply
A decrease in demand along with a decrease in supply
Discuss the effects of each of the above on the equilibrium price and
quantity.