Chapter 3: Individual Markets: Demand & Supply

Market: An institution or mechanism that brings together buyers (“demanders”) and sellers (“suppliers”) of particular goods, services, or resources.All situations that link potential buyers with potential sellers are markets.Purely competitive markets with a large number of independent buyers and sellers.

Demand

Demand is a schedule or a curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specific period of timeDemand shows the quantities of a product that will be purchased at various possible prices, other things equalA demand schedule shows price and quantity demanded for a particular good.The demand schedule alone does not indicate the price of the good in the market because that price will depend on demand AND supply.

Law of Demand

All else equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls. There is a negative (inverse) relationship between price and quantity demanded.

Inverse Relationship between Price and Quantity Demanded

People buy more of a product at a low price than at a high price. Think: Sales.Consumption is subject to diminishing marginal utility (MU).As successive units of a particular product yield less MU, consumers will buy additional units ONLY if the price of those units is progressively reduced.

Income & Substitution Effects

The income effect indicates that a lower price increases the purchasing power of a buyer’s money income, enabling the buyer to purchase more of the product that she or he could buy before.The substitution effect suggests that at a lower price buyers have the incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive.The income & substitution effects combine to make consumers able & willing to buy more of a product at a low price than at a high price.

The Demand Curve (Fig 3.1)

Quantity demanded on the horizontal axisPrice on the vertical axis.Downward (-) slope reflects the law of demand.Consumers buy more of a product, service, or resource as its price falls.

Market Demand

Competition requires that more than one buyer be present in each market.Add the quantities demanded by ALL consumers at each possible price to get from individual demand to market demand.To simplify, we assume that all buyers in a market are willing & able to buy the same amounts at each of the possible prices.Multiply quantity demanded of a single buyer by the number of buyers to obtain market demand.

Determinants of Demand

Consumers’ tastes/preferencesNumber of consumers in the marketConsumers’ incomesPrice of related goodsConsumer expectations about future prices and incomes

Change in Demand

A change in one or more of the determinants of demand will change the demand curveIncrease in demand is shown as a shift of the demand curve to the rightDecrease in demand is shown as a shift of the demand curve to the left

Income

A rise in income causes an increase in demandProducts whose demand varies directly with income are called superior goods, or normal goods.Goods whose demand varies inversely with money income are called inferior goods.

Prices of Related Goods

A change in the price of a related good may either increase or decrease the demand for a product.A substitute good can be used in place of another. The price of one and the demand for the other move in the same direction.A complimentary good is used together with another good and are usually demanded together. The price of one good and the demand for the other good move in opposite directions.

What causes an increase in demand?

Favorable change in consumer tastesIncrease in number of buyersRising incomes causes demand for normal goods to riseFalling incomes causes demand for inferior goods to riseIncrease in price of a substitute goodDecrease in the price of a complementary goodNew consumer expectations that either prices or income will be higher in the future.

Changes in Quantity Demanded

Change in demand is a shift of the ENTIRE demand curveChange in quantity demanded is a movement from one point to another point, from one price-quantity combination to another, on a demand curve caused by an increase or decrease in the price of the product.

Supply

A schedule or curve showing the amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specific period

Law of Supply

As price rises the quantity supplied risesAs price falls, the quantity supplied fallsFirms will produce and offer more of their product at a high price than at a low price.To a supplier, price represent REVENUE, which serves as an incentive to produce and sell a productThe higher the price, the greater the incentive, the greater the quantity supplied

The Supply Curve

Quantity supplied on the horizontal axisPrice on the vertical axis.Upward (+) slope reflects the law of supplyProducers sell more of a product, service, or resource as its price rises.

Determinants of Supply

Resource pricesTechnologyTaxes & SubsidiesPrices of other goodsPrice expectationsNumber of sellers in the market

Taxes & Subsidies

Taxes are a costTaxes increase production costs, reducing supplySubsidies lowers production costs, increasing supply

Price Expectations

Changes in expectations about future price of a product may affect the producer’s current willingness to supply that product

Changes in Quantity Supplied

A change in supply means a change in the entire schedule and a shift of the entire curveA change in quantity supplied is a movement from one point to another on a fixed supply curve, caused by a change in the price of the product.

Market Equilibrium

Assumes a competitive market, neither buyers nor sellers can set the priceExcess supply causes surplusesExcess demand causes shortagesWhen there are no shortages or surpluses, the price is at equilibrium at the intersection of the supply and demand curvesEquilibrium = “market-clearing” priceEquilibrium quantity: quantity supplied & demanded are equal

Individual Markets

Demand & supply are schedulesIntuitive understanding of the downward slope of demand and upward slope of supply curvesDeterminants of demand & supplyDistinction between shift or change in demand and change in quantity demandedDistinction between shift or change in supply and change in quantity suppliedFigure 3.6: Changes in Demand & Supply and the Effects on Price and Quantity (p. 51)

Price Ceilings and Price Floors

A price ceiling sets the maximum legal price a seller may charge for a product Shortage

A price floor is a minimum price fixed by the government Surplus

Distort resource allocation and cause negative side effects

Chapter 3 Study Questions

1: Law of Demand2: Changes in Demand4: Law of Supply5: Changes in Supply7a-c: Market Equilibrium8: Changes in Demand &/or Supply9: Changes in Supply