Demand & Supply

MarketsDemandSupplyPrice determinationChanges in demand & supply

Markets

“Markets are central institutions of a modern society. If you understand markets, you have a chance of understanding what is happening in your time. If you don’t, you don’t.” --Martin Mayer

Markets

A market is a group of buyers and sellers of a particular good or service

Types of markets: perfect competition, monopoly, oligopoly, monopolistic competition

Perfect competition Identical goods Many buyers and sellers who are price

takers

Markets

Monopoly One seller who is a price setter

Oligopoly Only a few sellers Can be any type of product

Monopolistic Competition Many sellers Slight product differentiation

Demand

Quantity demanded (QD): the amount that people are willing & able to buy at a specific price

Change in quantity demanded(QD): a change in the amount that people are willing & able to buy due to a change in the price of the good

Demand(D): the amounts that people are willing & able to purchase at various prices, ceteris paribus

Demand

We focus on the basic relationship between price of the good and QD

Nonprice determinants or ceteris paribus assumptions are: prices of related goods, income, expectations, number of buyers, & tastesRelated goods are either substitutes or

complements

Demand

Demand shows that there is a negative relationship between price & QD (law of demand)

Diminishing marginal utility explains the negative relationship

Demand

Graphics A single point on the demand curve

refers to QD The entire function refers to the

definition of demand

Demand

A movement along the demand curve refers to change in QDMeans that people are willing & able to buy

a different quantity due to a change in the price of the good

A movement down the demand curve is an increase in QD

A movement up the demand curve is a decrease in QD

Demand

The slope of the demand curve shows there is a negative relation between P & QD

Demand

Change in demand (D) Caused by a change in a nonprice

determinant (ceteris paribus condition) Means that people are willing & able to

buy a different quantity regardless of price

Is represented by a shift of the demand function

Demand

An increase in demand is a rightward (or upward) shift of the function

An increase in demand means people are willing & able to buy more at the same prices

An decrease in demand is a leftward (or downward) shift of the function

A decrease in demand means people are willing & able to buy less at the same prices

Supply

Quantity supplied (QS): the amount that people are willing & able to sell at a specific price

Change in quantity supplied (QS): a change in the amount people are willing & able to sell due to a change in the price of the good

Supply (S): the amounts that people are willing & able to sell at various prices, ceteris paribus

Supply

We focus on the basic relationship between price of the good and QS

Nonprice determinants or ceteris paribus assumptions are: input prices, technology, expectations, and number of sellers

Supply

Supply shows that there is a positive relationship between price and QS (law of supply)

Increasing profits can explain positive slope of supply curve

Supply

Graphics A single point on the supply curve refers

to QS The entire function refers to the

definition of supply

Supply

A movement along the supply curve refers to a change in QS Means that people are willing & able to

sell a different quantity because of a change in the price of the good

A movement up the supply curve is an increase in QS

A movement down the supply curve is a decrease in QS

Supply

The slope of the supply curve shows there is a positive relation between P & QS

Supply

Change in supply (S) Caused by a change in a nonprice

determinant (ceteris paribus condition) Means that people are willing & able to

sell a different quantity regardless of price

Is represented by a shift of the supply function

Supply

An increase in supply is a rightward (or downward) shift of the function

An increase in supply means that people are willing & able to supply more at the same prices

A decrease in supply is a leftward (or upward) shift of the function

A decrease in supply means that people are willing & able to sell less at the same prices

Price Determination (Equilibrium)

Equilibrium is the point towards which the economy tends to move; once that point is reached, the economy tends to remain there unless some outside force pushes it away

In the context of the S/D model, we are concerned with two equilibrium values, price (Pe) and quantity (Qe)

Price Determination

The equilibrium price is the one at which QD = QS

The equilibrium quantity is the one at which QD = QS

Graphically, equilibrium occurs at the point where the D & S functions intersect

Price Determination

P > Pe An excess supply (surplus) will exist (QS

> QD) There will be a tendency for price to fall As price falls, QD will increase & QS will

decrease; the excess supply will be eliminated

Price Determination

P < Pe An excess demand (shortage) will exist

(QD > QS) There will be a tendency for price to

increase As price rises, QD will decrease & QS

will increase; the excess demand will be eliminated

Predicting Changes in Price & Quantity

Three steps must be undertaken to analyze a change in equilibrium Did the events change demand or

supply? Was there an increase or decrease in

the function? What happened to the equilibrium price

and quantity?

Predicting Changes in Price & Quantity

Changes in demand An increase in D will increase both Pe & Qe A decrease in D will decrease both Pe & Qe

Changes in supply An increase in S will decrease Pe & increase

Qe A decrease in S will increase Pe & decrease

Qe

Predicting Changes in Price & Quantity

If both D & S change, the change in only one equilibrium value can be predicted If both D & S increase, Qe will increase.

We cannot predict Pe. If both D & S decrease, Qe will

decrease. We cannot predict Pe.

Predicting Changes in Price & Quantity

If D increases & S decreases, Pe will increase. We cannot predict Qe.

If D decreases & S increases, Pe will decrease. We cannot predict Qe.