1 market demand and supply ©2006 south-western college publishing

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Market Demand and Supply

©2006 South-Western College Publishing

The Market Forces of Supply and Demand

Supply and demand are the two words that economists use most often.

Supply and demand are the forces that make market economies work.

Modern microeconomics is about supply, demand, and market equilibrium.

Markets

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

The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets.

Markets Buyers determine demand.

Sellers determine supply.

Market Type: A Competitive Market

A competitive market is a market. . .

with many buyers and sellers.

that is not controlled by any one person.

in which a narrow range of prices are established that buyers and sellers act upon.

Competition: Perfect and Otherwise

Products are the same Numerous buyers and sellers so that

each has no influence over price Buyers and Sellers are price takers

Perfect Competition

Competition: Perfect and Otherwise

Monopoly One seller, and seller controls price

Oligopoly Few sellers Not always aggressive competition

Competition: Perfect and Otherwise

Monopolistic Competition Many sellers Slightly differentiated products Each seller may set price for its own

product

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What is demand?

Demand represents the choice making behavior of buyers

Demand Schedule

Price Quantity$0.00 120.50 101.00 81.50 62.00 42.50 23.00 0

Law of Demand

The law of demand states that there is an inverse

relationship between price and quantity demanded.

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What is a demand curve?

Depicts the relationship between price and quantity demanded

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Why do demand curves have a negative slope?At a higher price buyers will buy fewer units, and at a lower price they will buy more units

Ceteris Paribus

Ceteris paribus is a Latin phrase that means all variables other than the

ones being studied are assumed to be constant. Literally, ceteris

paribus means “other things being equal.”

The demand curve slopes downward because, ceteris paribus, lower prices

imply a greater quantity demanded!

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Market Demand

Market demand refers to the sum of all individual demands for a particular good or service.

Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

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IMPORTANT - KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY DEMANDED AND A CHANGE IN DEMAND

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When price changes, what happens?

The curve does not shift - there is a change in

the quantity demanded

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Change in Price

Change in Quantity

Demanded

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When something changes other than

price, what happens?The whole curve

shifts,there is a change in demand

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What can cause a demand curve to shift?

A change in:• Number of buyers in the market• Tastes and preferences• Income• Expectations of consumers• Prices of related goods

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Change in a Nonprice

determinant

Leftward or rightward shift in

the demand curve

Decrease or increase in

demand

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Why does Sunkist http://www.sunkist.com, a major producer of oranges, provide free orange recipes? To increase the demand for oranges, of course

Consumer Income

As income increases the demand for a normal good will increase.

As income increases the demand for an inferior good will decrease.

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What aresubstitute goods?

Goods that compete with one another for consumer purchases

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What happens when the price increases for

a good that has a substitute?

The demand curve for the substitute good increases

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What happens when the price decreases for

a good that has a substitute?

The demand curve for the substitute good decreases

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What does a direct relationship

between price and quantity mean?

The two move in the same direction

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What are complementary goods?

Goods that are jointly consumed with another good

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What happens when the price increases for

a good that has a complement?

The demand curve for the substitute good decreases

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What happens when the price decreases for

a good that has a complement?

The demand curve for the substitute good increases

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What does an inverse relationship between

price & quantity mean? It means that the two move in opposite directions

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What is supply?

Supply represents the choice making behavior of sellers

Supply Schedule

Price Quantity$0.00 00.50 01.00 11.50 22.00 32.50 43.00 5

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What is thelaw of supply?

The principle that there is a direct relationship between the price of a good and the quantity sellers are willing to offer for sale in a defined time period, ceteris paribus

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Why do supply curves have a positive slope?

Only at a higher price will it be profitable for sellers to incur the higher opportunity cost associated with supplying a larger quantity

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What is market supply?

The horizontal summation of all the quantities supplied at various prices that might prevail in the market

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IMPORTANT - KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY SUPPLIED AND A CHANGE IN SUPPLY

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When price changes, what happens?

The curve does not shift - there is a change in the quantity supplied

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Change in Price

Change in Quantity Supplied

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When something changes other than

price, what happens?The whole curve shifts -

there is a change in supply

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Change innonprice

determinant

Change in supply

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What can cause a supply curve to shift?

A change in:• Number of sellers in the market• Technology• Resource prices• Taxes and subsidies• Expectations of producers• Prices of other goods the firm

could produce

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What is the equilibrium price?

The price towards which the economy tends

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Where is the equilibrium price?

At the price where the quantity demanded and the quantity supplied are equal

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Surplus

When the price is above the equilibrium price, the quantity supplied exceeds the quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

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Shortage

When the price is below the equilibrium price, the quantity demanded exceeds the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

Steps To Analyzing Changes in Equilibrium

Determine the Event Decide whether the event shifts the supply or

demand curve (or both in very rare cases). Shift demand or supply to the left or to the

right. (Make a cheat sheet!) Find the new equilibruim Examine how the shift affects equilibrium

price and quantity.