Markets and Market Participants
(Supply and Demand)
Chapter-3
In This Chapter….
3.1. Market Participants, their Goals, and Interactions in the Market Place
3.2. The Representation (Characterization) of Market Participants Supply and demand
Individual and Market
3.3. The formation of Market Signals that guide us in Allocating the Scarce Resources
3.1. Identifying Markets, Market Participants and their Behavior
Who? Millions of people (domestic or
foreign), firms, and government institutions participate directly or indirectly in the market (a given country’s economy).
We can identify three broad groups of market participants
3.1. Identifying Markets, Market Participants and their Behavior Consumers (Households):
Those economic agents who go to the marketplace to buy goods and services and satisfy their needs (wants) from their limited resources.
Producers (Businesses or firms): Economic agents who go to the marketplace to
sell goods and services so as to make profits from their limited outputs (services)
Government (Government Institutions): Serve the public needs interest by using the
available resources
3.1. Identifying Markets, Market Participants and their Behavior
The Purpose (Goal) of Market Participants? Consumers (Households):
maximize their utility (satisfaction) given limited resources.
Producers (Businesses): maximize profits by using resources efficiently in
producing goods. Government Institutions:
maximize general welfare of the society.
Maximizing Behavior
3.1. Identifying Markets, Market Participants and their Behavior
Maximizing Behavior The basic goals of utility maximization,
profit maximization, and welfare maximization thus explain most market activity.
How do Markets enable Participants to Achieve the goal Maximization?
3.1. Identifying Markets, Market Participants and their Behavior Economic interactions …the opportunity for
specialization and exchange. Our economic interactions with others in
the market place is necessitated by two constraints:1. Our absolute inability as individuals to do
(produce) all the things we need or desire.
2. The limited amount of time, energy, and resources we have producing those things we could make for ourselves…scarcity
3.1. Identifying Markets, Market Participants and their Behavior Markets thus refer to a place where consumers
and producers come together and where exchange takes place.
Although identifiable and peculiar in some cases, there is no specific place where markets are located (they could be virtual)
A market exists wherever and whenever an exchange takes place.
Based on the items for exchange, however, we can identify TWO MAIN types of markets
3.1. Identifying Markets, Market Participants and their Behavior
1. Factor Markets:… are any place where factors of production (e.g., land, labor, capital) are bought and sold.
2. Product Markets: … are any place where finished (final)
goods and services (products) are bought and sold.
3.1. Interaction in the Market Place
Internationalparticipants
Consumers(Households)
Internationalparticipants
Producers (Firms)
Governments
ProductMarkets
FactorsMarkets
Factors ofproduction supplied
Goods and servicesdemanded
Factors ofproduction demanded
The Circular Flow
Goods and servicessupplied
Dollars and Exchange
Every market transaction involves an exchange of dollars for goods (in product markets) or resources (in factor markets).
3.1. Interaction in the Market Place
Internationalparticipants
Consumers(Households)
Internationalparticipants
Producers (Firms)
Governments
ProductMarkets
FactorMarkets
Household Expenses
Costs of Production
The Circular Flow
Revenue
Incomes Factors ofproduction demanded
Factors ofproduction supplied
Goods and servicesdemanded Goods and services
supplied
3.2. Characterization of the Activities of Market Participants
Market is a place that brings together Consumers (Buyers) and Producers (Sellers).
For every market transaction, there must be a buyer and a seller.
The sellers represent the supply side of the market.
The buyers represent the demand side of the market.
3. 2. Supply and Demand
Demand
3. 2. Supply and Demand
What is Demand ? is the ability and willingness of
consumers (buyers) to buy specific quantities of a good at alternative prices in a given time period, ceteris paribus.
Quantity Demanded: The amount of a good that a consumer is
willing and able to buy at given time and price level, ceteris paribus
3.2. Supply and Demand
A demand exists only if someone is willing and able to pay for a good. Thus…
“Demand” is an expression of consumer buying intentions – of a willingness and ability to buy – not a statement of actual purchases.
Individual Demand
Three different ways to present demand:
1. Using A table (Demand Schedule)2. Using A graph (Demand Curve)3. Using A Mathematical Equation (Demand
Function)
Individual Demand
Demand schedule: is a table showing the quantities of a
good a consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus.
Individual Demand
Demand curve:
is a curve (graph) describing the quantities of a good a consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus.
Demand Schedule and Curve
2 4 6 8 10 12 14 16 18 20Quantity of Tutoring Demanded (hours)
PRICE$5045403530252015105
0
A
B
CD
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Individual Demand
Demand Function:
an algebraic representation of the quantities of a good a given consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus.
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Individual Demand
The Law of demand:
The quantity of a good demanded in a given time period increases as its price falls, ceteris paribus.
Determinants of Demand
Determinants of market demand include: Tastes — desire for the particular good
under consideration and other goods. Income — of the consumer. Other goods — their availability and price. Expectations — for income, prices,
tastes. Number of buyers.
Types of Demand
We can identify two types of demand:
Individual demand Market demand :
is the total quantities of a good or service people are willing and able to buy at alternative prices in a given time period.
It is the sum of individual demands.
Market Demand
Market demand is determined by the number of potential buyers and their respective tastes, incomes, other goods and expectations.
The Market Demand Curve
Market demand represents the combined demands of all market participants.
The separate demands of individual consumers is added up to determine the total quantity demanded at any given price.
Construction of the Market Demand Curve
+ + =
Morke’s demand curve
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$50
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Stacy’s demand curve
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Leah’s demand
curve
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Negassa’s demand
curve
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Price
Quantity Demanded
Construction of the Market Demand Curve
ABC
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The market demand curve
Pric
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Shifts in Demand Vs Movements along the Demand Curve The determinants of demand can and do
change.
A Change in demand is indicated by a shift in the demand curve.
Represents a change in the quantity demanded at every given price level.
Results from changes in one or more factors in the determinants of demand (due to changes in tastes, income, other goods, or expectations), except own price of the good
Shifts in Demand Vs Movements along the Demand Curve
Changes in quantity demanded :
Is indicated by movements along a demand curve, and it results only as a response to changes in the price of the good itself.
Changes in Demand
Change in Demand is indicted by a shift in the Demand Curve
An increase in demand shifts the demand curve to the right when:
A decrease in demand shifts the demand curve to the left when:
The good is normal and income increases
The good is normal and income decreases
The good is inferior and income decreases
The good is inferior and income increases
The price of a substitute good increases
The price of a substitute good decreases
The price of a complementary good decreases
The price of a complementary good increases
Market Effects ofChanges in Demand
Changes in Demand Shift the Demand Curve
An increase in demand shifts the demand curve to the right when:
A decrease in demand shifts the demand curve to the left when:
Population increases Population decreases
Consumer tastes shift in favor of the product
Consumer tastes shift away from the product
Consumers expect a higher price in the future
Consumers expect a lower price in the future
Movements vs. Shifts
PRICE
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2 4 6 8 10 12 14 16 18 20 22 Quantity
D1initial demand
d1
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g1
Shift in demand
D2 increased demand
d2
Pizza and Politics: Quiz (True or False)
At the Clinton White House whenever a political crisis erupted, the demand for pizza increased.
…we can represent this by a shift in demand curve for pizza (at the White House) not by movement along the same demand curve.
True
3. 2. Supply and Demand
Supply
3.2. Supply and Demand
What is Supply? is the ability and willingness of a
producer (supplier) to sell specific quantities of a good at alternative prices in a given time period, ceteris paribus.
Quantity Supplied The quantity of a given good that the
producer is willing and able to supply at a given price and time, ceteris paribus
Supply
Supply is the total quantities of a good that sellers are willing and able to sell at alternative prices in a given time period, ceteris paribus.
Law of Supply Larger quantities will be offered for sale at
higher prices.
Law of supply, the quantity of a good supplied in a given time period increases as its price increases, ceteris paribus.
Supply curves are thus upward-sloping to the right.
Market Supply
Quantity Supplied By:
Price Erin + Hussein + Miranda = Market
j $50 94 35 19 148
i 45 93 33 14 140
h 40 90 30 10 130
g 35 86 28 0 114
f 30 78 12 0 90
e 25 53 9 0 62
d 20 32 7 0 39
c 15 20 0 0 20
b 10 10 0 0 10
Market Supply
Erin’sSupply
Hussein’sSupply
Miranda’sSupply
Market Supply
Determinants of Supply
The determinants of market supply include:
– Factor costs
– Technology
– Other goods
– Taxes and subsidies
– Expectations
– Number of sellers
Market Supply
The market supply curve is just a summary of the supply intentions of all producers.
Market supply is an expression of sellers’ intentions (willingness and ability)– an offer to sell – not a statement of actual sales.
Movements and Shifts of Supply
Changes in the quantity supplied — movements along the supply curve.
Changes in supply — shifts in the supply curve.
Equilibrium Market Price
Equilibrium
Equilibrium price is the price at which the quantity of a
good demanded in a given time period equals the quantity supplied.
Equilibrium Quantity The quantity of the good purchased and
sold at the equilibrium price
Price Quantity Supplied Quantity Demanded $50 148 surplus 5
45 140 surplus 8 40 130 surplus 11 35 114 surplus 16 30 90 surplus 22 25 62 surplus 30 20 39 equilibrium 39 15 20 shortage 47 10 10 shortage 57
Equilibrium Price
Equilibrium Price
Market demand
Equilibrium price
Market supply$504540353025201510
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At equilibrium price, quantity demanded equals quantity supplied
100 125 Quantity39
Price
….Equilibrium Price is a Market Clearing Price
Everyone may not be happy with the prevailing price or quantity at equilibrium.
However, it is unique in that the outcome at market equilibrium is efficient. Resources are put to their best possible
use
The Invisible Hand
Adam Smith characterized this market mechanism as the invisible hand.
The market mechanism is the use of market prices and sales to signal desired outputs (or resource allocations).
Price Quantity Supplied Quantity Demanded $50 148 surplus 5
45 140 surplus 8 40 130 surplus 11 35 114 surplus 16 30 90 surplus 22 25 62 surplus 30 20 39 equilibrium 39 15 20 shortage 47 10 10 shortage 57
Deviation from the Equilibrium
Market Surplus
A market surplus is the amount by which the quantity supplied exceeds the quantity demanded at a given price – excess supply.
A market surplus is created when the market prices are too high.
Market Shortage
A market shortage is the amount by which the quantity demanded exceeds the quantity supplied at a given price – excess demand.
A market shortage is created when the market prices are too low.
Surplus and Shortage
Market demand Market supply$504540353025201510
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0 25 50 75 100 125 Quantity39
Price
Shortage
yx
Surplus
Self-Adjusting Prices
A market surplus will emerge when the market price is above the equilibrium price.
A market shortage will emerge when the market price is below the equilibrium price.
Self-Adjusting Prices
Buyers and sellers will change their behavior to overcome a surplus or shortage.
Only at the equilibrium price will no further adjustments be required.
Surplus and Shortage
Market demand
Equilibrium price
Market supply$504540353025201510
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0 25 50 75 100 125 Quantity39
Price
Shortage
yx
Surplus
Changes in Equilibrium
No equilibrium price is permanent. The equilibrium price will change
whenever the supply or demand curve shifts.
Changes in supply and demand occur when the determinants of supply and demand change.
Changes in Equilibrium
Should the demand curve shift, the result will be a change in equilibrium price and quantity.
Should the supply curve shift, the result will be a change in equilibrium price and quantity.
Changes in Equilibrium Demand Shift
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Price
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Market supply
New demand
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Changes in Equilibrium Supply Shift
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Initial demand
Market supply
Implications---Outcomes
In a free market economy, the market mechanism resolves the basic economic questions of WHAT, HOW, and FOR WHOM.
Market Outcomes
WHAT we produce is determined by the equilibrium of the markets.
HOW we produce is determined by profit seeking behavior and using resources efficiently.
FOR WHOM we produce is determined by those willing and able to pay the equilibrium price
Does the Market Outcome Satisfy Everybody?
Is it Perfect?
Is it Optimal?
Optimal, Not Perfect!!
Not everyone is happy with market outcomes.
But we are given the opportunity to maximize our own satisfaction.
Thus although the outcomes of the marketplace are not perfect, they are often optimal.
Because Everyone has done the best possible given their incomes and talents
Real Life Examples…
People are often upset with the market outcome.
In a market-driven economy of the U.S.A.(California), electricity prices are set by the forces of supply and demand.
Real Life Examples…
In 2000, Electricity prices increased in California because of two reasons:
an increase in demand (The demand curve shifted rightward)
and a decrease in supply (The supply curve shifted leftward).
Sharp Increase in Electricity Price..
Price Ceilings Create Shortages
Quantity Of Electricity(megawatts per hour)
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Real Life Examples…
This led to Government Intervention in Electricity pricing ….
The California legislature put a price ceiling on retail electricity prices.
A price ceiling is the upper limit imposed on the price of a good.
Price Ceilings Create Shortages
Quantity Of Electricity(megawatts per hour)
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Price ceiling
Consequences of Price Ceilings
Price ceilings have three predictable effects: Increase the quantity demanded. Decrease the quantity supplied. Create a market shortage.
Price Ceilings Create Shortages
Letting prices rise would have:
– Reduced the quantity demanded.– Increased the quantity supplied.– Alleviated the market shortage.