Chapter 4: The Market Forces of Supply & Demand

Competitive market

Market in which there are many buyers and many sellers so that each has a negligible impact on the market price.

Characteristics of a competitive market

Many buyers and sellers: no one individual has any influence over the price; the price is determined by the entire market.

Price takers

Term to describe buyers and sellers in a competitive market that must accept the price that the market determines.

In a monopoly market,

the lure of above-normal profits may give a firm an incentive to develop new products and technologies.

Oligopoly

A state of limited competition, in which a market is shared by a small number of producers or sellers.

Demand curve

A graph of the relationship between the price of a good and the quantity demanded. It shows how much consumers want to buy at any price, holding constant the many other factors that influence buying decisions.

Quantity demanded

Amount of a good that buyers are willing and able to purchase; a determinant of this is the price of the product.

Law of Demand

Consumers will buy more of a good when its price is lower and less when its price is higher. Price up, quantity down - negative relationship.

Market demand

The sum of all the individual demands for a particular good or service. The CURVE shows how the total quantity demanded of a good varies with the price of the good, holding constant all other factors that affect how much consumers want to buy.

Demand curves are summed

horizontally-- meaning that the quantities demanded are added up for each level of price.

An increase in demand in the demand curve is represented by

a shift of the demand curve to the right.

A decrease in demand in the demand curve can be represented by

a shift of the demand curve to the left.

Normal good

A good for which, other things equal, an increase in income leads to an increase in demand.

Inferior good

A good for which, other things equal, an increase in income leads to a decrease in demand.

Shifts in the Demand Curve are swayed by:

Income, prices of related goods, tastes, expectations [future income & prices], number of buyers

Substitutes

Two goods for which an increase in the price of one leads to an increase in the demand for the other.

Complements

Two goods for which an increase in the price of one good leads to a decrease in the demand for the other.

Supply curve

A graph of the relationship between the price of a good and the quantity supplied.

Quantity supplied

The amount of a good that sellers are willing and able to sell.

Law of Supply

The claim that the quantity supplied of a good rises when the price of the good rises, other things equal. Price up, quantity up - positive relationship.

Market supply curve can be found by

summing individual supply curves.

Individual supply curves

Summed horizontally at every price to obtain the market supply curve

The market supply curve shows

how the total quantity supplied varies as the price of the good varies.

Shifts in the supply curve are indicated by

Input prices, technology, expectations, number of sellers

An increase in supply can be represented by

a rightward shift of the supply curve.

An decrease in supply can be represented by

a leftward shift of the supply curve.

Market equilibrium

The point where the supply and demand curves intersect.

Equilibrium

A situation in which the price has reached the level where quantity supplied equals quantity demanded.

Equilibrium price

The price that balances quantity supplied and quantity demanded. Considered the "market-clearing" price because both buyers and sellers are satisfied at this price.

Equilibrium quantity

The quantity supplied and the quantity demanded at the equilibrium price.

If actual market price > equilibrium price,

leads to SURPLUS of the good.

Surplus

A situation in which quantity supplied is greater than quantity demanded.

How is surplus eliminated?

When producers lower price until market hits equilibrium

If actual market price < equilibrium price,

leads to SHORTAGE of the good.

Shortage

A situation in which quantity demanded is greater than quantity supplied.

How is shortage eliminated?

Sellers raise the price of the good until the market reaches equilibrium.

Law of Supply & Demand

The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance

How to analyze changes in equilibrium

1) decide whether the event shifts the supply and/or the demand curve

2) decide in which direction the curve shifts (right/left)

3) use the supply-and-demand diagram to see how the shift changes the equilibrium price and quantity

Change in quantity demanded

Movement along the demand curve showing that a different quantity is purchased in response to a change in price

Change in quantity supplied

Movement along a fixed supply curve