Chapter 4 - The Market Forces of Supply and Demand

market

group of buyers and sellers of a good or service

are markets typically organized or unorganized?

typically unorganized i.e. ice cream buyers don’t all meet at the same time and place to set a price, there’s no auctioneer deciding the price of ice cream

competitive maret

a market in which there are so many buyers and sellers that each has little effect on the market price. the price and quantity sold are determined by all the buyers and sellers as they interact in the marketplace

we assume that markets are perfectly competitive, what are the two characteristics?

(1) the goods offered for sale are all exactly the same

(2) the buyers and sellers are so numerous that no single buyer or seller has any influence over the market price

price takers

buyers and sellers in competitive markets - they have to accept the price the market determines

market price

at market price, buyers can buy all they want and sellers can sell all they want

what is an exception to a perfectly competitive market?

monopoly - one person/firm/nation has complete control over all production/selling of one good

quantity demanded

the amount of a good/service that buyers are willing and able to buy

what is the main determinant of quantity demanded?

the price

law of demand

with other things being equal, the quantity demanded of a good falls when the price of that good rises

**inverse/opposite relationship

demand schedule

table showing the relationship between the price of a good and the quantity demanded (use this to make the demand curve)

demand curve

line relating price and quantity demanded

**by convention price = y-axis, quantity demanded = x-axis

does the demand curve slope upward or downward

always downward because as price decreases, quantity demanded increases

market demand

the sum of all individual demands for a particular good or service

using graphs, how do you obtain market demand?

looking at two individual demand curves, you add together their horizontal components, so just the quantity demanded, and use the same price points, then make that graph the market demand curve.

when does the demand curve shift?

when something happens to alter quantity demanded at any given price

increase in demand

change that increases the quantity demanded at every price (shift RIGHT)

decrease in demand

a shift that decreases the quantity demanded at every price (shift LEFT)

6 variables that can shift the demand curve

income, tastes, substitutes, complements, expectations, # of buyers

income

increase or decrease in income can lead to increase/decrease in quantity demanded

normal good

when income falls, the quantity demanded of normal goods falls

inferior good

when income falls, the quantity demanded of inferior goods rises i.e. people can’t afford cars so they ride the bus more often

substitutes

when the price of one good rises, the quantity demanded of a similar good rises

when the price of one good falls, the quantity demanded of a similar good falls

i.e. froyo prices increase —> increase in quantity demanded of ice cream

complements

price of one good increases —> quantity demanded of a good that you typically buy with it also decreases

price of one good decreases —> quantity demanded of a good that you typically buy with it increases

i.e. if hot fudge prices fall, then ice cream quantity demanded likely increases because hot fudge and ice cream go together

tastes

Ex: if you like chocolate ice cream, you’ll buy more of it

**individual tastes are very important for demand but economists don’t typically try to explain them bc they’re unique to each person

**economists DO examine what happens when tastes change

expectations

expectations about the future change choices you make today:
Ex. if you think your income will increase next month, you might start spending more money now

Ex. if you think ice cream will be cheaper tomorrow, you may save your money today and buy it tomorrow.

# of buyers

if only one buyer, the quantity demanded is lower, if there are more buyers, quantity demanded increases

when does a demand curve shift occur?

curve shifts when there is a change in a relevant variable not measured on either axis.

Ex: a change in price represents a movement along the demand curve

HOWEVER, a change in income, substitutes, complements, tastes, expectations, and the number of buyers aren’t measured on either axis —> shift in demand curve

quantity supplied

the amount of a good/service that sellers are willing and able to sell

what is the main determinant in quantity supplied

the price

law of supply

when the price of a good is high, selling that good is very profitable —> quantity supplied is large

when the price of a good is low, selling that good is not as profitable —> quantity supplied is lowers

supply schedule

table showing relationship between price and quantity supplied (use this to make supply curve)

supply curve

line showing relationship between price and quantity supplied

**quant supplied = x-axis, price = y-axis

does the supply curve slope up or down?

it slopes upward because when price increases, quant supplied also increases

market supply

sum of all the supplies of all sellers

how to obtain market supply from two individual supply curves

add horizontally = just add together the quant supplied values and then keep the price points, then create a new graph

increase in supply

change that raises the quantity supplied at every price point

decrease in supply

a change that decreases the quantity supplied at every price

variables that can shift the supply curve

input prices, technology, # of sellers, expectations

input prices

when the price of an ingredient of a product increases, it becomes more expensive to produce that product —> quantity supplied decreases

when the price of an ingredient of a product decreases, it becomes cheaper to produce that product —> quantity supplied increases

technology

advancements in technology can allow firms to produce more goods using the same amount of resources —> increase in quantity supplied

**new tech reduces prices

in the long run, what is one of the most powerful forces affecting market outcomes?

technology advancements that lower cost of producing goods

expectations

if sellers expect price of ice cream to rise next week, they may supply less now so they can have a higher quant supplied later

# of sellers

more sellers = more quant supplied

when does a supply curve shift occur?

when there is a change in a variable that IS NOT on the graph i.e. input prices, technology, expectations, and # of sellers

equilibrium

point where demand and supply curves intersect

equilibrium price

the price value at the equilibrium point

**sometimes called market-clearing prices bc at this price, everyone in the market has been satisified; sellers sell everything and buyers buy everything they want

equilibrium quantity

the quantity at the equilibrium point

how does the concept of equilibrium and balance relate to equilibrium for supply and demand?

at the equilibrium price, the quantity of goods that buyers are willing and able to buy perfectly matches the quantity that sellers are willing and able to sell.

what moves markets towards equilibrium?

the actions of buyers and sellers

surplus/excess supply

producers are unable to sell all they want at the going price

RESPONSE: cut prices

then, quantity demanded increases and decrease the quantity supplied

**move ALONG the supply and demand curves, NOT shifts

shortage/excess demand

consumers are unable to buy all they want at the going price

not enough goods for buyers —> sellers raise prices bc demand is so high, so then quantity demanded falls and quantity supplied rises

**movement ALONG supply and demand curves, NOT shift

in well functioning markets, are surpluses and shortages temporary or long-lasting?

typically temporary because prices move quickly toward their equilibrium levels

law of supply and demand

the price of any good adjusts to bring the quantity supplied and the quantity demanded into balance

three steps to analyze changes in equilibrium

(1) decide if the event shifts the supply or demand curve (maybe both)

(2) decide in which direction the curve shifts

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

if the supply curve shifts to the left (decrease in quant supplied) and the demand curve shifts to the right (increase in quant demanded), what happens

**price ALWAYS increases

two outcomes are possible depending on the relative size of the demand and supply shifts:
(1) big D shift, little S shift = equilibrium quantity increases

(2) little D shift, big S shift = equilibrium quantity decreases