Competitive market model - Demand and `Supply Curves

Determinants of demand

Price of good, characteristics of the good and how it is provided, prices of other related goods and products (complementary goods and substitute goods), income, consumer tastes and preferences, population growth, government and tax regulations, and more.

An increase in the price of one substitute product causes…

an increase in demand for this product.

Increase in prices of complementary goods,..,

decreases demand for this product.

Name some characteristics of the good and services

preference, quality, proximity, scarcity, weather

For a normal good, when income increases…

demand increases

For an inferior good, when income increases…

demand decreases

A demand curve shows…

the quantity demanded of a product at each price, holding all other factors (determinants of demand) fixed.

The slope of a demand curve is almost always…

downward sloping y=-ax+b

What goods have the rare upwards sloping demand curves?

Some luxury goods

Is a demand curve actually linear?

No, but we linearise them for simplicity.

What is the dependent value on a demand and supply curve (y-axis)?

Price because we are keeping old conventions

Consumer surplus is…

the willingness to pay - the value actually payed

Producer surplus is…

minimum value willing to sell at - value actually sold at

Total economic surplus is…

consumer surplus + producer surplus

What is deadweight loss?

When the trade does not happen because something distorts the market price or quantity, causing mutually beneficial trades not to occur and reducing total economic surplus.

Causes for deadweight loss

Taxes, subsidies, import tariffs, etc.

Deadweight loss graphical explanation

• Equilibrium: supply and demand intersect → efficient quantity.

• Distortion: Creduces the quantity actually traded.

• DWL: the triangle between the supply and demand curves over the units that are no longer traded.

When is competitive equilibrium?

When demand = supply.

External shots

An unexpected event outside the market that changes supply or demand, shifting the supply or demand curve

Shot to the price of a good

Causes a movement along the demand curve (NO SHIFT)

Shot to other determinants of the good

Causes a horizontal translation of the demand curve. If quantity demanded decreases ←, if quantity demanded increases →

What is profit?

Total revenue - total costsD

Is lower price always mean lower revenue?

No, sometimes lowering the price means more units are sold increasing overall revenue.

When is it not worth it to lower price for more overall revenue?

When marginal revenue < marginal cost, as the next unit will reduce profit

What is the price under perfect competition?

price = marginal cost

Monopoly price

marginal cost < price

Shock to the price of the supplied good

Shift along the curve y=ax+b

Shock to the other determinants supplied

Shift horizontal

How does a decrease in taxes and regulation affect the supply curve?

Positive shift to the right as supply expands and price decreases

How does an increase a price of inputs change the supply curve?

Supply contracts, horizontal shift to the left, market equilibrium price increases.

To plot a supply or demand curve you need to…

invert the function to make it in terms of price. You also need to set the other determinants of supply/demand to constant, so that price is the only thing affecting quantity demanded/supply.

Function of quantity supplied

Assume linear function: Q=bP-a, where b>0

Inverse P=a/b +1/b P, slope here is 1/b

Slope for supply curves versus demand curves

The slope is positive for supply curves, and negative for demand curves

Willingness to sell = the supply curves, firms will not sell below…

y-intercept

Willingness to buy = the demand curve, consumers will not buy for a price above…

y-intercept

When will exchange not happen?

When willingness to sell>willingness to buy

When willingness to pay is higher than willingness to sell…

this generates a surplus

consumer surplus

willingness to pay - value actually sold at

producer surplus

value actually sold at - willingness to sell value

Excess supply

the horizontal distance between Qs and Qd when Qs>Qd, so above the crossing

Excess demand

the horizontal distance between Qs and Qd when Qd>Qs, so below the crossing

How do we decrease excess supply?

By decreasing price

How do we decrease excess demand?

By increasing price, usually the buyers increase their bids and excess demand increases until we reach market equilibrium

How to find equilibrium price?

Set Qs=Qd and solve for P, price

Positive shock to demand

Quantity increases

Price increases

Inflation

Negative shock to demand

Quantity decreases

Price decreases

Deflation

Positive shock to supply

Quantity increases

Price decreases

Negative shock to supply

Quantity decreases

Price increases

Positive shock to supply, positive shock to demand

Quantity increases

Price ambiguous

Positive shock to supply, negative shock to demand

Quantity ambiguous

Price increases

Negative shock to supply, negative shock to demand

Quantity decreases

Price ambiguous

Negative shock to supply, positive shock to demand

Quantity ambiguous

Price decreases

What does market demand do?

It associates every price between 0 and infinity to a quantity demanded by the market on a line y=-ax+b

The market demand is the sum of…

the individual demand curves

What is the consumer problem?

How the buyer needs to allocate limited income to goods and services in the world with the goal of maximising self-interest

What do problem do you solve to find the demand curve for a consumer?

Solve the consumer problem for all prices greater than or equal to 0, holding fixed M income, and other prices.

4 steps to the consumer problem

Prefernces, Budget set, Choice, and Demand curve

What is a consumption bundle?

A combination of possible goods and services that the consumer may consume in a certain period of time.

Consumption bundle is a bit like a

vector

What is the maximum number of consumption bundles?

There is none, we can generate infinite bundles (as many as there are points the graph for 2 goods)

What is the solution to the consumer problem?

A consumption bundle

What do we assume about preferences?

They are rational and don’t need justification

What are the two principles of rationality?

Ranking principle and Choice principle

Ranking principle

The consumer is able to rank their preferences (even if some are ranked equally) → his preferences are ‘complete and transitive’

Complete preferences

The consumer can compare any two bundles and say which he prefers or if he is indifferent.

Transitive preferences

A consumer makes logically consistent choices, so if bundle A is preferred to B, and B is preferred to C, then A must be preferred to C

Choice preferences

The consumer chooses the bundle he prefers among those that are available

Non-satiation

The assumption that prefer more and are never satiated by consuming more

Convexity

A shape property where a blend or average of two options is preferred over the two extreme options alone. Consumers prefers variety to extremes. A convex indifference curve represents a preference for variety because it reflects a diminishing marginal rate of substitution. Slope less so you value the increasing in units more per individual unit.on

convexity example

If you make an average bundle C=A/2 + B/2, C>A and C>B, where B and A are indifferent

Indifference curve

Curves on which multiple bundles that are indifferent to one another find themselves (generally downwards sloping)

Are bundles on higher IC or lower IC preferred?

Higher IC

How many indifference curves are there?

Infinite

To whom does a family of indifference curves belong?

To an individual agent and describes all of their preferences