Supply and Demand: Intro to Price Setting Competitive Markets

A set of flashcards covering key vocabulary and definitions related to supply and demand in competitive markets.

Transaction Cost

Anything that adds cost to trade, like time to bargain or search for goods.

money

the medium of exchange and store of value

Market

A mechanism for the exchange and allocation of goods.

Price

An amount of money required in exchange for a good.

Price Taker

An agent that behaves as if they have no control over prices.

Competitive Equilibrium

An allocation and a set of prices such that every consumer and firm is maximizing their payoff and total production equals total consumption.

important notes of competitive market and competitive equilibrium 

1. Every agent acts as a price taker

2. Agents only need to know their own payoff and their own set of choices

3. This is a model, so it is wrong.

Characteristic of competitive market

1. There are many buyers and many sellers of similar item items

2. Prices are transparent

3. Free entry/exit

4. Transaction costs are low

Non-competitve markets

1. oligarchy - one producer

2. monopoly - few producers

Demand Curve

A graph that shows how much quantity of a good is consumed given a specific price with everything else constant.

Quantity demanded

the amount of goods consumers choose 

model of consumer choice

Agents: consumers

Choices: What bundle to purchase and consume

Payoffs: preferences over bundle 

budget set

set of bundles a consumer can afford given prices Pa, Pb, and income Y

Law of Demand

Demand is typically downward sloping; as price increases, quantity demanded decreases.

Variables that affect demand and can cause a “shift”

1. income

2. prices of related goods

3. preferences

4. expectation

5. number of buyers 

Market Demand Curve

The sum of individual demand curves

Substitute Goods

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

Complement Goods

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

Normal Good

A good for which an increase in income causes an increase in demand.

Inferior Good

A good for which an increase in income causes a decrease in demand.

Quantity supplied

amount of a good a producers chooses to create and sell

Supply Curve

A function that indicates the profit maximizing quantity produced at any price.

Supply

Agents: producers(firms)

Choices: how much to produce

Payoffs: profit 

Firm

an organization that takes resources, called inputs, and converts them into something new, called outputs

Revenue

money collected from the sale of goods, denoted R(q)

Cost of Production

the expenditure on the creating the output quantity, denoted C(q)

Profit

total revenue minus total cost, denoted pi(q)=R(q)-C(q)

Marginal Revenue

The amount that revenue increases with the next unit of production.

Marginal Cost

The amount that cost increases with the next unit of production.

1. MR>MC

2. MR<MC

3. MR=MC

1. producing more increases profit

2. Producing more decreaes profit

3. producing at this level maximizes profit

“Shifts in supply”

1. input prices

2. Tech

3. Expectations about future

4. # of sellers

Market supply curve

sum of individual supply curves

Surplus

Occurs when supply exceeds demand at the current price.

• could occur with a left shift in demand or right shift in supply(or both)

Shortage

Occurs when demand exceeds supply at the current price.

• could occur with right shift in demand or left shift in supply(or both)

Price setting competitive market

a market that uses prices to allocate good and every agent is a price taker.

price setting competitive market has:

decision makers: consumers ane firms; choices: What to consume and what to produce; Payoffs: some measure of consumer payoff(utility) and producer payoff(profit)

What happens if market it not at equilibrium?

1. market gets out of equilibrium when one or both curves change

2. Markets tend to adjust quickly back toward equilibrium, but nothing is instantaneous