Chapter 4 Market Forces of Supply and Demand

Competitive market

A market with many buyers and sellers, each having little influence over the market price.

Perfectly competitive market

A market with identical goods and so many buyers and sellers that no individual can influence the price.

Price taker

A buyer or seller who accepts the market price rather than controlling it.

Quantity demanded

The amount buyers are willing and able to purchase at a particular price.

Law of demand

Other things equal, a higher price reduces quantity demanded and a lower price increases it.

Demand curve axes and slope

Price is on the vertical axis and quantity on the horizontal axis; the demand curve normally slopes downward.

Market demand

The sum of all individual quantities demanded at each price; add quantities horizontally.

Demand versus quantity demanded

Demand is the entire price-quantity relationship; quantity demanded is the amount purchased at one particular price.

Movement along the demand curve

A change in the good's own price changes quantity demanded along the existing curve.

Shift of the demand curve

A non-price determinant changes how much buyers demand at every price.

Increase in demand

The demand curve shifts right: buyers demand more at each price.

Decrease in demand

The demand curve shifts left: buyers demand less at each price.

Five demand shifters

Number of buyers, income, prices of related goods, tastes, and expectations.

Number of buyers and demand

More buyers increase market demand; fewer buyers decrease it.

Normal good

A good whose demand rises when income rises and falls when income falls.

Inferior good

A good whose demand falls when income rises and rises when income falls; the term describes an income relationship, not quality.

Substitutes

Goods that can replace each other; a higher price of one increases demand for the other.

Complements

Goods used together; a higher price of one decreases demand for the other.

A fall in a substitute's price

Demand for the other good decreases and its demand curve shifts left.

A fall in a complement's price

Demand for the other good increases and its demand curve shifts right.

Tastes and demand

Greater preference for a good shifts demand right; reduced preference shifts it left.

Expectations and current demand

Expected future prices or income can affect current demand; for example, an expected price increase may encourage buying now.

Quantity supplied

The amount sellers are willing and able to sell at a particular price.

Law of supply

Other things equal, a higher price increases quantity supplied and a lower price decreases it.

Supply curve axes and slope

Price is on the vertical axis and quantity on the horizontal axis; the supply curve normally slopes upward.

Market supply

The sum of all individual quantities supplied at each price; add quantities horizontally.

Supply versus quantity supplied

Supply is the entire price-quantity relationship; quantity supplied is the amount offered at one particular price.

Movement along the supply curve

A change in the good's own price changes quantity supplied along the existing curve.

Shift of the supply curve

A non-price determinant changes how much sellers supply at every price.

Increase in supply

The supply curve shifts right: sellers supply more at each price.

Decrease in supply

The supply curve shifts left: sellers supply less at each price.

Four supply shifters

Input prices, technology, expectations, and number of sellers.

Input prices and supply

Higher input costs decrease supply; lower input costs increase supply.

Technology and supply

Technology that lowers production costs increases supply and shifts the curve right.

Number of sellers and supply

More sellers increase market supply; fewer sellers decrease it.

Expectations and current supply

For storable goods, an expected higher future price may encourage sellers to hold inventory and reduce current supply.

Market equilibrium

The intersection of supply and demand, where quantity supplied equals quantity demanded.

Equilibrium price and quantity

The price that balances quantity supplied and demanded, and the quantity traded at that price.

Surplus

Quantity supplied exceeds quantity demanded, usually because price is above equilibrium; surplus equals quantity supplied minus quantity demanded.

Price adjustment during a surplus

Sellers face unsold goods and tend to lower prices, reducing quantity supplied and increasing quantity demanded toward equilibrium.

Shortage

Quantity demanded exceeds quantity supplied, usually because price is below equilibrium; shortage equals quantity demanded minus quantity supplied.

Price adjustment during a shortage

Competition among buyers and sellers' responses tend to raise prices, increasing quantity supplied and reducing quantity demanded toward equilibrium.

Three steps for analyzing an equilibrium change

Identify which curve shifts, determine its direction, then compare the old and new intersections to find price and quantity changes.

Demand increases with supply unchanged

Equilibrium price rises and equilibrium quantity rises.

Demand decreases with supply unchanged

Equilibrium price falls and equilibrium quantity falls.

Supply increases with demand unchanged

Equilibrium price falls and equilibrium quantity rises.

Supply decreases with demand unchanged

Equilibrium price rises and equilibrium quantity falls.

Demand and supply both increase

Equilibrium quantity rises; the price change depends on the relative sizes of the shifts.

What does an ambiguous equilibrium price change mean?

Price may rise, fall, or remain unchanged; the directions of the shifts alone do not give enough information.

Role of prices in a market economy

Prices signal scarcity and coordinate buyers' and sellers' decisions, helping allocate resources.

Market

A group of buyers and sellers of a particular good or service.