Competitive Markets

Demand

  • Law of Demand: There is a negative relationship between price and quantity demanded, other things being equal.
    • As price rises, quantity demanded falls, and vice versa.
    • Explained by the income effect and the substitution effect.
  • Demand Curve: Graphical representation of the negative relationship between price and quantity demanded.
    • A change in the price of the goods leads to a change in quantity demanded (movement along the curve).
  • Determinants of Demand (excluding price):
    • Tastes and preferences
    • Number and prices of related goods (Substitutes and Complements)
    • Income (Normal and Inferior goods)
    • Distribution of income
    • Expectations of future prices
  • A change in any determinant other than price leads to a shift in the entire demand curve (change in demand).

Supply

  • Law of Supply: There is a positive relationship between price and quantity supplied, other things being equal.
    • As price rises, quantity supplied rises, and vice versa.
  • Supply Curve: Graphical representation of the positive relationship between price and quantity supplied.
    • A change in the price of the goods leads to a change in quantity supplied (movement along the curve).
  • Determinants of Supply (excluding price):
    • Costs of production (Input prices, Technology, Organisational changes, Government policies)
    • Profitability of other products
    • Profitability of goods in joint supply
    • Random shocks and unpredictable events
    • Number of suppliers
  • A change in any determinant other than price leads to a shift in the entire supply curve (change in supply).

Market Equilibrium

  • Equilibrium: Where the intentions of buyers match the intentions of sellers; quantity demanded equals quantity supplied.
  • Disequilibrium: Shortages or surpluses occur; prices adjust to restore equilibrium.
  • Rationing Function of Prices: Prices adjust so that buyers and sellers can agree to undertake an economic transaction.

Price Controls

  • Government may fix prices:
    • Maximum Price (Price Ceiling): Prevents prices from rising above a certain level.
    • Consequences: Shortages, queuing, discrimination, rationing, black markets, worsening scarcity.
    • Minimum Price (Price Floor): Prevents prices from falling below a certain level.
    • Consequences: Surpluses, government intervention to manage surplus, reduced incentive to cut costs.