Market Mechanism and Price Elasticity

Prismekanismen Material

  • Notes from the review
  • Textbook Arena 123 – Market forces (p. 183-)
  • Youtube, Klas explains - supply and demand

Learning Objectives:

  • Be able to explain equilibrium price using supply and demand diagrams and examples.
  • Supply/demand surplus
  • The effect of new technology/greater supply
  • The effect of changes in demand
  • Price elasticity

Exercise tasks

1. What characterizes a market where perfect competition prevails?

A market with perfect competition is characterized by:

  • Many buyers and sellers – no single actor can influence the price.
  • Homogeneous products – the goods are the same, e.g. wheat.
  • Free establishment and exit – companies can easily enter or leave the market.
  • Complete information – everyone knows everything about prices and quality.
    *Price is determined by supply and demand – the market controls the price, not the companies.

2. Give examples of when it does NOT work as it is assumed to work in perfect competition.

Examples of markets that do not follow perfect competition:

  • Monopoly – only one company sells the product, e.g. Systembolaget.
  • Oligopoly – few companies dominate, e.g. the gasoline market.
  • Cartels – companies cooperate to set prices, which is illegal.
  • Asymmetric information – one party knows more, e.g. used cars.

3. What does it mean for a market to be in balance?

When a market is in balance (equilibrium) it means that:

  • Supply = Demand at a certain price.
  • Everyone who wants to buy at that price can do so, and all sellers get their goods sold.
  • There is neither shortage nor surplus.

4. Assume that the price is set above the equilibrium price.

a. Figure:

  • Draw two curves: supply (upward sloping) and demand (downward sloping).
  • Set a price above the equilibrium price.
  • There you see that the supply becomes greater than the demand → supply surplus.

b. How do sellers notice?

  • They notice that goods become unsold.
  • Warehouses fill up.
  • They may lower the price to get rid of the surplus.

5. Assume that the price is set below the equilibrium price.

a. Figure:

  • Draw the same type of figure.
  • Set a price below the equilibrium price.
  • Now the demand becomes greater than the supply → demand surplus.

b. How do sellers notice?

  • The goods run out quickly.
  • Customers queue or run out.
  • Sellers notice that they could take a higher price.

6. Explain the following events:

a. The demand curve shifts inwards.

  • Means that demand decreases at every price.
  • Result: lower price and lower quantity produced.
  • Causes: e.g. lost income, trends change, or new alternatives.

b. The supply curve shifts inwards.

  • Means that the supply decreases at every price.
  • Result: higher price and lower production.
  • Causes: e.g. more expensive raw materials, natural disasters, strikes.

c. Example:

  • a: People stop buying soda because they become more health conscious.
  • b: Bad weather causes the harvest to decrease → less grain for sale.

7. What is meant by high and low price elasticity?

  • Price elasticity shows how sensitive demand or supply is to price changes.

High price elasticity:

  • Small price change → large change in demand.
  • Usually applies to luxury goods or goods with many alternatives, e.g. clothing.
  • In the diagram: the demand curve is flatter.

Low price elasticity:

  • The price changes a lot → the demand changes a little.
  • Usually applies to necessities, e.g. medicine or gasoline.
  • In the diagram: the demand curve is steep.