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Market Forces of Supply and Demand – VOCABULARY Flashcards (Chapter 4)

Markets and Competition

  • Market:

    • Group of buyers and sellers of a good/service.

    • Buyers determine demand.

    • Sellers determine supply.

  • Competitive Market:

    • Many buyers and sellers.

    • Each has a negligible impact on price.

  • Perfectly Competitive Market:

    • Features identical goods.

    • Participants are price takers (cannot affect market price).

    • Buyers can buy all they want; sellers can sell all they want at market price.

Demand

  • Quantity Demanded (Q_d): Amount buyers are willing and able to purchase.

  • Law of Demand:

    • As price (P) rises, quantity demanded (Q_d) falls.

    • As P falls, Q_d rises.

  • Demand Schedule: Table showing P vs. Q_d.

  • Demand Curve: Graph showing P vs. Q_d (downward-sloping).

  • Market Demand: Sum of all individual demands (horizontal aggregation).

Shifts in the Demand Curve

  • Change in Demand:

    • Shift of the entire demand curve due to non-price determinants.

    • Causes of Demand Curve Shifts (Non-price determinants):

    • Number of Buyers:

      • Increase in buyers: Q_d at each price increases, shifts demand right.

      • Decrease in buyers: Q_d at each price decreases, shifts demand left.

    • Income:

      • Normal Good: Demand increases with income, shifts right.

      • Inferior Good: Demand decreases with income, shifts left.

    • Prices of Related Goods:

      • Substitutes: Increase in price of one good increases demand for the other (shifts right).

      • Complements: Increase in price of one good decreases demand for the other (shifts left).

    • Tastes: Favorable changes in preferences increase demand, shifts right.

    • Expectations about the Future:

      • Expected higher future income/prices: Increases current demand, shifts right.

  • Change in Quantity Demanded: Movement along a fixed demand curve due to a price change.

Supply

  • Quantity Supplied (Q_s): Amount sellers are willing and able to sell.

  • Law of Supply:

    • As price (P) rises, quantity supplied (Q_s) rises.

    • As P falls, Q_s falls.

  • Supply Schedule: Table showing P vs. Q_s.

  • Supply Curve: Graph showing P vs. Q_s (upward-sloping).

  • Market Supply: Sum of all individual supplies (horizontal aggregation).

Shifts in the Supply Curve

  • Change in Supply:

    • Shift of the entire supply curve due to non-price determinants.

    • Causes of Supply Curve Shifts (Non-price determinants):

    • Input Prices: Fall in input prices (e.g., wages, raw materials) lowers production costs, shifts supply right.

    • Technology: Cost-saving technological improvements lower costs, shifts supply right.

    • Number of Sellers:

      • Increase in sellers: Q_s at each price increases, shifts supply right.

      • Decrease in sellers: Q_s at each price decreases, shifts supply left.

    • Expectations about the Future: Expected higher future prices may decrease current supply (e.g., holding inventory), shifts left.

  • Change in Quantity Supplied: Movement along a fixed supply curve due to a price change.

Supply and Demand Together: Equilibrium

  • Equilibrium:

    • State where quantity supplied equals quantity demanded at the equilibrium price (P^) and quantity (Q^).

    • No pressure for price change.

  • Markets Not in Equilibrium:

    • Surplus (Excess Supply):

    • When P > P^*, then Qs > Qd.

    • Sellers cut prices to increase sales, leading to movement towards equilibrium.

    • Shortage (Excess Demand):

    • When P < P^*, then Qd > Qs.

    • Sellers raise prices due to high demand, leading to movement towards equilibrium.

  • Law of Supply and Demand: Price of any good adjusts to bring Qs and Qd into balance.

Analyzing Changes in Equilibrium (Three Steps)

  • Decide which curve(s) shifts: Supply, demand, or both.

  • Decide direction of shift(s): Right (increase) or left (decrease).

  • Compare initial and new equilibrium: Determine effects on equilibrium price and quantity.

How Prices Allocate Resources

  • Markets are efficient for organizing economic activity.

  • Equilibrium prices serve as crucial signals, guiding economic decisions and allocating scarce resources efficiently.

Formulas and Key Relationships

  • Law of demand: \frac{\text{d}Q_d}{\text{d}P} < 0 (Quantity demanded falls as price rises)

  • Law of supply: \frac{\text{d}Q_s}{\text{d}P} > 0 (Quantity supplied rises as price rises)

  • Equilibrium condition: Qd = Qs

  • Surplus condition: Qs > Qd at a given price

  • Shortage condition: Qd > Qs at a given price