Chapter 3: Demand, Supply, and Market Equilibrium

Markets - Bring together buyers + sellers

• Highly competitive markets have large #s of independently acting buyers + sellers of standardized products

Demand - Schedule/curve showing various amounts of product that consumers willing + able to buy at several possible prices during a specific period of time

• Statement of buyer’s plans/intentions of purchase of product

Demand schedule - Illustrates quantity demanded of a good or service at different prices

Law of demand - Other things equal, as price falls, the quantity demanded rises (and vice versa)

• Inverse relationship
• Diminishing marginal utility - Each successive unit of product consumed → Buyers get less satisfaction
• Income effect - Lower price increases purchasing power of income → Buyer can purchase more of product than before (and vice versa)
• Substitution effect - Buyer has incentive to substitute less expensive products for similar products that are relatively more expensive

Demand curve - Quantity demanded on horizontal axis, price on vertical axis; downward slope reflects law of demand

• Increase in demand → Curve shifts right
• Decrease in demand → Curve shifts left

Add quantities demanded by all consumers at each possible price → Market demand

Determinants of demand - Other factors besides price that affect purchases; shifts the demand curve

• Consumer preferences
• Number of buyers
• Consumer incomes
• Normal goods - Rise in income causes increase in demand
• Inferior goods - Rise in income causes decrease in demand
• Prices of related goods
• Substitute goods - Increase in price of one related good → Demand for other good increases
• Complementary goods - Increase in price of one related good → Demand for other good decreases
• Independent/unrelated goods
• Consumer expectations

Change in demand - Shift of demand curve to right/left

Change in quantity demanded - Movement from one point to another on a fixed demand curve (the same demand curve)

Supply - Schedule/curve showing various amounts of product that producers are willing + able to make available for sale at several possible prices during a specific period of time

Supply schedule - Illustrates quantity supplied of a good or service at different prices

Law of supply - Other things equal, as price rises, the quantity supplied rises (and vice versa)

Supply curve - Upward sloping; reflects law of supply

Sum quantities supplied by each producer at each price → Market supply

Determinants of supply - Other factors besides price that affect supply; shifts supply curve

• Resource prices
• Technology
• Taxes and subsidies
• Prices of other goods
• Producer expectations
• Number of sellers in the market

Change in supply - Shift of supply curve to right/left

Change in quantity supplied - Movement from one point to another on a fixed supply curve (the same supply curve)

Equilibrium price - Price where quantity demanded = quantity supplied

• Intersection of supply + demand curve

Equilibrium quantity - Quantity demanded and quantity supplied at the equilibrium price

Surplus - Quantity supplied exceeds quantity demanded; drives prices down

Shortage - Quantity demanded exceeds quantity supplied; drives prices up

Rationing function of prices - Competitive forces of supply + demand establish equilibrium price

Productive efficiency - Production of a good in the least-costly way

Allocative efficiency - Production of the particular mix of goods and services most highly valued by society

Demand reflects marginal benefit, supply reflects marginal supply

• MB = MC → Allocative efficiency

Changes in supply + demand

• Increase in demand → Increase in equilibrium price + equilibrium quantity
• Increase in supply → Decrease in equilibrium price + increase in equilibrium quantity
• Supply increase, demand decrease → Equilibrium price decrease, equilibrium quantity indeterminate
• Supply decrease, demand increase → Equilibrium price increase, equilibrium quantity indeterminate
• Supply increase, demand increase → Equilibrium price indeterminate, equilibrium quantity increase
• Supply decrease, demand decrease → Equilibrium price indeterminate, equilibrium quantity decrease

Price ceiling - Maximum legal price a seller can charge for a good or service

• Must be below equilibrium price to be binding
• Shortage
• Rationing problem - Gov’t must establish formal system of rationing in order to solve inequitable distribution of gasoline
• Black markets - Goods illegally bought and sold at prices above the legal limits
• Rent controls - Maximum rents established by law

Price floor - Minimum legal price a seller can charge for a good or service

• Must be above equilibrium price to be binding
• Surplus
• Gov’t can solve surplus by either restricting supply or purchasing surplus output
• Distorts resource allocation