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
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- 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
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- 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
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- 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)
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- Equilibrium price - Price where quantity demanded = quantity supplied * Intersection of supply + demand curve
- Equilibrium quantity - Quantity demanded and quantity supplied at the equilibrium price
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- 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
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- 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
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- 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
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