Week 2: The Market Forces of Supply and Demand

Overview of Economics and Microeconomics

  • Economics Definition: The study of how scarce resources are allocated within a society.

  • Microeconomics Definition: The study of how various agents in the economy, including households, firms, and governments, make specific decisions and interact with one another.

  • The Use of Models: Economists utilize models, which are defined as simplified frameworks for analyzing complex behaviors.     * Assumptions: Every model involves a set of assumptions.     * Evaluation Criteria: A model is judged based on two factors:         * The suitability of its underlying assumptions.         * How effectively it captures and explains complex real-world phenomena.

Introduction to Supply and Demand (S&D)

  • Focus of the Theory: The theory of supply and demand considers how buyers and sellers behave and interact in competitive markets.

  • Market Outcomes: The interaction between buyers and sellers determines two primary outcomes:     * The quantity of each good or service produced.     * The price at which that good or service is sold.

Defining Markets and Competitive Structures

  • Market Definition: A group of buyers and sellers interacting to trade a particular good or service.     * Physical Locations: Examples include traditional squares or shopping centers, such as Paddy’s Market.     * Virtual Locations: Examples include internet-based platforms, such as Facebook’s Marketplace.     * Organization Levels: Markets can be highly organized, such as the fish market auction in Sydney, or less organized, such as the market for ice cream in Sydney.

  • Competitive Markets: A market characterized by having so many buyers and so many sellers that each individual participant has a negligible impact on the market price.     * Degree of Competition: The smaller the ability of a single buyer or seller to affect the price, the more competitive the market is considered.

  • Perfectly Competitive (PC) Market Characteristics:     * Homogeneity: The goods offered for sale are all exactly the same.     * Price Takers: Buyers and sellers are so numerous that none can influence the price; they must accept the market price as given.     * Real-world application: While PC is a simplification, it applies well to sectors like agricultural markets.

Other Market Structures

  • Monopoly:     * A firm that is the sole seller of a product that lacks close substitutes.     * Cause: Fundamental cause is barriers to entry that prevent other firms from competing.     * Price Control: Unlike competitive firms, a monopoly can influence the price of its output by adjusting the quantity it supplies.     * Examples: Google (accused of monopoly in search engines) and Meta (owning Facebook, Instagram, and WhatsApp, accused of monopoly in social media).

  • Monopolistic Competition:     * Attributes: Features many sellers competing for the same customers and product differentiation (each firm's product is slightly different).     * Control: Firms are not price takers and have a degree of control over price.     * Examples: Restaurants and clothing stores.

  • Oligopoly:     * A market structure with only a few sellers.     * Australian Context: Research by Andrew Leigh and Adam Triggs (2016) in "Markets, Monopolies and Moguls: The Relationship between Inequality and Competition" (TheAustralianEconomicReviewThe Australian Economic Review, vol. 4949, no. 44, pp. 389389–412412) found that in sectors like department stores, newspapers, banking, health insurance, supermarkets, domestic airlines, ISPs, baby food, beer, and soft drinks, the top four firms control more than four-fifths (80%80\%) of the market.     * Current Events: Reference to the 2024 Inquiry into Price Gouging; the article "Supermarkets, airlines and power companies are charging ‘exploitative’ prices despite reaping record profits"; and the Four Corners episode "The cost of living with Coles and Woolworths."     * Airlines: Mention of the ACCC’s 2024 report on Airline competition.

The Theory of Demand

  • Quantity Demanded: The amount of a good that buyers are willing and able to purchase.     * Willing: Buyer wants that specific amount based on tastes and preferences.     * Able: Buyer has sufficient income to purchase the amount at the current price.

  • The Law of Demand: Other things being equal (Ceteris paribus\text{Ceteris paribus}), the quantity demanded of a good falls when the price of the good rises, and rises when the price falls.

  • Representations of Demand:     * Demand Schedule: A table showing the relationship between price and quantity demanded.     * Demand Curve: A graph showing the same relationship, typically downward-sloping.

  • Market vs. Individual Demand: Market demand is the sum of all individual demands for a specific good or service.     * Horizontal Summation: Individual demand curves are summed horizontally to obtain the market demand curve.     * Example Illustration:         * At a price of $0.00\$0.00, Catherine demands 1212 units and Nicholas demands 77 units; Market demand = 1919.         * At a price of $1.00\$1.00, Catherine demands 1010 units and Nicholas demands 66 units; Market demand = 1616.

Movements vs. Shifts in Demand

  • Movements Along the Curve: Occurs when the price of the good itself changes. This is referred to as a "change in quantity demanded."

  • Shifts in the Demand Curve: Occurs when factors other than the price of the good change. This is referred to as a "change in demand."     * Factors Leading to Shifts:         * Income: For a "Normal Good," demand increases as income increases. For an "Inferior Good," demand decreases as income increases (e.g., public transport is often considered an inferior good).         * Prices of Related Goods:             * Substitutes: A decrease in the price of one good leads to a decrease in the demand for the other (e.g., if the price of one fruit falls, demand for a similar fruit decreases).             * Complements: A decrease in the price of one good leads to an increase in the demand for the other (e.g., software and hardware).         * Tastes: Changes in preferences; if a consumer likes a product more, they buy more of it.         * Expectations: Expectations about future income or future prices of the good.         * Number of Buyers: An increase in the number of consumers increases market demand.

  • General Rule for Shifts: A curve shifts whenever there is a change in a relevant variable that does not appear on either axis (Price or Quantity).

The Theory of Supply

  • Quantity Supplied: The amount of a good that sellers are willing and able to sell.     * Willing: The producer wants to sell that amount.     * Able: Sale is feasible given resources and technology.

  • The Law of Supply: Other things being equal (ceteris paribus\text{ceteris paribus}), the quantity supplied of a good rises when the price rises, and falls when the price falls.

  • Representations of Supply:     * Supply Schedule: A table showing the relationship between price and quantity supplied.     * Supply Curve: A graph showing the relationship, typically upward-sloping.

  • Market vs. Individual Supply: Market supply is the sum of all individual supplies. Like demand, it is summed horizontally.

Movements vs. Shifts in Supply

  • Movements Along the Curve: Caused by a change in the price of the good itself; referred to as a "change in quantity supplied."

  • Shifts in the Supply Curve: Caused by changes in determinants other than price; referred to as a "change in supply."     * Factors Leading to Shifts:         * Input Prices: Supply is negatively related to the price of inputs (e.g., wages, raw materials). If input prices rise, supply decreases.         * Technology: Improvements in technology increase productivity, allowing producers to supply more with the same inputs.         * Expectations: If suppliers expect prices to rise in the future, they may store goods and decrease current supply.         * Number of Sellers: Market supply depends positively on the number of sellers.

Questions & Discussion

  • Question 1: Which factor generates a shift to the right in demand for private tutors?     * Options: (A) All students get a scholarship worth $10,000\$10,000, (B) Evidence that tutoring leads to higher grades, (C) Market hourly rate falls by $25\$25, (D) Lecturers no longer offer consultation hours.     * Analysis: A, B, and D lead to shifts (income increase, taste/preference change, and complements/substitutes adjustment). C is a movement along the curve because it is a change in the price of the service itself.

  • Question 2: Which factor generates a shift to the left in the supply for private tutors?     * Options: (A) All students get a scholarship worth $10,000\$10,000, (B) Hourly rate for other part-time work increases by $25\$25, (C) Market hourly rate of tutors falls by $25\$25, (D) Evidence that part-time work leads to lower grades.     * Analysis: (B) and (D) are likely to shift supply. (B) represents an increase in opportunity cost/input price equivalent. (C) is a change in the price of the good itself, causing a movement along the curve.