Page 3: Markets and Competition

• A market is a group of buyers and sellers of a particular product.

• A competitive market is one with many buyers and sellers, each has a small effect on price.

• A perfectly competitive market: all goods exactly the same, buyers & sellers so numerous that no one can affect market price – each is a “price taker”

• In this chapter, we assume markets are perfectly competitive.

Page 4: Demand

• The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase.

• Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal

• The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price.

Page 5: The Demand Schedule

• Demand schedule: A table that shows the relationship between the price of a good and the quantity demanded.

• Example: Helen’s demand for lattes.

  • Price of lattes: $0.00, Quantity of lattes demanded: 16

  • Price of lattes: $1.00, Quantity of lattes demanded: 14

  • Price of lattes: $2.00, Quantity of lattes demanded: 12

  • Price of lattes: $3.00, Quantity of lattes demanded: 10

  • Price of lattes: $4.00, Quantity of lattes demanded: 8

  • Price of lattes: $5.00, Quantity of lattes demanded: 6

  • Price of lattes: $6.00, Quantity of lattes demanded: 4

• Notice that Helen’s preferences obey the Law of Demand.

Page 7: Market Demand versus Individual Demand

• The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price.

• Suppose Helen and Ken are the only two buyers in the Latte market.

• Helen’s Qd: 4, 6, 8, 10, 12, 14, 16

• Ken’s Qd: 2, 3, 4, 5, 6, 7, 8

• Market Qd: 6, 9, 12, 15, 18, 21, 24

Page 9: The Law of Demand

• Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded.

• Substitution effect and income effect

Page 10: Substitution effect

• When the price of a good rises, other things remaining the same, its relative price/opportunity cost rises.

• Each good has a substitute e.g. meat & Chicken.

• As the opportunity cost of a good rises, people buy less of that good & more of its substitutes.

• For instance, a fast food chain sells Beef burgers and hot dogs. If the price of burgers goes up, but the price of hot dogs stays the same, you might be more inclined to buy a hot dog.

• This tendency to change your purchase based on changes in relative price is called the substitution effect.

Page 11: Income effect

• Changes in price can affect buyers' purchasing decisions; this effect is called the income effect.

• Increases in price, while they don't affect the amount of your paycheck, make you feel poorer than you were before, and so you buy less.

• Decreases in price make you feel richer, and so you may feel like buying more.

Page 12: Demand Curve Shifters: # of buyers

• Increase in # of buyers increases quantity demanded at each price, shifts D curve to the right.

Page 14: Demand Curve Shifters: income

• Demand for a normal good is positively related to income.

• Increase in income causes an increase in quantity demanded at each price, shifts D curve to the right.

• Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.

• Normal goods: NEW clothing, NEW car, NEW computer

• Inferior goods: USED clothing, USED car, USED computer

Page 15: Demand Curve Shifters: prices of related goods

• Two goods are substitutes if an increase in the price of one causes an increase in demand for the other.

• Example: pizza and burgers. An increase in the price of pizza increases demand for burgers, shifting the burger demand curve to the right.

• Two goods are complements if an increase in the price of one causes a fall in demand for the other.

• Example: computers and software. If the price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left.

• Other examples: college tuition and textbooks, ink and printer, burger and ketchup

Page 17: Demand Curve Shifters: tastes

• Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right.

• IPods, BlackBerry

Page 18: Demand Curve Shifters: expectations

• Expectations affect consumers’ buying decisions.

• Examples:

  • If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now.

  • If the economy turns bad and people worry about their future job security, demand for new autos may fall now.

Page 19: What determines a change in demand?

• The price of related good e.g. complements/Substitutes

• Expected future prices

• Income (normal or inferior good)

• Population/ number of buyers

• Preferences or taste

Page 20: Summary: Variables That Affect Demand

• Price: causes a movement along the D curve

• No. of buyers: shifts the D curve

• Income: shifts the D curve

• Price of related goods: shifts the D curve

• Tastes: shifts the D curve

• Expectations: shifts the D curve

Page 26:

• Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied.

• Example: Starbucks' supply of lattes.

• Starbucks' supply schedule obeys the Law of Supply.

• Price of lattes and quantity of lattes supplied are listed in the table.

Page 27:

• Starbucks' Supply Schedule & Curve

• Price of lattes and quantity of lattes supplied are listed in the table.

• The supply curve is shown.

Page 28:

• Market Supply versus Individual Supply

• The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price.

• Example: Starbucks and Jitters are the only two sellers in this market.

• The market quantity supplied is calculated.

Page 29:

• The Market Supply Curve

• Price and quantity supplied in the market are listed in the table.

Page 30:

• Supply Curve Shifters: input prices

• Examples of input prices: wages, prices of raw materials.

• A fall in input prices makes production more profitable at each output price.

• The S curve shifts to the right.

Page 31:

• Suppose the price of milk falls.

• The quantity of lattes supplied will increase by 5.

• Supply Curve Shifters: input prices

Page 32:

• Supply Curve Shifters: technology

• Technology determines how much inputs are required to produce a unit of output.

• A cost-saving technological improvement shifts the S curve to the right.

Page 33:

• Supply Curve Shifters: # of sellers

• An increase in the number of sellers increases the quantity supplied at each price.

• The S curve shifts to the right.

Page 34:

• Supply Curve Shifters: expectations

• Example: Events in the Middle East lead to expectations of higher oil prices.

• Owners of Texas oilfields reduce supply now and save some inventory to sell later at the higher price.

• The S curve shifts left.

• Sellers may adjust supply when their expectations of future prices change.

Page 35:

• A change in Supply

• Five key factors: the price of resources used to produce, the price of related goods produced, expected future price, the number of suppliers, technology.

Page 36:

• Summary: Variables That Affect Supply

• Variables that affect supply: price, input prices, technology, number of sellers, expectations.

Page 37:

• Draw a supply curve for tax return preparation software.

• Scenarios: retailers cut the price of the software, a technological advance allows the software to be produced at lower cost, professional tax return preparers raise the price of the services they provide.

Page 38:

• Fall in price of tax return software.

• The supply curve does not shift.

• Move down along the curve to a lower price and lower quantity.

Page 39:

• Fall in cost of producing the software.

• The supply curve shifts to the right.

• Quantity increases at each price.

Page 40:

• Professional preparers raise their price.

• This shifts the demand curve for tax preparation software, not the supply curve.

Page 41:

• Equilibrium quantity: quantity supplied and quantity demanded at the equilibrium price.

Page 42:

• Surplus: when quantity supplied is greater than quantity demanded.

• Example: If price is $5, there is a surplus of 16 lattes.

Page 43:

• Shortage: when quantity demanded is greater than quantity supplied.

• Sellers raise the price, causing quantity demanded to fall and quantity supplied to rise.

Page 44:

• Three Steps to Analyzing Changes in Eq'm

• Determine if the event shifts the supply curve, demand curve, or both.

• Determine the direction of the shift.

• Use supply-demand diagram to see how the shift changes equilibrium price and quantity.

Page 45:

• Terms for Shift vs. Movement Along Curve

• Change in supply: a shift in the supply curve.

• Change in the quantity supplied: a movement along a fixed supply curve.

• Change in demand: a shift in the demand curve.

• Change in the quantity demanded: a movement along a fixed demand curve.

Page 46:

• Changes in supply and demand

• Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads.

• Event A: A fall in the price of compact discs.

• Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell.

• Event C: Events A and B both occur.

Page 47:

• Fall in price of CDs.

• Demand curve shifts left.

• Price and quantity both fall.

Page 48:

• Fall in cost of royalties.

• Supply curve shifts to the right.

• Price falls and quantity rises.

Page 49:

• Fall in price of CDs and fall in cost of royalties.

• Both curves shift.

• Demand shifts left, supply shifts right.

• Price falls, effect on quantity is ambiguous.

Page 50:

• Chapter Summary

• If the market price is above equilibrium, a surplus results, causing the price to fall.

• If the market price is below equilibrium, a shortage results, causing the price to rise.

• The supply-demand diagram can be used to analyze the effects of any event on a market