The Market Forces of Supply and Demand
The Market Forces of Supply and Demand
Factors Affecting Demand and Supply
The chapter explores the following essential questions: - What factors affect buyers' demand for goods?
What factors affect sellers' supply of goods?
How do buyers and sellers behave and interact?
How do supply and demand determine prices?
How do changes in the factors affecting demand or supply influence the market price and quantity of a good?
How do prices allocate scarce resources?
Markets and Competition
Market: - Defined as a group of buyers and sellers of a particular good or service.
Buyers:
Determine the demand for the product.
Sellers:
Determine the supply of the product.
Competitive Markets
Competitive market: - Characterized by many buyers and sellers where each has a negligible impact on market price.
Perfectly competitive market: - Goods are homogenous (identical products).
Price takers:
Because of a large number of buyers and sellers, no single buyer or seller can affect the market price.
At the prevailing market price, buyers can purchase all they desire, and sellers can supply as much as they want.
Demand
Quantity demanded: - The amount of a good that buyers are willing and able to purchase.
Law of demand: - Other things held constant:
The quantity demanded of a good falls when the price of the good rises.
The quantity demanded of a good rises when the price of the good falls.
Demand Schedule and Demand Curve
Demand schedule: - A table showing the relationship between the price of a good and the quantity demanded.
Demand curve: - A graphical representation of the relationship between the price of a good and the quantity demanded.
Example 1A: Sofia's Demand for Muffins
Price of Muffins | Quantity Demanded |
|---|---|
$0.00 | 16 |
$1.00 | 14 |
$2.00 | 12 |
$3.00 | 10 |
$4.00 | 8 |
$5.00 | 6 |
$6.00 | 4 |
$7.00 | 2 |
This example demonstrates that Sofia's preferences adhere to the law of demand.
Example 1B: Sofia
Continuing from the previous example, the demand curve illustrates the relationship between muffin price and quantity demanded.
A decrease in price results in an increase in the quantity demanded, moving along the demand curve.
Market Demand
Market demand: - The total demand for a good or service, calculated as the sum of all individual demands.
Market demand curve: - Obtained by horizontally summing all individual demand curves, showing total quantity demanded at varying prices.
Example 1C: Market vs. Individual Demand
Buyers: Sofia and Diego
Price
Sofia's Qd
Diego's Qd
Market Qd
$0.00
8
10
18
$1.00
7
9
16
$2.00
6
8
14
$3.00
5
7
12
$4.00
4
6
10
$5.00
3
5
8
$6.00
2
4
6
For the market demand curve, total quantity demanded is calculated by adding individual quantities at each price point.
A shift in the demand curve occurs due to changes in non-price determinants of demand, such as: - Number of buyers
Income
Prices of related goods
Tastes
Expectations
Changes in Number of Buyers
Increase in buyers: - Results in higher quantities demanded at each price, shifting the demand curve to the right.
Decrease in buyers: - Results in lower quantities demanded at each price, shifting the demand curve to the left.
Example 1E: Demand Curve Shifts
Assuming the number of buyers increases, at each price level, the quantity demanded increases (e.g., by 5), thus the demand curve shifts to the right.
Changes in Income
Normal goods: - When income increases, demand for the good increases, shifting the demand curve to the right.
Inferior goods: - When income increases, demand for the good decreases, shifting the demand curve to the left.
Changes in Prices of Related Goods
Substitutes: - If the price of one good increases, the demand for its substitute increases (e.g., pizza and hamburgers).
Complements: - If the price of one good increases, the demand for its complement decreases (e.g., smartphones and apps).
Changes in Tastes
Changes in consumer preferences lead to shifts in demand. - For example, advertising may promote health benefits from consuming a good, thereby increasing demand.
Expectations about the Future
Anticipations regarding income increases or price increases can boost current demand. - For instance, if consumers foresee higher income, they may demand more expensive meals now.
Shift vs. Movement Along the Curve
Change in demand: - A shift in the demand curve addressing non-price determinants.
Change in quantity demanded: - A movement along the fixed demand curve occurs due to price changes.
Supply
Quantity supplied: - The amount of a good that sellers are willing and able to sell.
Law of supply: - Holding other factors constant, the quantity supplied of a good rises when its price rises and falls when its price falls.
Supply Schedule and Supply Curve
Supply schedule: - A table depicting the relationship between a good's price and the quantity supplied.
Supply curve: - A graph showing this relationship visually.
Example 2A: Starbucks
Price of Muffins | Quantity of Muffins Supplied |
|---|---|
$0.00 | 0 |
$1.00 | 3 |
$2.00 | 6 |
$3.00 | 9 |
$4.00 | 12 |
$5.00 | 15 |
$6.00 | 18 |
Starbucks' supply schedule conforms to the law of supply.
Example 2B: Starbucks
This representation shows how the quantity of muffins supplied changes regarding their price.
Market Supply vs. Individual Supply
Market supply: - The total supply of all sellers of a good or service combined.
Market supply curve: - Summing individual supply curves horizontally to find total quantity supplied at each price.
Example 2C: Market vs. Individual Supply
Consider two sellers, Starbucks and Peet’s Coffee, where:
Price
Starbucks' Qs
Peet’s Qs
Market Qs
$0.00
18
12
30
$1.00
15
10
25
$2.00
12
8
20
$3.00
9
6
15
$4.00
6
4
10
$5.00
3
2
5
$6.00
0
0
0
This demonstrates how individual supplies contribute to market supply.
Graphically shown, a rise in price leads to an increase in the quantity of muffins supplied.
Shifts in the Supply Curve
The supply curve indicates how price affects quantity supplied under the condition of non-price determinants of supply which include: - Input prices
Technology
Number of sellers
Future expectations
Changes in Input Prices
Input prices include wages, materials, and overhead costs. - A decline in input prices increases the quantity supplied at each price, thereby shifting the supply curve rightward.
Example 2E: Changes in Input Prices
If the price of flour decreases, muffin supplies will increase at each price point, shifting the supply curve right.
Changes in Technology
Technological advances impact production efficiency & costs. - Cost-saving technological improvements shift supply curves to the right as they lower production costs.
Changes in Number of Sellers
An increase in sellers raises the quantity supplied at each price, shifting the supply curve right.
A decrease in sellers decreases the quantity supplied, shifting the supply curve left.
Expectations about Future Prices
Sellers may adjust current supply based on expected future prices. - For example, if oil prices are anticipated to rise, current supply may be reduced to save inventory for future higher prices.
Shift vs. Movement Along the Supply Curve
Change in supply: - Refers to shifts of the supply curve based on non-price factors.
Change in quantity supplied: - Involves movement along a static supply curve triggered by price alterations.
Market Equilibrium
Equilibrium: - Occurs when the quantity supplied equals quantity demanded. It represents a state of balance in the market where there is no inherent tendency for change in price or quantity.
At this point, the market clears, meaning every unit supplied is demanded.
Equilibrium price: - The price where supply meets demand, noted as QS = QD. This is also known as the market-clearing price.
Equilibrium quantity: - The quantity supplied and demanded at the equilibrium price.
Surplus and Shortage
Surplus: - Occurs when quantity supplied exceeds quantity demanded (e.g., when the price is above the equilibrium price).
For example, if price = $5, and QD = 9 while QS = 25, resulting in a surplus of 25 - 9 = 16 muffins.
Market Response to Surplus: - With excess supply, sellers have unsold goods, creating pressure to lower prices to attract more buyers. As prices fall, quantity demanded increases and quantity supplied decreases, moving the market back towards equilibrium until the surplus is eliminated.
Shortage: - Occurs when quantity demanded exceeds quantity supplied (e.g., when the price is below the equilibrium price).
For example, if price = $1, where QS = 5 and QD = 21, leading to a shortage of 21 - 5 = 16 muffins.
Market Response to Shortage: - With unsatisfied buyers attempting to purchase more goods than available, there is upward pressure on prices. As prices rise, quantity supplied increases and quantity demanded decreases, restoring the market to equilibrium until the shortage is eliminated.
The Law of Supply and Demand
Law of Supply and Demand: - States that the price of any good adjusts to equilibrate quantity supplied and demand.
At equilibrium, the price remains stable, with no further upward or downward pressure. This dynamic adjustment process ensures that eventually, the market will settle at an equilibrium point.
Analyzing Changes in Equilibrium
Decide whether the event affects the demand curve, supply curve, or both.
Determine the direction of curve shifts (right or left).
Use supply-and-demand diagrams to compare initial and new equilibria, analyzing effects on price and quantity.
Resource Allocation Through Prices
Market economies rely on prices to organize economic activities.
Prices adjust to balance supply and demand, signaling economic decision-making and resource allocation.
Summary: Variables Influencing Demand and Supply
Recognizing Shifts in Equilibrium Price and Quantity
To recognize the impact of curve shifts on equilibrium price (PP) and quantity (QQ):
Effect of Demand Shifts (Supply Constant):
Demand increases (shifts right): Both equilibrium price (PP) and equilibrium quantity (QQ) will increase.
Demand decreases (shifts left): Both equilibrium price (PP) and equilibrium quantity (QQ) will decrease.
Effect of Supply Shifts (Demand Constant):
Supply increases (shifts right): Equilibrium price (PP) will decrease, and equilibrium quantity (QQ) will increase.
Supply decreases (shifts left): Equilibrium price (PP) will increase, and equilibrium quantity (QQ) will decrease.
Effect of Simultaneous Shifts (Both Demand and Supply Shift):
When both curves shift, the effect on either equilibrium price or quantity might be indeterminate without knowing the relative magnitudes of the shifts. However, one of the outcomes will be clear:
Both Demand and Supply Increase: Equilibrium quantity (QQ) will increase. Equilibrium price (PP) is indeterminate.
Both Demand and Supply Decrease: Equilibrium quantity (QQ) will decrease. Equilibrium price (PP) is indeterminate.
Demand Increases and Supply Decreases: Equilibrium price (PP) will increase. Equilibrium quantity (QQ) is indeterminate.
Demand Decreases and Supply Increases: Equilibrium price (PP) will decrease. Equilibrium quantity (QQ) is indeterminate.
Resource Allocation Through Prices
Market economies rely on prices to organize economic activities.
Prices adjust to balance supply and demand, signaling economic decision-making and resource allocation.
Summary: Variables Influencing Demand and Supply
The demand curve illustrates how quantity demanded varies with price, influenced by several determinants.
The supply curve highlights how quantity supplied varies with price, also affected by numerous determinants.
Market equilibrium arises when demand meets supply, reflecting balance in the marketplace.
Buyer and seller interactions guide markets toward equilibrium, resulting in either surplus or shortage corrections to stabilize pricing.