Principles of Microeconomics Chapter 4 The Market Forces of Supply & Demand

Ch. 4 - The Market Forces of Supply and Demand

4-1 Markets and Competition

• What is a market? 

  • Market: a group of buyers and sellers of a particular good/service

  • Some markets are organized, meaning that buyers and sellers know exactly what they want (ex. Agricultural commodities).

  • Some markets can be less organized (ex. Ice cream in a town).

• What is competition?

  • Price and quantity are determined by ALL buyers and sellers as they interact.

  • Competitive market: a market in which there are so many buyers and sellers that each has a negligible impact on the market price

  • Perfectly competitive market means that: 1. The goods offered for sale are THE SAME 2. Buyers and sellers are so numerous that no SINGLE buyer/seller has influence over market price (ex. wheat market). 

  • Price takers: buyers and sellers that accept market price (at which buyers can buy all they want, and sellers can sell all they want)

  • Monopoly: only one seller, who sets the price

4-2 Demand

• The Demand Curve: the relationship between price and quantity demanded 

  • Price (y); quantity demanded (x) 

  • Quantity demanded: the amount of a good buyers are willing and able to buy

  • Law of Demand: other things being equal, when the price of a good RISES, the quantity demanded FALLS, and vice versa

  • Demand schedule: table that shows relationship between price and quantity demanded

  • Demand curve: Line relating price and quantity demanded, and has a NEGATIVE SLOPE

• Market demand vs individual demand

  • Market demand: the SUM of all individual demands for a good/service

  • To graph market demand: add together each individual’s demand at a given price and plot that quantity demanded

• Shifts in the Demand Curve

  • If quantity demanded CHANGES at any price, the demand curve SHIFTS

  • If demand curve shifts RIGHT = increase in demand and vice versa

  • Variables that can shift the demand curve: 

  • 1. Income: 

    • Normal good: if the demand for the good FALLS when income FALLS (ex. Ice cream)

    • Inferior good: if the demand for the good RISES when income FALLS (ex. Bus rides)

  • 2. Prices of related goods: 

    • Substitutes: when a fall in the price of 1 good REDUCES the demand for ANOTHER good. This is often goods that can replace each other (ex. Ice cream & frozen yogurt)

    • Complements: when a fall in the price of 1 good RAISES the demand for ANOTHER good (ex. Gasoline & cars) 

  • 3. Tastes: if you like more of something, you’ll buy more

  • 4. Expectations: if you expect the future price to drop, you’ll buy more today

  • 5. # of buyers: more individual buyers means greater market demand

  • Price changes, such as taxes, represent a movement ON the demand curve, not a shift 

4-3 Supply

• The Supply Curve: the relationship between price and quantity supplied

  • Quantity supplied: the amount sellers are willing and able to sell

  • Law of supply: other things equal, when the price of a good RISES, the quantity supplied also RISES, and vice versa

  • Supply schedule: table that shows relationship between price and quantity supplied

  • Supply curve: Line relating price and quantity supplied, and has a POSITIVE SLOPE

• Market supply vs. individual supply

  • Market supply: the sum of the supplies of ALL individual sellers

• Shifts in the Supply Curve

  • When the supply curve shifts right, there has been an increase in supply 

  • Variables that can shift the supply curve: 

  • 1. Input prices: if the input prices are LOW, then supply will INCREASE (input includes ingredients, resources, buildings/land, labor), causing the supply curve to shift RIGHT

  • 2. Technology: better tech → reduces amount of labor/costs → supply curve shifts RIGHT

  • 3. Expectations: expects future price to be high → put some production into storage → supply curve shifts LEFT 

  • 4. # of sellers: fewer sellers → supply curve shifts LEFT

  • Price of good itself only represents movement ALONG THE CURVE

4-4 Supply and Demand Together

• Equilibrium

  • Equilibrium: the point in which supply and demand curves intersect, where the price at which the quantity of good buyers are willing and able to buy BALANCES the quantity that sellers are willing and able to sell 

  • The equilibrium price is also known as the market-clearing price, so everyone in the market is satisfied

  • Markets NATURALLY move towards equilibrium through changes ALONG the curves

  • Surplus: quantity supplied > quantity demanded; PRICE moves down

  • Shortage: quantity demanded > quantity supplied; PRICE moves up

  • In free markets, shortages/surpluses are temporary because prices moved towards equilibrium 

  • Law of supply and demand: the price of any good adjusts to bring the quantity supplied and quantity demanded of that good into balance

  • Whichever shift has a LARGER MAGNITUDE (supply or demand) determines the new price

• 3 Steps to Analyzing Changes in Equilibrium

  • When analyzing how an event affects equilibrium, follow these steps: 1. Which curve moves? Just one or both? 2. Which direction (left or right)? 3. How does the new equilibrium compare to the old one, and how does the equilibrium price and quantity change?

  • Change in demand/supply = the CURVE shifts, whereas change in qty demanded/supplied = movement ALONG the curve