Chapter Three: Individual Markets: Demand and Supply

I. Markets are institutions or mechanisms that bring together buyers and sellers of particular goods, services, or resources: A. Markets exist in many forms. 1. All situations that link potential buyers to potential sellers are markets. a. Markets occur in local, national, and international senses. 2. The focus of this chapter will be on large, highly competitive marketss with discovered prices. a. Discovered prices come through interacting decisions of buyers and sellers. b. Set prices come when one or a handful of producers state the price of a good. II. Demand is a schedule or curve that shows the various amounts of a product that consumers are willing and able purchase at each of a series of possible prices during a specied period of time. A. The above is a denition for product markets. For a factor market, factor input replaces product and producer replaces consumer. B. Demand shows the quantities of a product purchased at various possible prices, ceteris peribus. C. The law of demand states that, ceteris peribus, there is an inverse relationship between price and demand. i. All other things equal is a very important assumption in this case. a. There are many factors other than price that aect the amount purchased. ii. Reasons why this law works: a. The law of demand is consistent with common sense. b. In any specic time period, each buyer of a product will derive less utility from each successive unit of the product consumed. Consumption is subject to diminishing marginal utility. c. Income and substitution eects i. Income eect: Lower price increases purchasing power, meaning that a buyer can get more of the product than would have been possible before. ii. Substitution eect: Lower price gives the buyer incentive to substitute what is now a less expensive product for similar products that are now more relatively expensive. D. Graphing the inverse relationship of quantity demanded versus price results in a demand curve. i. The downward slope of this graph demonstrates of the law of demand. E. Market demand is all of the quantities demanded by individuals customers added together. i. Assume all buyers are willing and able to buy the same amounts at each of the possible prices. a. Multiplying those amounts buy the number of buyers therefore renders market demand. i. Made with the assumption that prices is the most important inuence on purchases. a. The other inuences that exist are called determinants of demand or demand shifters.
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F. A change in the demand schedule or a shift in the demand curve is called a change in demand i. An increase in demand is when consumers desire to buy more product at each possible price than is reected in the predicted amount. ii. A decrease in demand occurs when consumers buy less product at each possible price. iii. A change in a determinant is what results in the change in demand. a. Tastes: A favorable change in consumer tastes means that more of it will be demanded at each price. a. Taste can be aected by the arrival of new products and information. b. Number of buyers: Demand has a linear relationship with the number of buyers in a market. c. Income: i. Products whose demand varies directly with income are called superior or normal goods. ii. Goods whose demand varies inversely with money income are called inferior goods. d. Prices of related goods: A change in the price of a related good may either increase or decrease the demand for a product depending on the related good is either a substitute or complimentary good. i. A substitute good : One that can be used in place of a given good. a. When two products are substitutes, the price of one and the demand for the other move in the same direction. ii. A complimentary good : One that is used together with a given good. a. When two products are compliments, the price of one and the demand for the other move in opposite directions. iii. The vast majority of goods that are not related to one another are called independent goods. Change in the price of one has little to no eect on demand for the other. e. Expectations: Changes in consumer expectations for prices may shift demand. i. The expectation of higher future prices might lead to increasing current demand. ii. The expectation of lower future prices might lead to decreasing current demand. iii. A change in expectations regarding product availability might also aect current demand. iv. A change in expectations concerning future income may prompt consumers to change daily spending. G. Changes in quantity demanded are dierent from changes in demand. i. A change in demand is a shift of the demand curve to the left or right. ii. A change in quantity demanded is a movement from one point to another point on a xed demand schedule or demand curve. (Moving from one price-quantity combination to another).

III. Supply is a schedule or curve showing the amounts of a product that producers are able to make available for sale at each of a series of possible prices during a specic period. A. The above is a denition for product markets. For a factor market, factor input replaces product and producer replaces consumer. B. The law of supply states that, there is a direct correlation between price and quantity. 1. The supplier is on the receiving end of the products price. Price, as a result, represents revenue. a. Revenue serves as an incentive to produce and sell a product. The higher the price, the greater this incentive. 2. Beyond some quantity of production, marginal costs increase. However, the limits of resources often prevent these costs from becoming too high. C. Graphing the direct relationship of quantity supplied versus price results in a supply curve 1. Market supply curves are obtained by adding the supply curves of individual producers. D. A change in supply is when the entire supply curve shifts due to a change in a determinant of supply. 1. The basic determinants of supply are as follows: a. Resource prices: Prices of resources help determine the costs of production incurred by companies. Higher resources prices raise production and, assuming a particular product price, squeeze prots. Lower resource prices reduce production costs and increase prots. b. Technology: Improvements in technology enable rms to produce units of output with fewer resources. Using fewer resources lowers production costs and increases supply. c. Taxes and subsidies: Business treat most taxes as costs. An increase in sales or property taxes will increase production costs and reduce supply. d. Prices of other goods: Firms that produce a particular product can sometime reallocate their resources to produce alternative goods. Higher of prices of these alternative goods may entice producers to switch to these products. This is called a substitution in production, which will indubitably reduce the supply of the original product. e. Price expectations: Changes in expectations about the future price of a product may aect the producers current willingness to supply that product. a. Farmers might withhold some of their current harvest with the expectation that prices will rise, therefore causing a current decline in the size of the wheat market. b. Expectations of price increases may induce rms to add a shift of workers or expand production facilities, causing an increase in supply. f. Number of sellers: Ceteris peribus, the number of suppliers relates directly to market supply. E. Changes in quantity supplied is a movement from one point to another on a xed supply curve. 1. Supply is the full schedule of prices and quantities shown; this does not change when price changes.

IV. Supply and Demand: Market Equilibrium A. Surpluses occur when there is excess supply of an item that will not be bought at a given price. B. Shortages occur when there is excess demand for an item at a given price. C. The market clearing or equilibrium price of a product is when there is no shortage or surplus. 1. Here, the quantity supplied and quantity demanded are in balance at the equilibrium quantity. 2. If graphing supply and demand curves, the equilibrium quantity and price are at the intersection of the two lines. a. Points above the equilibrium indicate surplus and those below indicate shortage. D. The ability of the competitive forces of supply and demand to establish a price at which selling and buying conditions are consistent is called the rationing function of prices. E. Change in the equilibrium price of a good is aected by changes in supply and demand. i. Changes in demand correlate directly with changes in equilibrium price and quantity. ii. Changes in supply correlate directly with eq. quantity and conversely with eq. price. iii. In complex cases where both supply and demand change, the eect is a combination of the individual eects. a. Supply increase and demand decrease means that there is a decrease in equilibrium price, and a varying change in quantity dependent upon which shift (the increase or decrease) was larger. b. Supply decrease and demand increase means an increase in equilibrium price and, again varying quantity dependent on conditions. c. Supply increase and demand increase varies equilibrium price and increases equilibrium quantity. d. Supply decrease and demand decrease varies equilibrium price and drops equilibrium quantity. e. Special cases arise when increase in one and decrease in another leads to a zero net eect on price. IV. Application: Government-Set Prices A. If government concludes that prices will be unfairly high for buyers or low for producers, they might intervene. B. Price Ceilings and Shortages i. A price ceiling sets the maximum legal price a seller must charge for a product or service. a. These ceilings enable buyers to obtain the good or service that would otherwise be unobtainable. b. Graphical analysis of price ceilings shows that the rationing ability of the free market is rendered null and creates potentially problematic market disequilibrium. ii. Rationing problem: If shortage, should government ration? iii. Black Markets iv. Rent controls establish maximum rents that can be charged to protect low income families.
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Problems income on the supply side of things. v. Price Floors and Surpluses a. A price oor sets the minimum price when free market system has not provided sucient for resource suppliers or producers. b. Graphical analysis of price oors shows that oors can be above equilibrium and thus render surplus.