Chapter 4: The Market Forces of Supply and Demand

This chapter introduces the theory of supply and demand, considers how buyers and sellers behave, how they interact with one another, how supply and demand determine prices ina market economy and how prices allocate the economy's scare resources.

Now, to understand all of these theories, we must come to understand the 2 major terms, market, and competition.

Markets:
A market is a group of buyers and sellers of a particular good or service. Each buyer determines the demand for a good while the sellers determine the supply of the product. Markets take either a highly organized or a little to no organized position. Organized groups tend to meet together, to set prices and arrange sales. However, most markets are not as organized, because buyers do not gather to discuss products and sellers do not gather to discuss prices.

Competition:
Most markets are highly competitive. Thus, the prices and the quantity of goods are determined by all buyers and sellers as they interact with each other. This is called a competitive market, a market where there are so many buyers and sellers that each has a negligable impact on the society. In this market, each seller has limited control over the price. They have no reason to raise the price, or the goods would just be bought somewhere else, and they have no real influence in increasing the price. Much like buyers, they have little power to influence the prices of goods.

For a perfectly competitive market, there must be 2 characterisitics: 1) the goods offered for sale are the same and 2)the buyers and sellers are numerous. In a perfectly competitive market, both buyers and sellers must accept the prices, and become price takers. However not all goods are sold in perfectly competitive markets. Some only have one seller and is in control of all of the good. This is called a monopoly. But despite all the types of markets, assuming perfect competition is a sueful simplicfication and the easiest place to start.

DEMAND:
The Demand Curve:

The quantity demanded is basically the amount of goods that buyers are able and willing to purchase. Many things determine the quantity demanded of any good, but the central idea would have to be the price of the good. With a cheaper good, it is obvious that one would buy more of the good. With a more expensive good, it is obvious that you would buy less of the good. This is so common in markets that it is called the law of demand, the claim that other things equal, the quantity of a good falls when the prices of a good rises. Now, putting this into action is the chart below, a chart that shows the demand schedule, a table that shows the relationship between the price of a good and the quantity demanded.

external image 3_2_static_market_demand.jpg

Now, the chart above shows the individual demand for a product. The downward-sloping line relating price and quantity is called the demand curve. To determine the market demand, we need to find the sum of all the individual demands for a service. Basically, this is a simple version of a market demand, simply adding the 2 demands together and finding the average demand.

Shifts in the Demand Curve:
A demand curve does not always remain stable over time, mainly because it all depends on the buyers decisions. if anything hapens to alter the quantity demanded at any given time, the demand curve shifts. Andy changes that increases the quantity demanded at any price shifts the demand curve to the right and is called an increase in demand. Any change that reduces that quantitty demanded at every price shifts the demand curve to the left and is called a decrease in demand. This is shown in the figure below.

external image Demand_Shift.gif

Here are the most important cariables that can shift the demand curve

Income:
A lower income will mean that you have less money to spend, which means that you will spend less money purchasing a certain good. Most goods that decrease in demand because of a decrease in income is called a normal good. But not all goods are normal goods, if the demand for a good rises when income falls, it is called an inferior good. These are goods that people tend to purchase more of during hard times.

Prices of Related Goods:
There are 2 types of goods that can raise or lower the price of a good. They are called substitutes and compliments. Substitutes are goods that increase as the price of the other good increases and decreases and the price of the other good decreases. Compliments are goods that where if one price decreases, the other good's prices increase and vice-versa.

Tastes:
The most obvious determinant of the demand are the tastes. If a person likes a type of good, they of course buy more of that good. Tastes are usually base on historical and psycholoogical forces so economists do not try to explain tastes.

Expectations:
Expectations about a certain good for the future can help change your buying decisions

Number of Buyers:
The more buyers there are, basically is the higher need or demand of that certain good.

SUPPLY:
Supply Curve:

For the supply curve, we must look at the quantity supplied. The quantity supplied is the amount of a good that sellers are willing and able to sell. Again, price plays a big role in determining the quantity supplied. When the price of a good is low, a business is less profitable, thus they sell less, and if a price of a good is high, the business is more profitable, thus they sell more. Since price rises as quantity supplied rises, they are postitively related. This is called the law of supply. The table below, shows the supply schedule, a relationship between the price of a good and the quantity supplied.

external image demand_supply_supply1.gif

The curve that slopes upward is called the supply curve and it relates price and quantity supplied.

Shifts in the Supply Curve:
If the supply curve shifts to the right it is an increase in supply, if it shifts to the left it is a decrease in supply. There are several reasons that supply curve can shift away to the right or the left.

Input Prices:
when the price of a input rises, creating the good becomes so much less profitable than before. Thus, the supply of a good is negatively related to the price of inputs.

Techonology:
The techonolgy can reduce the amount of labor needed to make a certain good. This reduce in cost and labor can raise the supply of the good.

Expectations:
If a firm expects the price of a good to rise in the future, the amount of goods would decrease because the firms would store the goods for the future.

Number of Sellers:
The more sellers there are, the more supply is being created.

SUPPLY AND DEMAND TOGETHER

Equilibrium:
The figure below shows the market supply and demand curve put in the same chart together.

external image demand_supply_price_equilibrium1.gif

Where they both intercect is called the market's equilibrium. The price at this equilibrium is called the equilibrium price, and the quantity is called the equilibrium quantity. Equilibrium is the situation in which the market price has reached the quantity supplied equals the quantity demanded. Equilibrium price is the price that balances quantity supplied and quantity demanded. Equilibrium quantity is the quantity supplied and the quantity demanded at the equilibrium price.

If the goods are not sold at the equilibrium price, there will be either a surplus, a situation in which quantity suplied is greater than quantity demanded or a shortage, a situation in which quantity demanded is greater than quantity supplied. When a price is above equilibrium price, there is an excess supply known as a surplus. When the price is below the equilibrium price, there is a shortage.

external image surplus.gifexternal image shortage.gif

In most markets however the law of supply and demand automatically adjusts to bring the quantity supplied and quantity demanded for that good into balance.

Three steps in analyzing changes in equilibrium. First, one must decide wheter the event shifts the supply curve, the demand curve or both curve. Second, one must decide whether it shifts to the right or the left. Finally one must use the supply and demand diagram to compare the initial and the new equilibrium. This is all shown in the charts below

external image answer3.gifexternal image supply-and-demand.gifexternal image v7n4a07-f01.gif
Thus this chapter anaylzed both supply and demand in the same market. Thought its early to judge wheater discussiona re good or bad, in this chapter, the factors of how markets work have taken shape. We have also come to learn that the most important factor in all of supply and demand would have to be the prices.

Key Terms/Concepts that you need to know

-market: a group of buyers and sellers of a good
-competitive market: a market where there are many buyers and sellers and each have a negligible impact on the market price
-quantity demanded: the amount of a good that buyers are willing to purchase
-law of demand: the claim that quantity demanded of a good falls when the price rises
-demand schedule: a table that shows the relationship between the price of a good and the quantity demanded
-demand curve: a graph of the relationship between the price of a good and the quantity demanded
-normal good: a good that increases in income leads to an increase in demand
-inferior good: a good that incresses in income leads to a decrease in demand
-substitutes: two goods for which an increase in the price of one leads to a decrease in the demand for the other
-compliements: two goods for which an increase in the price of one leads to a decrease in the demand for the other
-quantity supplied: the amount of a good that sellers are willing and able to sell
-law of supply: the claim that quantity supplied of agood rises when the price of the good rises
-supply schedule: a table that shows the relationship between the price of a goo and the quantity supplied.
-supply curve: a graph of the relationship bewteen the price of a good and the quantity supplied
-equilibrium: a situation in which the market price has reached the level at which quantity supplied equals quantity demanded
-equilibrium price: the price tthat balances quantity supplied and quantity demanded
-equilibrium quantity: The quantity supplied and quantity demanded at the equilibrium price
-surplus: a situation in which quantity supplieed is greater than quantity demanded
-shortage: a situationin which quantity demanded is greater than quantity supplied
-law of supply and demand: the claim that the price of any good adjusts to bbring the quantity supplied and the quantity demanded for that good into balance.


Picture links:
http://www.mbs.edu/home/jgans/mecon/value/media%20%20files/static%20graphics/jpegs/Segment%203/3_2_static_market_demand.jpg
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