Ch.4+The+Market+Forces+of+Supply+and+Demand

In this chapter, we are going to discuss what supply and demand are, and how they determine the market price. But before that, we have to define some key words.

=What is Market?=

A **market** is all the groups of buyers and sellers of a particular good or service. Buyers determines the demand, and sellers determine the supply.

Markets don't have to be organized. For example, in a t-shirt market, there are no set time where all buyers and sellers meet. Instead, buyers just go out to buy t-shirts whenever they feel like they need to. Each buyer can decide to buy them or not to buy them depending on the prices. However, this is still called a legitimate market. Like this, a market does not have to be organized.

=What is Competition?=

A market like t-shirt market is said to be a **competitive market**, because there are a lot of sellers trying to sell them. There are also many buyers of t-shirts. Buyers face many choices when buying t-shirts. Therefore, the price of a t-shirt is not determined by just one seller and one buyer. Instead, all buyers and sellers are involved in determining to price.

This market is called competitive market because there are so many buyers and so many sellers that each has a negligible impact on the market price. For example, if Nike has little reason to charge less on t-shirts, because less price will decrease their earning. At the same time, Nike can't really charge more, because people will start buying at Adidas and Abercombie with cheaper price than at Nike with with higher price. Also, if one buyer can't afford $30 t-shirt because one is poor, price cannot change because there are many other buyers that can afford the price. Like this, in a competitive market not one has the ability to change the price.

A **perfectly competitive** market has two characteristics: the goods offered for sale are all exactly the same, and the buyers and sellers are so numerous that no single buyer or seller has any influence over the market price. Because buyers and seller cannot change the price and must accept it, they are called the **price takers**. In this chapter, we assume all markets to be perfectly competitive.

However in real world, not all the markets are perfectly competitive. Some markets have only one seller that sets the price. One good example would be ETS that has sole power over all the testings. ETS sets the price for all the testings such as SAT, AP, TOEFL, TOEIC. ETS is said to be a **monopoly**.

Even though there are many different types of markets in the real world, starting with perfectly competitive market is a good way to learn first. It is the most simple market and most applicable market for further learning.

=Demand=

Let's say you want to buy a new basketball. You are only willing to buy a basketball that's cheaper than $30. Likewise, your friend also wants a basketball. But he is only willing to buy a ball cheaper than $20.

Like this, everyone has his or her own willingness to pay. This willingness to pay is called the **demand**. Logically thinking, if a good is more expensive, people would buy less of that good. With higher price, amount of the good that buyers are willing and able to purchase, or the **quantity demanded**, decreases. This relationship is called the **law of demand**. It states that the price and the quantity demanded are in an inverse relationship; less price means more quantity demanded, higher price means less quantity demanded.

It is easier to understand the concept if you observe it in tables and graphs.


 * Tom's Demand Schedule for a Basketball**
 * Price || Quantity ||
 * $0 || 10 ||
 * $10 || 8 ||
 * $20 || 4 ||
 * $40 || 2 ||
 * $80 || 1 ||
 * $100 || 0 ||

This figure shows how many basketballs Tom would buy at each different price of basketball. If the basketballs were free, he would buy 10 of them, simply because buying more would be unnecessary and would take up extra space in his room. At $10, he would buy 8 basketballs. The quantity demanded decreases as the price goes up until at $100 he would not buy the basketball. This table is called the **demand schedule**.

Let's say this represents the demand for a product X. At price P2, people are willing to buy Q2 amount of product X. However, when the price goes up to P1, people are willing to buy less at Q1. On the other hand, if the price decreases to P3, people are willing to buy more at Q3. This downward-sloping line demonstrates the law of demand, and is called the **demand curve**.
 * Figure 1**

Shifts in the Demand Curve
Demand for a product X does not change with the price. For example, if the people are not willing to pay more than $30 for a product X, and the sellers charge $20, the people's demand is still at $30. Likewise, if the sellers charge $40, the demand is still at $30. However, the quantity demanded does change with the price. if charged $20, people will buy 1 product X. but if charged $40, people will buy none product X. Change in quantity demanded occurs with and only with the change in price.

However, there are cases when the people's demand can change. For example with the product X above, if the doctors find out that the purchase of product X can prevent cancer, then the people's demand will increase (instead of $30, they will want to pay $40 because they feel they need it more). Likewise, if the doctors find out that the purchase of product X might cause cancer, people's demand will decrease (people are more reluctant to buy with fear). Any increase in demand shifts the demand curve to the right. Any decrease in demand shifts the demand curve to the left. Figure 2 shows how the shift of demand curve works.

There are 5 main factors that can shift the demand curve.

Income
If your income falls, you would most likely want to spend less on most products. If the demand for a product falls when income falls, the good is said to be a **normal good**. The demand curve shifts left with less income, and shifts right with increase in income for normal goods.

Some goods are called **inferior goods** when the demand increases with less income. An example of this would be a Junior Whopper from Burger King. With less income, more people are reluctant to buy a normal Whopper burger, and instead will choose to buy cheaper Junior Whopper. The demand shifts right with less income and shifts left with higher income for inferior goods.

Prices of Related Goods
==

Basketball and baseball are two of the most popular sports in America. With this fact, let's consider this situation.

If the price of a baseball decreases, the law of demand states that the demand for baseballs will increase. Because many people like baseball and basketball, many people will now prefer to buy cheaper baseballs than more expensive basketballs. Therefore the demand for basketballs will decerase. Likewise, if the price of a baseball increases, more people will want to buy basketballs. Therefore the demand for basketballs will increase. These goods are said to be substitutes. Some examples of substitutes are MacBook and PC, PSP and PS2, and Coke and Pepsi.



Another relationship between related goods is called complements. Complement goods are usually used together, such as Coke and Burger King, cars and gasoline, and computers and software. Decrease in price of Coke will increase the demand for Coke. Consequently, since Coke goes extremely well with burgers at Burger King, the demand for Burger King will increase. Likewise, an increase in the price of Coke will decrease the demand for Coke, and consequently decrease the demand for Burger King.

Tastes
It is pretty obvious that if your taste changes, the demand will change. For example, if this new food was introduced to a country, people will be a bit scared to try it. However as time passes, people will start to realize that the new food tastes good. This will increase the demand of the new food.

Expectations
This is pretty straightforward too. For example, if you expect that you will get higher income in near future, you will be less reluctant to buy more goods now. This will increase the demand. In contrast, if you expect the price of a good to decrease in near future, why would you bother buying it now at more expensive price? This will result in decrease of demand.

Number of Buyers
This is simple. If there are more buyers in the market, the demand will go up. For example, if Japan's baby birth rate increases, the demand for babysitters will increase (there are more babies to be looked after). The demand curve for babysitters will shift to the right.

=Supply=

Let's say that you want to sell a basketball. If the price is $80, you are willing to sell 6 basketball. If the price of a basketball is $100, you are willing to sell 8 basketballs. This willingness and ability to sell is called the supply. With higher price, the product is more profitable, and therefore the amount that sellers are willing and able to sell, or the quantity supplied, is large. In contrast, if the price is low, the quantity supplied of the product is low. This is because sellers work hard, buys all the machines, and hires workers to sell the products. If they only get little profit from the product, the sellers won't be able to sell as much. If they get a lot of profit from the product, they can hire more people and supply more. This relationship between the price and the quantity supplied is called the lay of supply; they are in a direct relationship. When one goes up, the other goes up. When one goes down, the other goes down.


 * Tom's Supply Schedule for a Basketball**
 * Price || Quantity ||
 * $0 || 0 ||
 * $10 || 1 ||
 * $20 || 2 ||
 * $40 || 4 ||
 * $80 || 8 ||
 * $100 || 10 ||

The figure above shows how many basketballs Tom would supply at each different price of a basketball. If the basketballs are free, then Tom would would not sell any, because it is not profitable. If the basketball is $100, then Tom will supply 10 basketballs because he can make more with more profit. This table is called the supply table.

Let's say this represents the supply for a product X in Europe. According the the graph, at €0.50, the sellers are willing to sell 400. However at €0.20, they are willing to sell only 100. Like this, this graph demonstrates the lay of supply. This line is called the supply curve.

=Shifts in the Supply Curve=

Supply for a product X does not change with the price. For example, if a company is not willing to sell more than 200 units at price $30 and the price is at $20, the supply is still at 200 for $30. Likewise, if the price is $30, the supply is still 200 units for $30. However, the quantity supplied changes. At $20, the company will sell 150 units. At $30, the company will sell 200 units. The quantity supplied changes with and only with the change in price.

However there are cases when the seller's supply can change. For example with the product X above, if the company starts using new technologies that will enhance the production of product X, then the company's ability to supply will increase. This will shift the supply curve to the right. In contrast, if the company's workers start getting lazy, the company's ability to produce will decrease. This will shift the supply curve to the left.



There are 4 main factors that can shift the supply curve.

Input Price
To produce a product, sellers use a lot of inputs: machines, workers, land, factories, etc. When the price of input rises, it will become harder to produce the good. Therefore, the supply will decrease and the supply curve will shift to the left. In contrast, when the price of input decreases, it will become easier to produce more goods. Therefore, the supply will increase and the supply curve will shift to the right.

Technology
This is similar to the change in input price. If a new technology allowed the sellers to produce a good with a super computer in less time that it used to take, then the supply will increase and the supply curve will shift to the right.



Expectations
The sellers' expectation can shift the supply curve as well. For example, if the sellers expect that someone is going to invent a new machine to enhance technology and lower the input price, then the sellers will not supply a lot now. Instead they will wait for the new invention so they can make more profits with the goods.

Number of Sellers
Let's take Nike for example. If Nike only had sellers in the United States, its willingness to supply is not as big compared to if Nike had sellers all over the world. More seller means more supply. Therefore it will shift the supply curve to the right.

=Supply and Demand Together=

Equilibrium


In the graph above, supply and demand curves are drawn together. You can see that there is a point where the supply curve and the demand curve intersect. This point is called the market's **equilibrium**. The price at this point P* is called the **equilibrium price**, and the quantity at this point Q* is called the **equilibrium quantity**. At this point, everyone in the market is satisfied; the buyers are getting all they wanted to get while the sellers are selling all they could sell.

In a free market, the behaviors of the buyers and sellers naturally lead the market price into the equilibrium point.

But why?

Let's see what happens if a market charges more than the equilibrium price.

In the figure above, P2 is the equilibrium price. According to the supply curve, at price P1 the sellers will supply Q3 units. But according to the demand curve, at price P1 the buyers will only demand Q1 units. This means there are goods that are produced but not bought by anyone in the market. This situation is called the **surplus** and it occurs when the price is too high.

In a surplus, the buyers are satisfied because they demand Q1 units and they get Q1 units. However, the sellers are not satisfied. They want to sell Q3 units, but only Q1 units are being sold. For the sellers, surplus of goods means waste of input energy. Therefore, the sellers will have to decrease the price to get rid of the surplus. Eventually, the sellers will find out the equilibrium price where there are no surplus.

Let's see what happens if a market charges less than the equilibrium price.

According to the supply curve, at price P3 which is lower than the equilibrium price, the sellers are willing to sell Q1 units. But according to the demand curve, at P3 the buyers are willing to buy Q3 units. In this situation, there are not enough products produced to meet the demand of the people. This situation is called the **shortage** and it occurs when the price is too low.

In a shortage, the sellers are satisfied because they want to sell Q1 units and buyers buy all Q1 units. however, the buyers are not satisfied because they want to buy Q3 units when there are only Q1 units in the market. Not all the people who want to buy the product will get the product. As a result, those people will want to pay more to get the product. The sellers say, "Sure if you guys want to pay more, I'll take the price," and will raise the price until P2 where the demanders will stop paying more.

Like this, supply and demand will eventually move toward their equilibrium levels. This is called the **law of supply and demand**.

One thing you may have realized about all these laws is that these laws make sense because we are all greedy. In fact, one of the 10 principles of economics states that rational people think at the margin. In other words, we are all greedy! Simple reason why we study economics is to find out a way to control and satisfy all the greedy human beings in the world.

=Changes in Equilibrium Price=

Since equilibrium point is determined by the demand and supply curves, it changes when and only when the curves shift.

For example, let's say that a hurricane hit the state of Arizona. What would happen to the equilibrium price and quantity of potatoes? Hurricanes will surely ruin many of the potatoes. Therefore, the supply of the potatoes will decrease and the supply curve will shift to the left (S1 to S2 on the graph).

Before the shift, the equilibrium price was $3 and equilibrium quantity was 30 potatoes (Point A). After the decrease in supply, the new equilibrium price is $4 and new equilibrium quantity is 20 potatoes (Point B). The hurricane that hit the state of Arizona will raise the price and lower the quantity of potatoes.

Let's give another example. Say that Michael Jordan said he used Nike basketballs when he was young and that Nike made him the greatest basketball player. What would happen to the equilibrium prince and quantity of the Nike basketballs?

This Michael Jordan's bold comment will make many basketball players think, "Maybe if I bought more Nike basketball, I could be better than I am right now at basketball." Therefore, more people are going to buy Nike basketballs, and its demand will increase (shift from D1 to D2).

Before the shift, the equilibrium price was $3 and the equilibrium quantity was 30 basketballs (Point A). After the increase in the demand, the new equilibrium price is $4 and the new equilibrium quantity is 40 basketballs (point B). Michael Jordan's one comment will raise the equilibrium price and the equilibrium quantity.

[|Questions & Answers]

media type="youtube" key="xlLz1TvK4HA" width="425" height="350" [|*Demand]

media type="youtube" key="Gj5e33jysVU" width="425" height="350" [|*Supply]

__**Key Concepts**__
 * market**: group of buyers and sellers
 * competitive** **market**: a market that has many buyers and sellers
 * quantity** **demanded**: the quantity that buyers are willing to pay for
 * law** **of** **demand**: quantity demanded decreases when price increases
 * demand schedule**: table that shows the relationship between price and quantity demanded
 * demand curve**: downward sloping curve relevant to price and quantity demanded
 * normal good**: a good which consumption falls when income falls
 * inferior good**: a good which consumption increases when income falls
 * substitutes**: the relationship of two goods which increased price of one good increases the consumption of the other good
 * complements**: the relationship of two goods which increased price of one good decreases the consumption of the other good
 * quantity supplied**: the quantity that sellers are willing to sell for
 * law of supply**: quantity supplied increases when price increases
 * supply schedule**: table that shows the relationship between price and quantity supplied
 * supply curve**: upward sloping curve relevant to price and quantity supplied
 * equilibrium**: the point where quantity supplied = quantity demanded
 * equilibrium price**: price that makes quantity supplied equal to quantity demanded
 * equilibrium quantity**: quantity at the equilibrium price
 * surplus**: a circumstance where quantity is left over (quantity supplied > quantity demanded)
 * shortage**: a circumstance where quantity is insufficient (quantity demanded > quantity supplied)
 * law of supply and demand**: the price balances the quantity demanded and quantity supplied

1. Which country has the absolute advantage on lumber? on computers?
 * __Questions__**

2. Which country has the comparative advantage on lumber? on computers?

Answers Ch 4 YD