The Market Forces of Supply and Demand



external image supply.jpg

Introduction
A market is composed of a group of buyers and sellers.
In this chapter, we'll learn how supply and demand created by buyers and sellers affect the market and competition.


What We Will Learn
-buyers and sellers in a competitive market
-demand curve, price, and quantity
-supply curve, market supply, and individual supply
-analysis of equilibrium



Key Terms
-market: interaction of buyers and sellers of a certain good or service
-competitive market: a market in which each buyer or seller cannot influence the market price because there are so many of them
-quantity demanded: the quantity that buyers are willing and able to pay at specific price
-law of demand: the claim that the quantity demanded and the price of the good have negative relationship
-demand schedule: a table that shows the quantity demanded of a good at each price
-demand curve: a graph that shows the quantity demanded of a good at each price
-normal good: a good for which income and demand have positive relationship
-inferior good: a good for which income and demand have negative relationship
-substitutes: two goods for which the price of one and the demand for the other have the positive relationship
-complements: two goods for which the price of one and the demand for the other have the negative relationship
-quantity supplied: the quantity that sellers are willing and able to sell at specific price
-law of supply: the claim that the quantity supplied and the price of the good have positive relationship
-supply schedule: a table that shows the quantity supplied of a good at each price
-supply curve: a graph that shows the quantity supplied of a good at each price



Topics

1) Market and Competition

Market – a group of buyers and sellers of a particular good or service
i. Highly organized like a stock market
ii. Less organized like a market for ice cream

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

A perfectly competitive market (Ex: agriculture markets) has two main characteristics:
i. The goods offered for sale are all the same.
ii. The buyers and sellers are so numerous that no one buyer or seller can influence the price.
If a market is perfectly competitive, both buyers and sellers are said to be price takers because they cannot influence the price.

Other types of markets:
i. Monopoly – market has only one seller
ii. Oligopoly – market has only a few sellers
iii. Monopolistically competitive – market has many sellers but each product is
slightly different so that each seller has some ability to set its own price


2) All About Demand Curve

Quantity demanded – amount of a good that buyers are willing and able to purchase.
i. Price of a good plays central role in determining quantity demanded of a good
ii. An increase in the price of a good reduces the quantity demanded

Law of demand – the negative relationship between the price of a good and the quantity demanded of a good
Demand schedule – a table showing the relationship between the price of a good and the quantity demanded
Demand curve – a graph of this relationship with the price on the vertical axis and the quantity demanded on the horizontal axis; downward sloping due to the law of demand

Market demand – sum of quantities demanded for each individual buyer at each price
Market demand curve is the horizontal sum of the individual demand curves
The curve shows the total quantity demanded of a good at each price, while all the other factors that affect how much buyers wish to buy are held constant

When people change how much they wish to buy at each price, the demand curve shifts
i. If buyers increase the quantity demanded at each price, the demand curve shifts right, which is called an increase in demand
ii. If buyers decrease the quantity demanded at each price, the demand curve shifts left, which is called a decrease in demand

Income:
i. Normal good – good for which increase in income leads to increase in demand
ii. Inferior good – good for which increase in income leads to decrease in demand

Prices of related goods:
i. Substitutes – two goods that can be used in place of one another; an increase in price of one good leads to an increase in the demand for the other good
ii. Complements – two goods that are used together; an increase in the price of one good leads to a decrease in the demand for the other good

Tastes: If your preferences shift toward a good, it will lead to an increase in the demand for that good.

Expectations: Expectations about future income or prices will affect the demand for a good today.

Number of buyers: An increase in the number of buyers will lead to an increase in the market demand for a good because there are more individual demand curves to horizontally sum.

Picture_18.png
A change in the price of a good represents a movement along the demand curve while a change in other variables causes a shift in the demand curve.




4)All About Supply Curve

Quantity supplied – amount of a good that sellers are willing and able to sell.
i. Price of a good plays central role in determining the quantity supplied for a good
ii. An increase in the price makes production more profitable and increases the quantity supplied
Law of supply – the positive relationship between the price of a good and the quantity supplied
Supply schedule – a table showing the relationship between the price of a good and the quantity supplied
Supply curve – a graph of this relationship with the price on the vertical axis and the quantity supplied on the horizontal axis; upward sloping due to the law of supply

Market supply – sum of the quantity supplied for each individual seller at each price
Market supply curve is the horizontal sum of the individual supply curves
The curve shows the total quantity supplied of a good at each price, while all other factors that affect how much producers wish to sell are held constant

When producers change how much they wish to sell at each price, supply curve shifts
i. If producers increase the quantity supplied at each price, the supply curve shifts right, which is called an increase in supply
ii. If producers decrease the quantity supplied at each price, the supply curve shifts left, which is called a decrease in supply

Input Prices: A decrease in the price of an input makes production more profitable and increases supply.

Technology: An improvement in technology reduces costs, makes production more profitable, and increases supply.

Expectations: Expectations about the future will affect the supply of a good today.

Number of Sellers: An increase in number of sellers will lead to an increase in the market supply for a good because there are more individual supply curves to horizontally sum.

Picture_19.png
A change in the price of a good represents a movement along the supply curve while a change in other variables causes a shift in the supply curve.




5) Equilibrium and Its Changes

The intersection of supply and demand is called the market’s equilibrium.
i. Equilibrium – situation in which the price has reached the level where quantity supplies equals quantity demanded.
ii. Equilibrium price (market clearing price) – price that balances the quantity demanded and the quantity supplied
iii. Equilibrium quantity – quantity supplied equals the quantity demanded at the equilibrium price

The market moves naturally toward its equilibrium
i. If the price is above the equilibrium price, the quantity supplied exceeds the quantity demanded and there is a surplus, or an excess supply of the good.
• Surplus causes the price to fall until it reaches equilibrium
ii. If the price is below the equilibrium price, the quantity demanded exceeds the quantity supplied and there is a shortage, or an excess demand for the good.
• Shortage causes the price to rise until it reaches equilibrium
iii. This natural adjustment of the price to bring the quantity supplied and the quantity demanded into balance is known as the law of supply and demand

When an economic event shifts the supply or the demand curve, the equilibrium in the market changes.

The analysis of this change is known as comparative statics because we are comparing the initial equilibrium to the new equilibrium.

When analyzing the impact of some event on the market equilibrium, employ 3 steps:
i. Decide whether the event shifts the supply curve or demand curve or both.
ii. Decide which direction the curve shifts.
iii. Use the supply-and-demand diagram to see how the sift changes the equilibrium price and quantity


Picture_16.png





Conclusion

To analyze how markets work, we need to determine the market demand, which is the sum of all the individual demands for a particular good or service. We've done this through this chapter:) I hope you understood the demand, supply, and equilibrium.




Quiz
When the price of a good is legally set below the equilibrium level, a shortage often results. This shortage:
-occurs because the price ceiling prevents the market mechanism from establishing an equilibrium price.

The market pricing system corrects an excess supply by:
-lowering the product price and decreasing producer profits.

When a government subsidy is granted to the buyers of a product, sellers can end up capturing some of the benefit because:
-the market price of the product will rise in response to the subsidy.




Sources

Mankiw, Gregory N. Principles of Microeconomics. 4th ed. Print.
http://community.ere.net/media/photologue/photos/supply.jpg