Chapter 2. Competitive markets: demand and supply Flashcards
What is a market?
Any kind of arrangement where buyers and sellers (of goods, services or resources) are linked together to carry out an exchange
What is competition?
process in which rivals compete in order to achieve some objective
What does a greater degree of competition between sellers lead to?
smaller market power, weaker control over price
What is market power/monopoly power?
control that a seller may have over the price of the product it sells.
What are competitive markets composed of?
large numbers of sellers and buyers acting independently
How is price determined in competitive markets? (2)
No individual has ability to control price of product sold
Price is determined by interactions of many sellers and buyers + through demand and supply
What is demand?
quantities of a good or service the consumer is willing and able to buy at a range of prices during a particular time period, ceteris paribus
What is a demand curve?
A curve showing the relationship between the quantities of a good consumers are willing and able to buy during a particular time period, and their respective prices
What does the law of demand state?
ceteris paribus, there is a negative causal relationship between a good’s price and the quantity demanded by consumers over a time period
What are the explanations for why the demand curve slopes downward?
- principle of decreasing marginal benefit/ law of diminish marginal utility
- the income effect
- the substitution effect
How does the principal of decreasing marginal benefit explain the law of demand?
since marginal benefit falls as quantity consumed increases, the consumer will be persuaded to buy each extra unit only if its price falls
What is marginal benefit?
extra or additional benefit received from consuming one more unit of a good
How does the the income effect explain the law of demand?
as price of a good decreases, quantity demanded increases because consumers now have more real income to spend (more buying power)
How does the the substitution effect explain the law of demand?
as price of a good decreases, consumers switch from other substitute good to this good as its price is comparatively lower
What does a change in price cause? How is this represented on the demand curve?
Change in price causes change in quantity demanded → movement on demand curve
What does a change in a non price determinant cause? How is this represented on the demand curve?
Change in a nonprice determinant causes change in demand → shift in demand curve
What is market demand?
sum of all individual consumer demands for a good or service.
What are non-price determinants of demand?
the variables (other than price) that can influence demand, and that determine the position of a demand curve
What does a rightward/upward shift of the demand curve indicate?
more is demanded for a given price
What does a leftward/downward shift of the demand curve indicate?
less is demanded for a given price
What are the six non-price determinants of market demand?
Income in the case of normal goods Income in the case of inferior goods Preferences and tastes Price of substitute goods Prices of complementary goods Demographic changes
What is a normal good?
a good the demand for which varies positively with income
What is a inferior good?
a good for which varies negatively with income (e.g. second hand cars)
What are substitute goods?
two/more goods that satisfy a similar need, so that one can be used in place of another
What are complements/complementary goods?
two/more goods that tend to be used together
What is the relationship between the demand of complementary goods?
They are directly proportional
What is supply?
various quantities of a good a firm is willing and able to produce and supply to the market for sale at different possible prices, during a particular time period, ceteris paribus.
What is a supply curve?
A curve showing the relationship between quantities of a good that firms are willing and able to produce and sell during a particular time period and their respective prices, ceteris paribus
What does the law of supply state?
ceteris paribus, there is a positive causal relationship between the quantity of a good supplied over a particular time period and its price
What are the explanations for why the supply curve slopes upward? (2)
- Higher prices generally mean that the firm’s profits increase, and so the firm faces an incentive to produce more output
- Higher prices mean that more firms can cover costs
What is market supply?
sum of all individual firms’ supplies for a good.
Why does the vertical supply curve occur? (2)
- Fixed quantity of the good supplied because there is no time to produce more of it
- Fixed quantity of the good because there is no possibility of ever producing more of it.
What are non-price determinants of supply?
variables (other than price) that can influence supply, and that determine the position of a supply curve
What does a rightward/upward shift of the supply curve indicate?
more is supplied for a given price
What does a leftward/downward shift of the demand curve indicate?
less is supplied for a given price
What are the nine non-price determinants of market demand?
Costs of factors of production (factor or resource prices)
Technology
Prices of related goods: competitive supply
Prices of related goods: joint supply
Producer (firm) expectations
Taxes (indirect taxes or taxes on profits)
Subsidies
The number of firms.
‘Shocks’, or sudden unpredictable events.
What is competitive supply?
In the case of two goods, refers to production of one or the other by a firm; in other words the two goods compete with each other for the same resources
What is joint supply?
production of two or more goods that are derived from a single product, so that it is not possible to produce more of one without producing more of the other
How might producer expectations affect supply?
firms expect rise in product price, they may withhold some current supply from the market (not offer it for sale), with the expectation that they will be able to sell it at the higher price in the future → a fall in supply in the present results
What is a subsidy?
An amount of money paid by the government to firms for a variety of reasons: to prevent an industry from failing, to support producers’ incomes, or as a form of protection against imports
What is a surplus? What is particularly in supply and demand?
excess of something over something else (if quantity demanded of a good is smaller than quantity supplied)
What is a shortage particularly in supply and demand?
the amount by which quantity demanded is greater than quantity supplied.
What is excess supply?
when the quantity of a good demanded is smaller than the quantity supplied, leading to a surplus
What is excess demand?
when the quantity of a good demanded is greater than the quantity supplied, leading to a shortage of the good
What is market equilibrium?
Occurs where quantity demanded is equal to quantity supplied, and there is no tendency for the price or quantity to change.
What is equilibrium price?
The price determined in a market when quantity demanded is equal to quantity supplied, and there is no tendency for the price to change
What is equilibrium quantity?
The quantity that is bought and sold when a market is in equilibrium, i.e. when quantity demanded is equal to quantity supplied.
What does a market clear?
a market clears when quantity demanded equals quantity supplied and there is no surplus or shortage
When does market disequilibrium occur?
occurs in a market where the quantity supplied does not equal the quantity demanded at the actual price
What are market forces always doing?
market forces (forces of demand and supply) are always pushing prices towards market equilibrium, the price at which demand equals supply and there are no products left over in the market.
Why can’t market disequilibrium last?
In a free market, a market disequilibrium cannot last, as demand and supply force (market force) the price to change until it reaches its equilibrium level.
Why is there no tendency for price to change in market equilibrium?
Once a price reaches its equilibrium level, consumers and firms are satisfied and will not engage in any action to make it change.
What will cause change in market equilibrium?
However, if there is a change in any of the non-price determinants of demand or supply, a shift in the curves results, and the market will adjust to a new equilibrium.
What is the demand function?
Qd = a+bP
What is the nature of the gradient on a demand curve?
Relationship between the dependent and independent variables is negative (or indirect) →
Gradient is always negative
What does parameter a represent in a demand function?
represents variables held constant under the ceteris paribus assumption. (non-price determinants of demand)
What will cause a change in parameter a and how will it be represented on a demand curve?
if there is a change in a nonprice determinant of demand, showing up as a shift in the demand curve
What does parameter b (the slope) represent and what is it an indicator of?
the amount by which quantity demanded will change as price changes (indicator of responsiveness)
What is the relationship between demand’s responsiveness to price and parameter b?
Greater the absolute value of the slope (b), the flatter the demand curve (more responsive)
Steeper curve → customers are less responsive to price changes
What does the P intercept indicate on a demand curve?
price at which consumers will start demanding
Why might parameter b change?
If something causes consumers to be more/less responsive to price changes, b variable will change
What is the supply function?
Qs = c+dP
What is the nature of the gradient on a supply curve?
Relationship between the dependent and independent variables is positive (or direct) →
Gradient is always positive
What does parameter c represent in a supply function?
represents variables held constant under the ceteris paribus assumption. (non-price determinants of supply)
What will cause a change in parameter c and how will it be represented on a supply curve?
if there is a change in a nonprice determinant of supply, value of c will change
it will show up in the graph as a parallel shift of the supply curve
What does parameter d (the slope) represent and what is it an indicator of?
the amount by which quantity supplied will change as price changes (indicator of responsiveness)
What is the relationship between supply responsiveness to price and parameter d?
Greater the absolute value of the slope (d), the flatter the supply curve (more responsive)
Steeper curve → producers are less responsive to price changes
What does the P intercept indicate on a supply curve?
price at which producers will start supplying
Why might parameter d change?
If something causes producers to be more/less responsive to price changes, d variable will change
What is allocative efficiency?
An allocation of resources that produces a combination of quantity of goods and services optimal from society’s point of view
What is the condition for allocative efficiency?
P = MC (Price = marginal social cost)
When does allocative efficiency happen?
Happens when the competitive market is in equilibrium
What is social surplus?
Sum of consumer surplus and producer surplus
What happens to social surplus when there is allocative efficiency?
Social/community surplus is maximized
We can only have allocative efficiency if we have what?
productive efficiency
When does productive efficiency occur?
Occurs when firms produce at the lowest possible cost
What is consumer surplus?
the extra satisfaction gained by consumers from paying a price that is lower than the price they were prepared to pay
What is the relationship between consumer surplus and welfare?
Consumer surplus is the total welfare gained from being able to consume.
What does consumer surplus represent?
Represents the difference between the highest price a consumer is willing and able to pay and the price the consumer actually pays
What is producer surplus?
excess of actual earnings that a producer makes from a given quantity of output above the amount a producer would be willing to accept for that output
What is the relationship between producer surplus and welfare?
producer surplus is total welfare gained from being able to produce; equal to producer profits.
What does producer surplus represent?
difference between the price received by firms for selling their good minus the lowest price that they are willing to accept to produce the good.
