Chapter 3: Markets: Supply And Demand Flashcards
Market
A group of buyers and sellers of a particular good or service.
Competitive market
A market in which there are many buyers and sellers.
The market model of supply and demand is based on the following assumptions:
- Many buyers and sellers.
- Perfect information for all buyers and sellers.
- Freedom of entry and exit.
- Identical goods.
- Buyers and sellers act in self interest.
- Clearly defined property rights.
Competitive markets
Many buyers and sellers, called price takers.
Characteristics of a perfectly competitive market:
- All goods for sale are the same.
- No buyer or seller can influence market price on their own.
Quantity demanded
The amount of good that buyers are willing and able to purchase.
Law of demand
The quantity demanded of a good falls when the price of the good rises.
Demand schedule
Shows the relationship between the quantity demanded and the price of the good.
Demand curve
A graph of the relationship between the price of the good and the quantity demanded of the good.
Ceteris paribus
Other factors affecting demand are held constant so we can analyze the effect of a change in price on demand.
Shift in demand curve
Caused by a factor other than a change in price
Movement along the demand curve
Caused by a change in the price of the product
E.g a tax that raises the price of milk results in a movement along the demand curve.
Inferior goods
Goods you buy less of as your income increases
The income effect
The substitution effect
(Assume the price of milk falls - more is demanded due to the income and substitution effects)
Assume that income remains constant. A fall in the price of milk means that consumers can now afford to buy more with their income.
Milk is lower in price compared to other similar products, so some consumers will choose to substitute the more expensive drinks with the now cheaper milk.
These effects have different effects depending on the type of good.
Shift in the demand curve
Caused by any changes that alters the quantity demanded at every given price.
Shifts caused by factors other than price:
- Prices of related goods
- Income
- Tastes
- Number of buyers
- Advertising
- Expectations
- Prices of related goods
Substitutes and complements:
- substitutes: two goods for which the increase in the price of one good leads to an increase in the demand for the other. E.g milk and water. Increase in one, people buy the other
- complements: two goods for which the increase in the price of one good leads to a decrease in the demand for the other. E.g tennis rackets and tennis balls, if the price of tennis rackets goes up, the demand for tennis balls falls. Increase in one, people don’t buy the other.
- Income
Lower income - spend less on some - probably most goods
Normal goods
The demand for a good falls when income falls and rises as income rises
Inferior good
The demand for a good rises when income falls. E.g when income falls, train ticket sales go up because people can’t afford cars/fuel.
- Tastes
More people may like something
Number of buyers
Population
Advertising
-
Expectations of consumers
Demand influenced by expectations of future income and future prices. E.g I will buy a house now if I think prices will rise next year.
Shifts in demand curve
Shift to the left: decrease in demand.
Shift to the right: increase in demand.
Shifts in demand curve for normal good
Increase in income - increase in demand - shift to the right
Shifts in demand curve - inferior good
Increase in income - decrease in demand - shift to the left.
Quantity supplied
The amount of a good that sellers are willing and able to sell.
Law of supply
The quantity supplied of a good rises when the price of a good rises
Supply schedule
A table that shows the relationship between the price of the good and the quantity supplied
Supply curve
The graph of the relationship between the price of a good and the quantity supplied. (Upward sloping)
Shifts in the supply curve:
6 causes
- Profitability of other goods in production and prices of good in joint supply
E.g farmer with cows and sheep, profitability of milk goes up, farmer sells sheep and gets more cows.
- Technology
-
Natural/social factors
Weather and changing attitudes
- Input prices
The prices of the factors of production
- Expectations of producers about the future state of the market
A change in the number of sellers in the market
Change in supply
Shifts to left or right - caused by a determinant other than price
Decrease in supply
Shifts to the left
Increase in supply
Shifts to the right
Equilibrium price
The price that balances quantity supplied and quantity demanded
The price at which the supply and demand curves intersect on a graph.
Equilibrium quantity
The quantity supplied and demanded at the equilibrium price.
The quantity at which the supply and demand curves intersect on a graph.
Market mechanism
The tendency in a free market for the price to change until the market is clear. ( QS = QD)
In the market model, the relationship between supply and demand exerts force on price ( if D>S, pressure on price to change , and vice versa)
Surplus
When price > equilibrium price = quantity supplied > quantity demanded.
Leads to excess (surplus) supply.
Suppliers will lower the price to increase sales, moving towards equilibrium
Shortage
Price < equilibrium price =. Quantity demanded > quantity supplied.
Excess demand/shortage
Suppliers raise the price due to too many buyers chasing too few goods, moving towards equilibrium. Raising the price reduces the amount of buyers in the market willing to pay that price.
Law of supply and demand
The claim that the price of any good adjusts to bring the quantity supplied and the the quantity demanded for that good into balance.
QS = QD
Prices as signals to buyers and sellers
The function of price in a free market is to act as a signal to both buyers and sellers.
For buyers: price tells them what they have to give up (usually money) to acquire the benefits. Price rise changes the nature of the trade-off buyers face.
For sellers: price acts as a signal in relation to the profitability of production. Price rises indicates a shortage so will increase production.
Shift in supply curve:
Change in supply
Movement along a fixed supply curve
Change in quantity supplied
Shift in demand curve
Change in demand
Movement along a fixed demand curve
Change in quantity demanded
Steps to analyzing changes in equilibrium
- Decide whether the event shifts the supply or demand curve (or both).
- Decide whether the curve shifts to left or to the right.
- Use the supply and demand diagram to see how the shift affects equilibrium price and quantity
Look at table four
Summary
- Economists use the model of supply and demand to analyze competitive markets.
- In a competitive market, there are many buyers and seller, each of whom has little or no influence on the market price.
- The demand curve shows how the quantity of a good demanded depends upon the price.
- The supply curve shows how the quantity of a good supplied depends upon the price.
- Market equilibrium is determined by the intersection of the supply and demand curves.
- At the equilibrium price, the quantity demanded equals the quantity supplied.
- The behavior of buyers and sellers drives markets towards equilibrium.
- In market economies, prices are the signals that guide economic decisions and thereby allocate resources.
