Chapter 4 | Demand and Supply Flashcards
Whats a Market?
Markets connect competition between buyers, competition between sellers, and cooperation between buyers and sellers. Government guarantees of property rights allow markets to function.
Market
the interactions between buyers and sellers.
Market Information
Because any purchase or sale is voluntary, an exchange between a buyer and seller happens only when both sides end up better off.
– Buyers are better off when businesses supply products or services that provide satisfaction (marginal benefit) that is at least as great as the price paid.
– Sellers are better off when the price received is at least as great as marginal opportunity costs.
Property rights
legally enforceable guarantees of ownership of physical, financial, and intellectual property.
Where Do Prices Come From? Price Signals from Combining Demand and Supply
When there are shortages, competition between buyers drives prices up. When there are surpluses, competition between sellers drives prices down.
Prices are the outcome of a market process of competing bids (from buyers) and offers (from sellers).
When the market price turns out to be too low:
– shortage, or excess demand — quantity demanded exceeds quantity supplied.
– shortages create pressure for prices to rise.
– rising prices provide signals and incentives for businesses to increase quantity supplied and for consumers to decrease quantity demanded, eliminating the shortage.
shortage, or excess demand
quantity demanded exceeds quantity supplied.
What happens to prices when there are shortages
shortages create pressure for prices to rise.
What do businesses do when there are rising prices
rising prices provide signals and incentives for businesses to increase quantity supplied and for consumers to decrease quantity demanded, eliminating the shortage.
When the market price turns out to be too high:
– surplus, or excess supply — quantity supplied exceeds quantity demanded.
– surpluses create pressure for prices to fall.
– falling prices provide signals and incentives for businesses to decrease quantity supplied and for consumers to increase quantity demanded, eliminating the surplus.
surplus, or excess supply
quantity supplied exceeds quantity demanded.
What happens when there are surpluses
surpluses create pressure for prices to fall.
What happens when there are falling prices
falling prices provide signals and incentives for businesses to decrease quantity supplied and for consumers to increase quantity demanded, eliminating the surplus.
What happens when prices dont change
Even when prices don’t change, shortages and surpluses also create incentives for frequent quantity adjustments to better coordinate smart choices of businesses and consumers.
When Prices Sit Still: Market-Clearing or Equilibrium Prices
Market-clearing or equilibrium prices balance quantity demanded and quantity supplied, coordinating the smart choices of consumers and businesses.
The price that coordinates the smart choices of consumers and businesses has two names:
market-clearing price
equilibrium price
market-clearing price
the price that equalizes quantity demanded and quantity supplied.
equilibrium price
the price that balances forces of competition and cooperation, so that there is no tendency for change.
Price Signals
Price signals in markets create incentives, so that while each person acts only in her own self-interest, the result (coordinated through Adam Smith’s invisible hand of competition) is the miracle of continuous, ever-changing production of the products and services we want.
Moving Targets: What Happens When Demand and Supply Change?
When demand or supply change, equilibrium prices and quantities change. The price changes cause businesses and consumers to adjust their smart choices. Well-functioning markets supply the changed products and services demanded.
For a change in demand (changes in preferences, prices of related products, income, expected future prices, number of consumers)
– an increase in demand (rightward shift of demand curve) causes a rise in the equilibrium price, and an increase in quantity supplied.
– a decrease in demand (leftward shift of demand curve) causes a fall in the equilibrium price, and a decrease in quantity supplied.
For a change in supply (changes in technology, environment, prices of inputs, prices of related products produced, expected future prices, number of businesses)
– an increase in supply (rightward shift of supply curve) causes a fall in the equilibrium price and an increase in quantity demanded.
– a decrease in supply (leftward shift of supply curve) causes a rise in the equilibrium price and a decrease in quantity demanded.
When both demand and supply change at the same time, we can predict the change in either the equilibrium price or in the equilibrium quantity. But without information about the relative size of the shifts of the demand and supply curves, we cannot predict what will happen to the other equilibrium outcome.
– when both demand and supply increase, the equilibrium price may rise/fall/remain constant, and the equilibrium quantity increases.
– when both demand and supply decrease, the equilibrium price may rise/fall/remain constant, and the equilibrium quantity decreases.
– when demand increases and supply decreases, the equilibrium price rises and the equilibrium quantity may rise/fall/remain constant.
– when demand decreases and supply increases, the equilibrium price falls, and the equilibrium quantity may rise/fall/remain constant.
Comparative statics
comparing two equilibrium outcomes to isolate the effect of changing one factor at a time.
Getting More Than You Bargained For: Consumer Surplus, Producer Surplus, and Efficiency
An efficient market outcome has the largest total surplus, prices just cover all opportunity costs of production and consumers’ marginal benefit equals businesses’ marginal cost.
Reading demand and supply curves as marginal benefit and marginal cost curves reveals the concepts of:
– consumer surplus
– producer surplus
– total surplus
– deadweight loss
producer surplus
the difference between the amount a producer is willing to accept, and the price actually received. The area below the market price but above the marginal cost curve.
total surplus
consumer surplus plus producer surplus.
deadweight loss
decrease in total surplus compared to an economically efficient outcome.
Efficient market outcome
coordinates smart choices of businesses and consumers so
– consumers buy only products and services where marginal benefit is greater than price.
– product and services are produced at lowest cost, with prices just covering all opportunity costs of production.
– at the quantity of an efficient market outcome, marginal benefit equals marginal cost (MB = MC).
