Demand, Supply and Equilibrium in Markets

Question 1

definition: demand

Answer 1

the quantity of a good or service that buyers are willing to buy at a given price at a particular time, ceteris paribus

Question 2

demand

Answer 2

when price increases, demand decreases

the demand curve maps this relationship

demand reflects real or perceived benefit from producing a good or service

also known as a marginal benefit curve

Question 3

the income effect

Answer 3

as a good becomes cheaper, our purchasing power (real income) improves that means we can afford to buy more goods for our given (unchanged) actual income

Question 4

the substitution effect

Answer 4

as a good becomes cheaper relative to other goods, we substitute away from the more expensive goods and toward the cheaper good, and buy more

Question 5

non price determinants of demand

Answer 5

incomes of buyers (Y)

tastes of buyers (t)

number of buyers (N)

price of related goods (Pr)

expectations of future price changes (Pe)

Question 6

income

Answer 6

affects the ability to pay, and therefore tends to have a positive effect on demand

can also affect willingness to pay because of a change in preferences = an increase in income can lead to a stronger preference for some goods and a weaker preference to other goods

the effect of income on demand depends on the type of good

• normal goods
• inferior goods

Question 7

tastes and preferences

Answer 7

affects perceived benefit, and thus willingness to pay
determined by fashion, advertising, information, hype, media, demographics

massive amounts of $$ being spent to try to sway consumers toward certain goods

very subjective, changes can be unpredictable

Question 8

number of buyers

Answer 8

market demand is the sum of the quantity demanded of all buyers in the market

population = a general increase in the population will tend to increase the number of buyers

demographics = the number of people in particular age - groups can affect the number of buyers for certain
goods and services

Question 9

price of related goods

Answer 9

substitute goods

• e.g. cornflakes and weetbix; tea and coffee; ipad and samsung tablet
• increase in price of cornflakes decreases quantity demanded for cornflakes and increases quantity demanded for weetbix
• the demand for a good is directly related to the price of a substitute good

complement goods

• e.g. cars and petrol; bikes and bike helmets; weetbix and milk
• increase in price of cars leads to decreased demand for cars and decreased demand for petrol
• the demand for a good is indirectly related to the price of a substitute good

Question 10

expectations of future price changes

Answer 10

if buyers expect prices to increase in the future, they will increase current demand

if buyers expect prices to decrease in the future, they will withhold current demand

Question 11

definition: supply

Answer 11

reflects willingness and ability to provide a good or service at a particular price

Question 12

non price determinants of supply

Answer 12

price of inputs (Pf)

prices of substitutes in production (Pa)

expected future prices (Pe)

the number of firms in the market (N)

Question 13

prices of inputs

Answer 13

all goods and services require inputs to produce them
if the price of these inputs change, then the overall cost to the producer will also change

an increase in the price of an input will increase overall costs, and so the supply curve will shift to the left and vice versa

Question 14

technological change

Answer 14

technology represents the stock of knowledge about how to combine resources most efficiently

therefore, an improvement in technology will lead to a decrease in the costs of production for firms which will cause the supply curve to shift right

Question 15

expected future prices

Answer 15

if firms expect prices to be higher in the future, they may decrease supply now and increase it in the future and vice versa

Question 16

prices of substitutes in production

Answer 16

here we mean goods that use the same or similar inputs

• land used for dairy cows can sometimes be used for producing crops
• land that was used for food-production prior to the US policies to promote use of ethanol-based fuels was soon converted to grow corn for ethanol production = this lead to a fall in the supply of grains for food production and hence an increase in food prices

Question 17

change in the number of sellers

Answer 17

the market supply is the sum of the quantity supplied of all sellers in the market

an increase in the number of sellers in the market means that supply shifts right

• e.g. massive increase in the number of wineries in margaret river leads to an increase in the supply of wine grapes

Question 18

what are markets

Answer 18

markets provide a mechanism whereby resources are allocated among competing claims

there are two sides to a market

• demand = individual organisations willing to pay to procure a good or service
• supply = individuals or organisations willing to provide a good or service for a price

Question 19

definition: markets

Answer 19

a market describes a situation where buyers and sellers interact to coordinate their competing wants and needs

Question 20

market equilibrium (ending a surplus and ending a shortage diagrams)

Answer 20

buyers only buy if they perceive that the marginal benefit outweighs the cost

sellers only sell if the price is high enough to cover the cost of producing

this is known as adam smith’s “invisible hand” of resource allocation

the interaction between buyers and sellers in a market results in market equilibrium

Question 21

equilibrium and disequilibrium

Answer 21

equilibrium occurs when the plans of the buyers match the plans of the sellers = QD equals QS so the market clears

changes in the determinants of demand and supply over time means this equilibrium price and quantity will also change over time

but the effect of these changes in the determinants occur in a predictable way

• in reality, markets often don’t spend much of the time in actual equilibrium
• rather, demand and supply move around a bit, creating temporary shortages and surpluses to which the market constantly adjusts

some markets are more “fluid”, which means disequilibrium is rare and only very transitory, so the market clears all the time e.g. stock-markets

some markets are much more “sticky”, and may spend a long time in disequilibrium before buyers and seller have time to adjust e.g. the housing market