03 The market at work-Supply and Demand

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Misconception - Sellers determine the price of the good.

What Are the Fundamentals of Markets?

In a market economy, resources are allocated among households and firms with little or no government interference.
The invisible hand is a phrase coined by Adam Smith to refer to the unobservable market force that guide resources to their highest-valued use.

Competetive Markets

A competetive market exists when there are so many buyers and sellers that each has only a small (negligible) impact on the market price and output.

Sales of salmon at Pike Place Market

Imperfect Markets

  • An imperfect market is a market in which either the buyer or the seller can influence the market price.
  • Market power is a firm's ability to influence the price of a good or service by exercising control over its demand, supply, or both.
  • A monopoly exists when a single company supplies the entire market for a particular good or service.
  1. Gas station at a busy interstate exit
  2. A furniture store in an isolated small town.
  3. A fresh produce stand at a farmes' market.

What determines demands?

In economics, the amount of a good or service that buyers are willing and able to purchase at the current price is known as the quantity demanded.
The law of demand states that, all other things being equal, quantity demanded falls when the price rises, and rises when the price falls.

The Demand Curve

  • A demand curve is a graph of the relationship between the prices in the demand schedule and the quantity demanded at those prices.

Market Demand

  • The market demand is the sum of all the individual quantity demanded by each buyer in a market at each price.

Shift of Demand Curve

A price change causes a movement along a given demand curve, but it cannot cause a shift of the demand curve.

Figure 3.3
A Shift or the Demand Curve
When the price changes, the quantity demanded changes along the demand curve, as indicated by the orange arrow. A shift of the demand curve, indicated by the black arrows, occurs when something other than price changes.
Shift to the left: A health warning causes buyers to demand fewer cantaloupes.
Shift to the right: A medical study reports that eating cantaloupe lowers cholesterol, which cause buyers to demand more cantaloupe.

1. Change in Buyer's Income

  • Purchasing power is the value of your income expressed in terms of how much you can afford.
  • Consumers buy more of a normal good as income rises, holding all other factors constant.
  • An interior good is purchased out of necessity rater than choice.

2. The Price of Related Goods

  • Complements are two goods that are used together. When the price of a complementary good rises, the demand for the related good goes down.
  • Substitutes are two goods that used in place of each other. When the price of a substitute good rises, the quantity demanded of that good falls and the demand for related good goes up.

3. Changes in Tastes and Preferences

Fashion goes in and out of style.
Economics in the Media - The Hudsucker Proxy

4. Price Expectations
If we expect a price to be higher tomorrow, we are likely to buy more today to beat the price increase. The result is an increase in current demand. Likewise, if you expect a price to decline soon, you might delay your purchase to try to get a lower price in furture. An expectation of a lower price in the future will therefore decrease current demand.

5. The Number of Buyers
Demographics changes in society are another source of shifts in demand.

countries with aging populations - the demand for baby products will decline and the demand for health care will expand.

6. Taxes
Changes in excise taxes (which are taxes on a single product or service) and sales taxes (which are general taxes on most goods and services) affect demand as well.

What determines supply?

The quantity supplied is the amount of a good or service that producers are willing and able to sell at the current price.
The law of supply states that, all other things being equal, the quantity supplied of a good rises when the price rises, and falls when the price falls.

The Supply Curve

  • A supply schedule is a table that shows the relationship between the price of a good and the quantity supplied.
  • A supply curve is a graph of the relationship between the prices in the supply schedule and the quantity suppled at those prices.

Market Supply

  • The market supply is the sum of the quantities supplied by each seller in a market at each price.

Shift of Supply Curve

A price change causes a movement along a supply curve, not a shift in the curve.

Figure 3.7
A Shift of the Supply Curve
When the price changes, the quantity supplied changes along the existing supply curve, illustrated here by the orange arrow. A shift in supply occurs when something other than price changes, illustrated by the black arrows.

  • Shift to the left: A hurricane that destroys the Colombian coffee crop causes sellers to produce less coffee.
  • Shift to the right: A new way to brew a richer coffee at half the cost, causes sellers to produce more coffee.

1. The Cost of Input

  • Input are resources used in the production process. Input may include workers, equipment, raw materials, and capital goods.

2. Taxes and Subsidies

  • A subsidy is a payment made by the government to encourage the consumption or production of a good or service.

3. The Number of Firms in the Industry

If a new pizza joint opens up nearby, more pizzas can be produced and supply expands. Conversely, if a pizza closes, the number of pizzas produced and supply contracts.

  1. Price Expectations
  • A seller who expects a higher price for a product in the future may wich to delay sales until a time when the product will bring a higher price.

Florists know that the demand for roses spikes on Valentine's Day and Mother's Day.
Economics in the real world - Why do the prices of new electronics always drop?

How do supply and demand interact to create equilibrium?

Supply, Demand, and Equilibrium

  • Equilibrium occurs at the point where the demand curve and the supply curve intersect.
  • The equilibrium price is the price at which the quantity supplied is equal to the quantity demanded. It is also known as the market-clearing price.
  • The equilibrium quantity is the amount at which the quantity supplied is equal to the quantity demanded.
  • The law of supply and demand states that the market price of any good will adjust to bring the quantity supplied and the quantity demanded into balance.
Shortages and Surplus
  • A shortage,or excess demand, occurs whenever the quantity supplied is less than the quantity demanded.
  • A surplus, or excess supply occurs whenever the quantity supplied is greater than the quantity demanded.

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