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Fall 2013

Principles of Microeconomics

T. Tung

Part IV

The Market Forces of Supply and Demand


The forces of

supply

and

demand

drive interactions in

markets.

Markets occur when groups of buyers and sellers interact to exchange particular goods and services

Markets are a fundamental aspect of economics and humans constantly interact with each other within markets

Competitive Market: A market where there are many buyers and sellers. Most markets for goods are highly competitive as sellers seek to gain more business than their competition. Due to the high number of sellers, each seller has a negligible impact on the market price.

Perfect Competition:

This portion of the class relies on the assumption of perfect competition. In perfect competition, the sellers and

buyers meet specic criteria: 1. The goods oered in the market are all exactly the same. 2. There are so many buyers and sellers that no individuals have any inuence over the market price. 3. Prices are determined in the market. Thus, the buyers and sellers are all price takers.

Demand:

Demand is driven by buyers/consumers. By studying the behavior of buyers, valuable information regarding demand can be gathered.

Law of Demand:

Quantity Demanded: The amount of a good that consumers are willing and able to purchase.

The claim that, other things equal, the quantity demanded of a good falls when the price of the good rises.
Demand Schedule: A table that shows the relationship between the price of a good and the quantity demanded.

Figure 1:

Demand Curve

Visual representation of the relationship between the price and the quantity demanded

Fall 2013

Principles of Microeconomics

T. Tung

The above gure demonstrates the demand curve of one individual in the economy. ket/economy has numerous buyers who all have their own demand schedule/curve. market demand:

However, every mar-

To nd

market demand,

every individual demand curve need to be summed. Individual demand curves are added horizontally to nd total

The market demand curve represents the total demand in an economy. referred to as the demand curve for the economy.

From this point forward, it will be

Shifts in Demand:

A key element of analyzing shifts in demand is the distinction between a movement along the demand curve and

a shift in the demand curve. A change in the price of the good is the higher prices, there is a lower level of quantity demanded. Any

only

factor that can cause a movement along that aects demand will cause a

the demand curve. This makes logical sense because price is on the y-axis and the law of demand states that at

external factor

shift in the demand curve. Any factor that changes the quantity demanded at every price causes a shift.An increase in demand shifts the curve to the right and a decrease in demand shifts the curve to the left. The following factors cause a shift in the demand curve. 1.

Changes in Income
(a) For a normal good, an increase in income will shift the demand curve to the right. normal goods including books, cats, movie tickets, etc. (b) For an inferior good, an increase in income will shift the demand curve to the left. An example of an inferior good is top ramen. As an individual's income increases, we would expect them to demand less top ramen (in favor of healthier, more expensive food). Most goods are

2.

Change in the Price of a Related Good


(a) Substitute goods can be consumed in place of one another with no change in consumer happiness. Pizza and burgers are substitutes because they can be consumed in place of one another. i. When the price of a substitute increases, demand will shift to the right ii. When the price of a substitute decreases, demand will shift to the left left (b) Complementary good are consumed together. Left shoes and right shoes are almost always consumed together. Thus, they are complementary goods. i. When the price of a complement increases, demand will shift to the left ii. When the price of a complement decreases, demand will shift to the right

3. 4.

Tastes

Human's tastes are constantly evolving. This can have a positive or negative impact on demand.

Expectations of Future Income or Prices


(a) An expectation of an increase in future will income will case demand to shift to the right

Fall 2013

Principles of Microeconomics

T. Tung

(b) An expectation that the price of a good will decrease in the future will cause demand to shift to the left. 5.

Number of Buyers

Supply: Law of Supply: The claim that, other things equal, the quantity supplied of a good rises when
Supply is determined by the sellers in a market. Quantity Supplied: The amount of a good that sellers are willing and able to sell.

the price of the good rises.

Supply Schedule: A table that shows the relationship between the price of a good and the quantity supplied

Figure 2: good.

Supply Curve:

A graph that shoes the relationship between the quantity supplied and the price of a

The above gure demonstrates the supply curve of one individual seller in the economy. However, every market/economy has numerous sellers who all have their own demand schedule/curve. To nd supply:

market supply,

every

individual supply curve need to be summed. Individual supply curves are added horizontally to nd total market

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Fall 2013

Principles of Microeconomics

T. Tung

The market supply curve represents the total supply in an economy. From this point forward, it will be referred

Shifts in Supply:

to as the supply curve for an economy.

A key element of analyzing shifts in supply is the distinction between a movement along the supply curve and

a shift in the supply curve. A change in price of the good is the prices, there is a higher level of quantity supplied. Any

only

factor that can cause a movement along the that aects supply will cause a shift in

supply curve. This makes logical sense because price is on the y-axis and the law of supply states that at higher

external factor

the supply curve. Any factor that changes the quantity supplied at every price causes a shift. An increase in supply shifts the curve to the right and a decrease in supply shifts the curve to the left. The following factors cause a shift in the supply curve. 1.

Input Prices
(a) When the prices of inputs (I.e. raw materials, ingredients, etc.) increases, supply shifts to the left.

2.

Technology
(a) Improvements in technology allow for more to be produced. Thus, supply shifts to the right.

3.

Expectations
(a) If a seller believes prices in the future will rise, they will keep some of their supply in storage to capitalize on this knowledge. Supply shifts to the left.

4.

Number of Sellers

Equilibrium:

Equilibrium occurs when the market price has reached the level at which quantity supplied equals quantity demanded. Equilibrium Price: The price that comes from demand and supply being in equilibrium and quantity demanded are balanced. Also known as the market clearing price.

quantity supplied

Equilibrium Quantity: The quantity demanded and the quantity supplied at the equilibrium price. A graph allows for visual determination of what the equilibrium and the equilibrium price will be:

Surplus: A situation in which quantity supplied is greater than quantity supplied. Surplus is also referred to as excess supply. Shortage: A situation in which quantity demanded is greater than quantity supplied. Shortage is also referred to as excess demand.

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Fall 2013

Principles of Microeconomics

T. Tung

In a shortage or surplus situation, buyers and sellers interact continue to interact with each other. The result of these interactions is movement back towards the equilibrium price. When the market experiences a shortage, demand exceeds supply. Consumers wait in line or get to stores immediately when they open to purchase the good. Thus, sellers can increase the price with no impact on revenues. As prices increase, quantity demanded will decrease and quantity supplied will increase. This process continues until the equilibrium price occurs. The phenomena of price adjustments to equilibrium are so pervasive that it is called the

3 Steps to Analyzing Changes in Equilibrium:

Law of Supply and Demand.

1. Determine whether the supply curve, the demand curve, or both curves shift. 2. Which direction is the shift (left/right or positive/negative) 3. Use the supply-demand diagram to compare the initial and the new equilibrium. changes in the system aect the overall picture. (a) Note: Be very careful when there is a movement along the curve vs. a shift in the curve. How Prices Allocate Resources: How do the shifts and

We all act as part of supply or demand in an economy whenever we interact in a market. Prices determine who produces each good and how much is produced. Though the decision making process is highly decentralized, when parties interact in markets at dierent prices, ecient allocations can occur.

Examples:

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