4 - The Market Forces of Supply and Demand

4 - The Market Forces of Supply and Demand#

4.1 - Markets and Competition#

What Is a Market?#

A market is a group of buyers and sellers of a good or service.

What Is Competition?#

The term competitive market describes a market in which there are so many buyers and sellers that each has little effect on the market price.

If we assume that things are perfectly competitive, a market has the following 2 characteristics:

  1. The goods offered for sale are exactly the same.

  2. The buyers and sellers are so numerous that no single buyer or seller has any influence over the market price.

Since buyers and sellers in a perfectly competitive market must accept the price determined by the market, they are called price takers.

A market where there is only one seller and the seller sets the price is called a monopoly.

4.2 - Demand#

The Demand Curve: The Relationship between Price and Quantity Demanded#

The quantity demanded of any good is the amount that buyers are willing and able to purchase.

The law of demand states that all other things being equal, when the price of a good rises, the quantity demand falls, and when the price falls, the quantity demanded rises.

A demand schedule is a table that shows the relationship between the price of a good and the quantity demanded, holding constant everything else that influences how much of the good a consumer wants to buy.

The line on a graph denoting the relationship between price and quantity demanded is the demand curve. By convention, the y-axis is price and the x-axis is quantity demanded.

Market Demand vs. Individual Demand#

Market demand is the sum of all the individual demands for a particular good or service.

A demand schedule is a chart that shows how much of a good consumers will consume at a given price. The sum of this value for all consumers determines the market demand curve.

Shifts in the Demand Curve#

Shifts in the demand curve to the right are called increases in demand and shifts to the left are called decreases in demand.

Many variables affect changes in the demand curve, including:

  • Income

    • If the demand for something falls when income falls, it’s called a normal good

    • If the demand for something rises when income falls, it’s called an inferior good

  • Prices of related goods

    • Substitutes are goods that lower the demand of another good when their price lowers (e.g. frozen yogurt vs. ice cream)

    • Complements are goods that raise the demand of another good when their price lowers (e.g. computers and software, electricity and air conditioning)

  • Tastes

  • Expectations

  • Number of buyers

4.3 - Supply#

The Supply Curve: The Relationship between Price and Quantity Supplied#

The quantity supplied of any good or service is the amount that sellers are willing and able to sell.

The relationship between price and quantity supplied is called the law of supply.

A supply schedule shows the relationship between the price of a good and the quantity supplied. The curve showing this relationship is the supply curve.

Market Supply versus Individual Supply#

The market supply of a good is the total of all individual supplies.

Shifts in the Supply Curve#

A shift that raises the quantity supplied at every price (e.g. a fall in the price of sugar affecting ice cream supply) causes the supply curve to shift to the right, and is called an increase in supply.

Many variables can shift the supply curve, including:

  • Input prices

  • Technology

    • For example, automation lowering production costs

  • Expectations

    • For example, a suspected increase in the price of a good may cause suppliers to hold on to more of their current stock

  • Number of sellers

Note that changes in price do not shift the supply curve, but rather represent a movement on the supply curve.

4.4 - Supply and Demand Together#

Equilibrium#

The point at which the supply and demand curves intersect is called the equilibrium. The price at this point is called the equilibrium price and the quantity is called the equilibrium quantity.

At the equilibrium price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell. Because of this, the equilibrium price is sometimes also called the market-clearing price.

If the quantity supplied exceeds the equilibrium price, there is a surplus of the good, which can also be called an excess supply. This results in the lowering of the price of the good, which is a movement along the supply and demand curves. This occurs until the equilibrium is achieved.

Similarly, if the quantity demanded exceeds the quantity supplied, there is a shortage of the good, which can also be called an excess demand.

The law of supply and demand is a phenomenon that describes how the price of any good adjusts to bring the quantity supplied and the quantity demanded into equilibrium.

Three Steps to Analyzing Changes in Equilibrium#

The 3 steps age given as followed:

  1. Decide if the event shifts the supply or demand curve (or both).

  2. Decide in which direction the curve(s) shifts.

  3. Use a supply-and-demand diagram to see how the shift changes the equilibrium price and quantity.

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