Market Model Note
Market Model Note EC101-05
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This 6 page Class Notes was uploaded by Prasanna Notetaker on Monday March 7, 2016. The Class Notes belongs to EC101-05 at Southeast Missouri State University taught by Mr. Brian Gehring in Spring 2016. Since its upload, it has received 21 views.
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Date Created: 03/07/16
Market Model In theory, we assume that all people in a market pay the equilibrium price, and that the seller gets the equilibrium price for each unit sold. This is the case in the absence of information that indicates otherwise. Of course, most people who buy the product would be willing to pay more than the equilibrium price, given that the demand curve is above the equilibrium price for nearly all units purchased. Note in the graph below the distance between the equilibrium price line and the demand curve. That distance represented by the triangle with CS represents how much more consumers would be willing to pay than the equilibrium price, and it also represents the additional value consumers who buy the product get from it in excess of what it costs. If the most a person is willing to pay for a product is $29 (based on the value expected from the product), and the person only has to pay $18 to get the product (equilibrium price), then the consumer has a net gain of $11 of value by purchasing the product. The seller would be willing to accept less than the equilibrium price for nearly all units sold, given that the supply curve for most of the units sold is below the equilibrium price. Nonetheless, there is typically one market price for all people in the market. The seller might have a minimum price acceptable for a unit of $8, but will sell the unit for $18. The difference is a net gain for the seller. This is represented by the distance between the supply curve and the equilibrium price. For all units sold, this area is represented by the triangle PS. $29 $8 S EP = $18 CS P D PS EQ = 100 Q If the quantity that is sold is less than equilibrium (equilibrium = 100), then consumers and producers aren’t getting as much of the net gain (CS and PS) from the market as they could if 100 units were sold. In markets that lack unusual circumstances, economic theory indicates that a quantity sold that is less than equilibrium quantity is a less-than-ideal quantity. Net gains could be realized by increasing the units sold up to 100. If more than 100 units are sold, then a less- than-ideal situation exists because buyers and sellers are incurring net losses with units beyond 100. Beyond 100, the sellers’ minimum price acceptable is higher than $18. The maximum price consumers are willing to pay (based on expected value from the product) is less than $18. Out of self-interest, with complete information, buyers and sellers would not want to trade more than 100 units. They also would not want to stop short of 100 units. Now that the basic model and all its components have been explained, the next step is to look at market conditions and start using it. The determinants of demand are what determine how many units the people in the market are willing and able to purchase at the various prices. There are many things that determine demand, but some of the important ones will be discussed. Bear in mind that these things determine the values in the demand schedule, and they determine where the demand curve is in the graph. Tastes and Preferences: This is something that affects the “willingness” part of the definition for demand. The more preferable something is, the greater the demand will be for it. Trends, fashion, and the desire for good living all affect our tastes and preferences for things. If a celebrity is hired to promote a particular product, the demand for that product will likely increase. Number of Consumers and Demographics: The more consumers in a market, the greater the demand will be. The composition of the people can affect demand for things. If the average age of people in the market is pretty old, then the demand for baby cribs will be fairly low. When more consumers enter the market, as it is defined, demand increases. Consumer Income: This is related to the “ability” part of the definition for demand. The greater the ability to purchase, the greater demand will be. When consumer income increases, demand increases for normal goods. For inferior goods, demand will actually decrease. People want to upgrade from inferior goods when their income rises. Expectations About Prices and Income: When someone who is contemplating the purchase of something expects the price of that item to change in the future, that change in price expectations can affect his demand in the current period. If he expects the price to increase in the future, he will be more likely to buy it in the current period. His demand increases in the current period represented by the market model. If a person expects his income to increase in the future, that will likely increase his demand for things today. He might buy on credit. Substitutes: Two goods are substitutes if they serve a similar purpose. Virtually every good has a substitute available. It might not be a good substitute, but when the price of something rises, we typically start looking for alternative products that will serve the same purpose at a lower price. When the price of one good rises, the demand for its substitute will increase. Complementary Goods: These are goods that one prefers to consume jointly, or together. The satisfaction from one is enhanced if the other is consumed, or used, with it. The tennis balls have limited value without the tennis racket. When the price of one decreases, the quantity demanded of it will increase, and the demand for the complementary good increases. The effect of these changes can be seen in the following graph. It causes the market price to rise, and more units are bought and sold. Notice that when demand increases, the quantity demanded increases at each price. This is indicated by the purple arrows for two of the many prices. 1 2 Q There are determinants of supply that determine the values in the supply schedule, and they determine where the supply curve is in the graph. Resource Costs: Since producers and sellers are in business to make a profit, they have to charge a high enough price to get sufficient revenue to cover costs and make a normal profit. The minimum price that is acceptable to them depends greatly on costs of production. When a resource needed to produce the good in the market has a price increase, the producer of the good will need to sell at a higher price to cover the increased cost of production. This causes the supply to decrease (the effect of an increase in the minimum price acceptable). When the cost of production falls then supply increases. Technology: The level of technology affects productivity. Typically, workers can produce more in a given time period with better technology. Waste is typically reduces as well. A producer can produce more with the same resources. This spreads the overall cost of production among more units, reducing the average cost. The minimum acceptable price will fall because of this. Supply increases. Excise Tax: If this is imposed on the seller of a product, then the seller has to pay the government the amount of the tax for each unit sold. This is viewed as an additional cost of doing business that must be covered by revenue. The seller needs more revenue to cover this cost, so the minimum price acceptable to the seller rises. This reduces (decreases) supply. Subsidies: When the government gives the seller a subsidy for each unit sold, this is viewed by the seller as additional revenue for which no additional cost was incurred to get the additional revenue. Now the seller doesn’t need to ask for as much from the customer to get the revenue needed to cover costs and make a normal profit. The minimum price acceptable falls, and supply increases. Number of Sellers: When a new seller of a product enters a market, this will increase supply. The total number of units sellers are willing to sell in the market will be greater than before. Acts of Nature and Political Disruptions: Adverse acts of nature have the effect of increasing costs of production, and that decreases supply. Political disruptions have the same effect. Expectations of Prices: When a producer thinks that the price of something he sells will rise in the future, he will prefer to sell later if possible. He will continue producing, but he will hold more of his product with the intention of selling at a higher price in the future. This reduces (decreases) supply in the current period. He may actually increase production now, but he will put it in inventory to sell in a later period. He isn’t willing to sell as much in the current period. Once again, that means supply decreases now. In the graph that follows, the effect of an increase in supply can be seen. The price in the market is expected to fall while more units are bought and sold. The quantity supplied increases at each price. Purple arrows indicate this for two of the many prices. S1 P S2 1 2 D1 1 2 Q By Brian Gehring