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Date Created: 09/23/15
ECON 201 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND MARKETS AND COMPETITION De nition of Market A group of buyers and sellers of a particular good or service In order to analyze a market you need to identify characteristics of goods andor services traded agents buyers and sellers structure of the market degree of competition Markets can be highly organized agricultural commodities and less organized ice cream in a town A market is competitive if there are many buyers and many sellers and each has a negligible impact on market price A market is perfectly competitive if it meets the following key conditions 1 There are many buyers and many sellers each of which is small relative to the market 2 Each rm in the market produces a homogeneous identical product 3 Buyers and sellers have perfect information 4 There are no transactions costs 5 There is free entry and exit in the market The above conditions imply that buyers and sellers are price takers and they must accept the price determined on the market Monopoly is a market structure in which a single firm serves an entire market for a good that has no close substitutes In a monopoly the seller sets the price Opposite of perfect competition All other market structures are between perfect competition and monopoly DEMAND Quantity demanded Amount of good that buyers are willing and able to purchase Law of demand Holding other things constant when the price of the good rises the quantity demanded of that good falls price and quantity demanded are inversely related A demand schedule is a table showing the relationship between the price of a good and the quantity demanded of that good A demand curve graphs the demand schedule it is a graph showing the relationship between the price of a good and the quantity demanded of that good Changes in the price of a good lead to a change in the quantity demanded of that good This corresponds to a movement along a given demand curve The market demand curve is the horizontal sum of the individual demand curves to nd the total quantities demanded in the market at each price we sum the individual quantities that are demanded at that price See Market Schedule and Market Demand as the sum of individual demands on Figure 2 page 69 The quantity demanded in a market is the sum of the quantities demanded by all the F I G U R E 2 buyers at each price Thus the market demand curve is found by adding horizontally the individual demand curves At a price of 200 Catherine demands 4 icecream cones and Nicholas demands 3 icecream cones The quantity demanded in the Market Demand as market at this price is 7 cones the sum of Individual Demands Price of IceCream Cone Catherine Nicholas Market 000 12 7 19 cones 050 1D 6 100 8 5 13 150 6 4 10 200 4 3 7 250 2 2 4 300 0 1 1 Catherine39s Demand Nicholas39s Demand Market Demand Price of Prlce of Prlce of IceCream Icecream Icecream Cane ne Cone 300 300 7 300 7 250 7 250 7 250 7 2n n An nnn 150 7 150 150 7 100 7 100 100 7 DCaEhenne Dmm 050 7 050 0mmas 050 7 ill lllllll ll lll lllll llllllllllllllll 123 6789101112 12 456789101112 2 4 6 81012141618 Quantity of IceCream Cones Quantity of lceCream Cones Quantity of IceCream Cones Changes in the price of a good lead to a change in the quantity demanded of that good movements along the demand Changes in variables other than the price of a good such as income tastes or the price of another good lead to a change in demand shi s of the entire demand curve Shifts in the demand curve Increase in demand Any change that increases the quantity demanded at every price Demand curve shifts right Decrease in demand Any change that decreases the quantity demanded at every price Demand curve shifts left Variables that can shift the demand curve Income Normal goods versus Inferior goods Prices of related goods Substitute versus Complement related goods Tastes informative and persuasive advertising and changes in composition of the population Expectations expectations of higher prices and stockpiling of durable products Number of buyers changes in size of the population Simple Examples Draw a demand curve for music downloads What happens to it in each of the following scenarios Why A The price of iPods falls B The price of music downloads falls C The price ofCDs falls SUPPLY Quantity supplied Amount of a good that sellers are willing and able to sell Law of supply Holding other things constant when the price of the good rises the quantity demanded of that good rises price and quantity demanded are directly related A supply schedule is a table showing the relationship between the price of a good and the quantity supplied of that good A supply curve graphs the supply schedule it is a graph showing the relationship between the price of a good and the quantity supplied of that good Changes in the rice of a good lead to a change in the quantity supplied of that good This corresponds to a movement along a given supply curve The market supply curve is the horizontal sum of the individual supply curves to nd the total quantities supplied in the market at each price we sum the individual quantities that are supplied at that price See Market Schedule and market supply as the sum of individual supplies on Figure 6 page 75 F I G u R E 6 Price 01 lcerCream Corie Ben Jerry Market Market Supply as the Sum of nclividual Supplies 000 0 D Ucones The quantity supplied in a market is l 50 u n a sum of the quantities supplied 100 1 o i by all the sellers at each price Thus 150 2 2 4 the market supply curve is found by 200 3 4 7 adding horizontally the individual 2 50 4 A 10 supply curves At a price of 2400 300 5 a 13 Ben supplies 3 icecream cones and Jerry supplies 4 icecream cones The quantity supplied in the market at this price is 7 cones Ben s Supply Jerry39s Supply Market Supply 5mm l l 1011 12 Changes in the price of a good lead to a change in the quantity supplied of that good movement along the supply Changes in variables other than the price of a good such as income tastes or the price of another good lead to a change in demand shi s of the entire supply curve Shifts in supply Increase in supply Any change that increases the quantity supplied at every price Supply curve shi s right Decrease in supply Any change that decreases the quantity supplied at every price Supply curve shi s le Variables that can shift the supply curve Input Prices Supply is negatively related to prices of inputs Technology Advance in technology lead to increase in supply Expectations about lture Number of sellers Simple Examples Draw a supply curve for tax return preparation so ware What happens to it in each of the following scenarios A Retailers cut the price of the so ware B A technological advance allows the so ware to be produced at lower cost C Professional tax return preparers raise the price of the services they provide SUPPLY AND DEMAND TOGETHER In Equilibrium market price has reached the level at which quantity supplied quantity J J J Producers are willing and able to sell exactly as much as buyers are willing and able to buy If Quantity supplied gt guantity demanded there is excess supply surplus and since rms are producing more than they can sell at a certain price there is a downward pressure on the price movement toward the equilibrium If Quantity demanded gt guantity supplied there is excess demand shortage and since there is not enough of the good to satisfy all consumers at a certain price there is an upward pressure on the price movement toward the equilibrium Figure 9 ln nannllal mm Hlnln nnullihrinm min 39 I H A rnnnl 39 39 39 39 and mi m m Inn n HH 0 r l mm H Rarau 50h marlwf nrim nf v 39 mm 39 quot 39 Hanna in and demand 3 Excess Supply h Ems Demand Prim a Pike 0 klCmam Supj IreCream gum ane Fm A mm Demand Dummy cl Onamity ul gm WWW krfveam my IKeCIEEIII ij idv L Cones p Lad Canes According to the Law of Supply and Demand the price of any good adjusts to bring the quantity supplied and the quantity demanded into balance Therefore in most markets surpluses and shortages are temporary Supply and demand together determine the prices of goods and services prices in turn are the signals that guide the allocation ofresources When some event in the market shi s either the demand curve or the supply curve or both the equilibriurn in the market changes This results in a new price and a new quantity exchanged between buyers and sellers To determine the effects of any event 1 Decide whether event shi s the supply curve the demand curve or both 2 Decide in which direction curve shi s 3 Use supplydemand diagram to see how the shi changes equilibrium price and quantity Terms for Shifts versus Movements along the curve Change in supply a shift in the Supply curve occurs when a nonprice determinant of supply changes like technology or costs Change in the quantity supplied a movement along a xed Supply curve occurs When Price changes Change in demand a shi in the Demand curve occurs when a nonprice determinant of demand changes like income or number of buyers Change in the quantity demanded a movement along a xed Demand curve occurs When Price changes How an Increase in Demand Affects the Equilibrium Figure Pritaof iceream How an Increase in Cm Demand Affects the Equilibrium Arr evenl that raises quantity demanded at any given price shifts the demand curve to the ht MW quot9 r V V New equimrm and the equilibrium quantrty h th yr a 39 hot summer rauses buyers to demand more ite cream rmlra will mm from DV to D1 whith causes the equilibrium price to rise rom 5200 to 250 and the equrlibrium quantity to rise 9 from 7 to to ones Quantity ol Ireream wills How a Decrease in Supply Affects the Equilibrium Irma Equlllblium Other Examples of Market Equilibrium Analysis and Curve Shifts Events in the Middle East lead to expectations of higher oil prices in few months In response owners of Texas oil elds decide to save some inventory to sell later at the higher price What happens now to the equilibrium price of oil Draw a supply and a demand curve for hybrid cars What happens if the price of gas 39 A ND new p1 uductiuu costs TOPICS OF DISCUSSION Changes in equilibrium due to shi s in demand and supply a Government intervention and the reduction of smoking informative and persuasive advertising versus tobacco taxation b The baby boomer effect on real estate prices equity prices and bond prices 0 V The effect of winter freeze on the prices of green beans tomatoes and on the size of Tropicana Orange Juice containers d The 20052007 depreciation of the dollar versus the price of US food commodities
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