Microeconomics The purpose of this section is to identify and explain the importance of markets and the role played by demand and supply. The failure of a market system are identified and possible solutions are examined.

Market  Is a situation where potential buyers are in contact with potential sellers (any place where buyers and sellers meet)  It enables the needs and wants of both parties to be fulfilled while establishing a price and allowing an exchange to take place.

Competitive Market  Is the market for a good with large numbers of buyers and sellers, where the single seller has very little or no market power Market power – ability to control the price Market power – ability to control the price

Market Structures  Perfect competitions Agricultural commodities (eg. Wheat, coffee) Agricultural commodities (eg. Wheat, coffee)  Monopolistic competitions Mechanics, restaurants, books Mechanics, restaurants, books  Oligopoly Airlines, breakfast cereals, cell phone networks Airlines, breakfast cereals, cell phone networks  Monopoly Local utilities Local utilities

Market Structures: Criteria 1. The no. of firms in the industry How many competitors How many competitors More firms mean more competitors, more consumer sovereignty & less market power More firms mean more competitors, more consumer sovereignty & less market power Consumer Sovereignty - consumers have a good deal of influence on prices and outputConsumer Sovereignty - consumers have a good deal of influence on prices and output

Market Structures: Criteria 2. A firm’s level of market power Ability of the firm to control the price of its product Ability of the firm to control the price of its product A firm will have a lot of market power when there are few competitors and few substitutes; less consumer sovereignty as a result A firm will have a lot of market power when there are few competitors and few substitutes; less consumer sovereignty as a result

Market Structures: Criteria 3. The degree of product differentiation between goods offered by different firms Homogeneous goods – identical & substitutable (i.e. rice, coffee, corn) Homogeneous goods – identical & substitutable (i.e. rice, coffee, corn) Heterogeneous goods – diffirentiated from possible substitutes (i.e. furniture, appliances) Heterogeneous goods – diffirentiated from possible substitutes (i.e. furniture, appliances)

Market Structures: Criteria 4. The ease of exit and entry Mean that it is difficult/costly for potential newcomers (firms) to enter the market Mean that it is difficult/costly for potential newcomers (firms) to enter the market High entry costs will reduce competition entering the market and stop the erosion of profitsHigh entry costs will reduce competition entering the market and stop the erosion of profits

Market Structures and their characteristics Perfect Competition MonopolisticCompetition Oligopoly OligopolyMonopoly Number of Firms Very many ManyFewOne Market Power None NoneLowHigh Very High Level Level of differentiation of differentiation Homogeneous ; no substitutes Hetero- geneous Both depending on industry None, no close subst. Barriers to Entry NoneLowHigh Very High

Importance of Price  Price signals the suppliers as to how much of the good should be put on the market  Shortage (demand > supply) will drive up the price  Surplus (supply > demand) would put downward pressure on the price  Equilibrium point is reached when supply equals demand

Goods Market The price mechanism: the effect of a rise in demand The price mechanism: the effect of a rise in demand

Goods Market DgDg  The price mechanism: the effect of a rise in demand The price mechanism: the effect of a rise in demand

Goods Market DgDg  shortage (D g > S g ) The price mechanism: the effect of a rise in demand The price mechanism: the effect of a rise in demand

Goods Market DgDg  shortage (D g > S g ) PgPg  The price mechanism: the effect of a rise in demand The price mechanism: the effect of a rise in demand

Goods Market DgDg  shortage (D g > S g ) PgPg  SgSg  The price mechanism: the effect of a rise in demand The price mechanism: the effect of a rise in demand

Goods Market DgDg  shortage (D g > S g ) PgPg  SgSg  DgDg  The price mechanism: the effect of a rise in demand The price mechanism: the effect of a rise in demand

Goods Market DgDg  shortage (D g > S g ) PgPg  SgSg  DgDg  until D g = S g The price mechanism: the effect of a rise in demand The price mechanism: the effect of a rise in demand

Definition of Demand  Is the quantity of a good or service that consumers are willing and able to purchase at a given price in a given time period  Negative relationship between the variables of price and quantity

Price ($ per Bicycle) Quantity Demanded (Millions of Bicycles) As the price of a product falls, the quantity demanded of the product will increase, ceteris paribus.

The demand curve: The demand for potatoes (monthly)

Quantity (tonnes: 000s) Price (pence per kg) Price (pence per kg) 20 Market demand (tonnes 000s) 700 A Point A Market demand for potatoes (monthly) Demand

Quantity (tonnes: 000s) Price (pence per kg) Price (pence per kg) Market demand (tonnes 000s) ABAB Point A B Demand Market demand for potatoes (monthly)

Quantity (tonnes: 000s) Price (pence per kg) Price (pence per kg) Market demand (tonnes 000s) ABCABC Point A B C Demand Market demand for potatoes (monthly)

Quantity (tonnes: 000s) Price (pence per kg) Price (pence per kg) Market demand (tonnes 000s) ABCDABCD Point A B C D Demand Market demand for potatoes (monthly)

Quantity (tonnes: 000s) Price (pence per kg) Price (pence per kg) Market demand (tonnes 000s) ABCDEABCDE Point A B C D E Demand Market demand for potatoes (monthly)

3 Reasons for increase in demand  1. Income Effect - when the price of a product falls, people will have an increase in their “real income”, people will be likely to buy more of the product

3 Reasons for increase in demand  2. Substitution Effect - when the price of a product falls, consumers will purchase more of that product, substituting it for products that were previously purchased whose prices have stayed unchanged

3 Reasons for increase in demand  3. The law of diminishing marginal utility - this law states as we consume additional units of something, the satisfaction (utility) we derive for each additional unit (marginal unit) grows smaller (diminishes).

Demand Exercise Draw a demand schedule for movie tickets Price of tickets ($) Quantity Demanded

The determinants of demand  Factors that determine demand and lead to an actual shift of the demand curve to either right or left  Variable that changes the pattern of demand other than price (non-price determinant of demand)  Always make the ceteris paribus assumption

The determinants of demand 1. Income – (2 types of products to consider)  Normal Goods - as income rises, the demand for normal goods will also rise - an increase in income will cause the demand curve to shift to the right  Inferior Goods - demand for inferior goods will fall as income rises (consumers starts to buy higher priced substitutes) - an increase in income will cause the demand curve to shift to the left

Price of normal goods ($) Quantity of normal goods 0 Q1 Q P D D1 Increase in income

Price of inferior goods ($) Quantity of inferior goods 0 QQ1 P D1 D Increase in income

Rule to NOTE  Changing the price does not change demand but the quantity demanded  A change in the quantity demanded is a movement along the demand curve

Price ($) Quantity 0 Q1 Q P D P1 Increase in quantity demanded

Price ($) Quantity 0 D D1 Increase in demand

Shifts in the demand curve Shifts in the demand curve

D1D1 Price P OQ0Q0 Q1Q1 Quantity An increase in demand D0D0

D0D0 Price P OQ0Q0 Q1Q1 Quantity A decrease in demand D1D1

The determinants of demand 2. The price of other products  Substitutes – if products are substitutes of each other, then a change in the price of one of the products will lead to a change in the demand for the other product  Complements – products that are often purchased together  Unrelated goods – if products are unrelated, then a change in the price of one product will have no effect upon the demand for the other product

Price (Soda A) Quantity Demanded As the price of soda A increases, the quantity demanded for soda B will increase, ceteris paribus.

D1D1 Price P OQ0Q0 Q1Q1 Qd An increase in demand for soda B D0D0

The determinants of demand  Tastes and Preferences  Expectations of future prices and income  Number of potential buyers  Demographic change  Government policy changes  Seasonal changes

The supply curve

Supply  Is the willingness and ability of producers to produce a quantity of a good or service at a given price in a given time period  Law of supply states: As the price of a product rises, the quantity supplied of the product will usually increase, ceteris paribus As the price of a product rises, the quantity supplied of the product will usually increase, ceteris paribus

Supply Exercise Draw a Supply schedule for frozen pizzas Price of frozen pizza ($) Quantity Supplied per week

The supply curve: The supply of potatoes (monthly)

Price (pence per kg) Quantity (tonnes: 000s) Supply a P 20 Q 100 a Market supply of potatoes (monthly)

Price (pence per kg) Quantity (tonnes: 000s) Supply a b P Q abab Market supply of potatoes (monthly)

Price (pence per kg) Quantity (tonnes: 000s) Supply a b c P Q abcabc Market supply of potatoes (monthly)

Price (pence per kg) Quantity (tonnes: 000s) Supply a b c d P Q abcdabcd Market supply of potatoes (monthly)

Price (pence per kg) Quantity (tonnes: 000s) Supply a b c d e P Q abcdeabcde Market supply of potatoes (monthly)

Determinants of Supply  Cost of factors of production

P QO S0S0 Shifts in the supply curve

P QO S0S0 Increase S1S1 Shifts in the supply curve If cost of production decreased

P QO S2S2 S0S0 S1S1 IncreaseDecrease Shifts in the supply curve If cost of production increased

Determinants of Supply  Cost of factors of production  Productivity  Price of other products, which the producer could produce instead of the existing product - Producer Substitutes - Producer Complements

Determinants of Supply  Availability and scarcity of factors  Unexpected events / Supply Shocks  The state of technology  Government Intervention - Indirect Taxes (VAT – value added tax) on consumption will in effect be an increase in costs for producers, which will decrease supply - Subsidy is a payment to producers which lowers costs and also acts as an incentive to produce more

Rule to NOTE  Changing the price does not change supply but the quantity supplied  A change in the quantity supplied is a movement along the supply curve

Price ($) Quantity 0 P0P0 S0S0 Q0Q0 Increase in quantity supplied Q1Q1 Decrease in quantity supplied Q2Q2

Price ($) Quantity 0 P0P0 S0S0 S2S2 S1S1 Increase in Supply Decrease in Supply

Shifting the supply curve exercise Wages for road workers fall Effect: cost of making road… falls Supply curve for roads shifts… RIGHT

Shifting the supply curve exercise Price of steel rises Effect: cost of making cars… rises Supply curve for cars shifts… LEFT

Shifting the supply curve exercise Price of flour falls Effect: cost of making bread… falls Supply curve for bread shifts… RIGHT

Shifting the supply curve exercise Fewer study medicine Effect: Fewer doctors in hospitals Supply curve for health care shifts… LEFT

Shifting the supply curve exercise Pilots go on strike Effect: Fewer flights available Supply curve for air travel shifts… LEFT

Shifting the supply curve exercise New copper deposits found Effect: More copper available Supply curve for electrical wire shifts… RIGHT

Shifting the supply curve exercise Increased use of robots Effect: Industrial production is faster Industrial supply curve shifts… RIGHT

Shifting the supply curve exercise Better basic education Effect: All laborers more efficient Supply curve for everything shifts… RIGHT

Shifting the supply curve exercise IT revolution Effect: Most production are more efficient Supply curve for most goods shifts… RIGHT

Shifting the supply curve exercise Increased restrictions on cigarette sales Effect: Fewer sales outlets for cigarettes Supply curve shifts to the… LEFT

Shifting the supply curve exercise Taxes on gasoline are increased Effect: A larger portion of sales revenue goes to the government Supply curve shifts to the… LEFT

Shifting the supply curve exercise A subsidy is granted for the production of milk Effect: Milk producers have an incentive to produce more milk Supply curve shifts to the… RIGHT

Increase in Demand – rightward shift in the D curve  An increase in income  A favorable change in taste  An increase in population  A decrease in price of complements  An increase in price of substitutes

Decrease in Demand – leftward shift in the D curve  A decrease in income  An unfavorable change in taste  A decrease in population  An increase in price of complements  A decrease in price of substitutes

Increase in Supply – rightward shift in the S curve  Growing Industry  Technology lowering costs  Prices of inputs falling  Subsidies  Favorable weather conditions

Decrease in Supply – leftward shift in the S curve  Declining industry  Technology raising costs  Prices of inputs rising  Indirect taxes  Unfavorable weather conditions

Terms to know: Market Competitive Market Perfect Competition Monopolistic Competition Oligopoly Monopoly

Terms to know: Demand Law of Demand Marginal benefit Determinants of Demand Normal good vs. Inferior good Substitute good vs. Complementary goods

Terms to know: Supply Law of Supply Determinants of Supply Supply Substitute

Online Exercise ne/bacContentFiles/EconomicFiles/Q uizzes/Eco_C2/Intro.html

Review exercise Explain why the demand curve for bicycles might increase egory/law-of-demand/

Review exercise Explain why the supply of coffee beans might decrease ive-main-reasons-coffee-prices-are- rising-in-2011-–-price-of-coffee- beans-going-up/