1 Market Demand and Supply ©2006 South-Western College Publishing

The Market Forces of Supply and Demand uSupply and demand are the two words that economists use most often. uSupply and demand are the forces that make market economies work. uModern microeconomics is about supply, demand, and market equilibrium.

Markets uA market is a group of buyers and sellers of a particular good or service. uThe terms supply and demand refer to the behavior of people... as they interact with one another in markets.

Markets u Buyers determine demand. u Sellers determine supply.

Market Type: A Competitive Market A competitive market is a market...  with many buyers and sellers.  that is not controlled by any one person.  in which a narrow range of prices are established that buyers and sellers act upon.

Competition: Perfect and Otherwise uProducts are the same uNumerous buyers and sellers so that each has no influence over price uBuyers and Sellers are price takers Perfect Competition

Competition: Perfect and Otherwise uMonopoly u One seller, and seller controls price uOligopoly u Few sellers u Not always aggressive competition

Competition: Perfect and Otherwise uMonopolistic Competition u Many sellers u Slightly differentiated products u Each seller may set price for its own product

9 What is demand? Demand represents the choice making behavior of buyers

Demand Schedule

Law of Demand The law of demand states that there is an inverse relationship between price and quantity demanded.

12 What is a demand curve? Depicts the relationship between price and quantity demanded

13 Why do demand curves have a negative slope? At a higher price buyers will buy fewer units, and at a lower price they will buy more units

Ceteris Paribus Ceteris paribus is a Latin phrase that means all variables other than the ones being studied are assumed to be constant. Literally, ceteris paribus means “other things being equal.” The demand curve slopes downward because, ceteris paribus, lower prices imply a greater quantity demanded!

15 Market Demand uMarket demand refers to the sum of all individual demands for a particular good or service. uGraphically, individual demand curves are summed horizontally to obtain the market demand curve.

16 IMPORTANT - KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY DEMANDED AND A CHANGE IN DEMAND

17 When price changes, what happens? The curve does not shift - there is a change in the quantity demanded

18 Change in Price Change in Quantity Demanded

19 When something changes other than price, what happens? The whole curve shifts,there is a change in demand

20 What can cause a demand curve to shift? A change in: Number of buyers in the market Tastes and preferences Income Expectations of consumers Prices of related goods

21 Change in a Nonprice determinant Leftward or rightward shift in the demand curve Decrease or increase in demand

22 Why does Sunkist a major producer of oranges, provide free orange recipes? To increase the demand for oranges, of coursehttp://

Consumer Income uAs income increases the demand for a normal good will increase. uAs income increases the demand for an inferior good will decrease.

24 What are substitute goods? Goods that compete with one another for consumer purchases

25 What happens when the price increases for a good that has a substitute? The demand curve for the substitute good increases

26 What happens when the price decreases for a good that has a substitute? The demand curve for the substitute good decreases

27 What does a direct relationship between price and quantity mean? The two move in the same direction

28 What are complementary goods? Goods that are jointly consumed with another good

29 What happens when the price increases for a good that has a complement? The demand curve for the substitute good decreases

30 What happens when the price decreases for a good that has a complement? The demand curve for the substitute good increases

31 What does an inverse relationship between price & quantity mean? It means that the two move in opposite directions

32 What is supply? Supply represents the choice making behavior of sellers

Supply Schedule

34 What is the law of supply? The principle that there is a direct relationship between the price of a good and the quantity sellers are willing to offer for sale in a defined time period, ceteris paribus

35 Why do supply curves have a positive slope? Only at a higher price will it be profitable for sellers to incur the higher opportunity cost associated with supplying a larger quantity

36 What is market supply? The horizontal summation of all the quantities supplied at various prices that might prevail in the market

37 IMPORTANT - KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY SUPPLIED AND A CHANGE IN SUPPLY

38 When price changes, what happens? The curve does not shift - there is a change in the quantity supplied

39 Change in Price Change in Quantity Supplied

40 When something changes other than price, what happens? The whole curve shifts - there is a change in supply

41 Change in nonprice determinant Change in supply

42 What can cause a supply curve to shift? A change in: Number of sellers in the market Technology Resource prices Taxes and subsidies Expectations of producers Prices of other goods the firm could produce

43 What is the equilibrium price? The price towards which the economy tends

44 Where is the equilibrium price? At the price where the quantity demanded and the quantity supplied are equal

45 Surplus When the price is above the equilibrium price, the quantity supplied exceeds the quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

46 Shortage When the price is below the equilibrium price, the quantity demanded exceeds the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

Steps To Analyzing Changes in Equilibrium uDetermine the Event uDecide whether the event shifts the supply or demand curve (or both in very rare cases). uShift demand or supply to the left or to the right. (Make a cheat sheet!) uFind the new equilibruim uExamine how the shift affects equilibrium price and quantity.