1. Business in Competitive Markets.
9th of October

2. Markets and Competition
What happens
To the price of petrol when war breaks out in Iran
To the price of mangoes when farmers have an abundant year
To the number of tourists when the tsunami hit Sri-Lanka
All of the above show the workings of Supply and Demand
Supply and Demand are the forces that make market economies work.
They determine the following
Quantity of Goods produced
Price of which goods are sold

3. What is a Market?
A group of buyers and sellers of a particular good or service.
Characteristics of markets
Organized markets
Less Organized markets.
A competitive market is a market which has many buyers and sellers so that each has a negligible impact on price.
For today’s class we will assume that markets are perfectly competitive.
The goods offered for sale are exactly the same so that no single buyer or seller has influence over price.

4. Demand Law of Demand The claim that other things equal the quantity
Quantity Demanded – the amount of a good that buyers are willing and are able to pay.
Market Demand – the sum of all individual demand for a particular good or service
Law of Demand
The claim that other things equal the quantity
Demanded of a good falls when the price of
The good increases.
Teach a parrot the terms 'supply and demand' and you've got an economist. Thomas Carlyle

5. Demand Relationship between demand and price The demand curve
the ‘law of demand’
the income effect
the substitution effect
The demand curve
constructing the demand curve
individual and market demand curves
assumptions 2

6. Price of Related Goods Substitutes Complements
Two goods for which an increase in price of one leads to an increase in demand for the price of the other
Complements
Two goods for which an increase in the price of one leads to a decrease in demand for the other.

7. Market demand for potatoes (monthly)
Point
Price
(pence per kg) 20 40 60 80
100
Market demand
(tonnes 000s)
700
500
350
200
100 A B C D E D C
Price (pence per kg) B A
Demand
Quantity (tonnes: 000s)

8. Demand Other determinants of demand tastes
number and price of substitute goods
number and price of complementary goods
income
distribution of income
expectations 3

9. Demand Movements along and shifts in the demand curve change in price
 movement along D curve
change in any other determinant of demand
 shift in D curve
increase in demand  rightward shift
decrease in demand  leftward shift 3

10. P Price O Q0 Q1 Quantity An increase in demand D1 D0
Possible causes of a rise in demand
Tastes shift towards this product
Rise in price of substitute goods
Fall in price of complementary goods
Rise in income
Expectations of a rise in price P
Price D0 O Q0 Q1
Quantity

11. Supply Law of Supply Quantity Supplied
The amount of a good that sellers are willing and able to sell.
Law of Supply
The claim that other things equal the quantity
Supplied of a good increase when the price of
The good increases.

12. Market supply of potatoes (monthly)d P 20 40 60 80
100 Q
100
200
350
530
700 a b c d e c
Price (pence per kg) b a
Quantity (tonnes: 000s)

13. Supply Other determinants of supply costs of production
profitability of alternative products (substitutes in supply)
profitability of goods in joint supply
nature and other random shocks
aims of producers
expectations of producers 5

14. Supply Movements along and shifts in the supply curve change in price
 movement along S curve
change in any other determinant of supply
 shift in S curve
increase in supply  rightward shift
decrease in supply  leftward shift 5

15. Shifts in the supply curve
Possible causes of a rise in supply
Fall in costs of production
Reduced profitability of alternative products that could be supplied
Increased profitability of goods in joint supply
Benign shocks
Expectations of a fall in price S0
Increase O Q

16. Shifts in the supply curve
Decrease
Increase O Q

17. Price and Output Determination
Equilibrium price and output
response to shortages and surpluses
shortage (D > S)
 price rises
surplus (S > D)
 price falls
significance of ‘equilibrium’ 7

18. Equilibrium price and output: The market demand and supply of potatoes (monthly)

19. The determination of market equilibrium (potatoes: monthly)
Supply D d C c
Price (pence per kg) B b a A
Demand
Quantity (tonnes: 000s)

20. The determination of market equilibrium (potatoes: monthly)
Supply D d C c
Price (pence per kg) b
SHORTAGE
( ) B a A
Demand
Quantity (tonnes: 000s)

21. The determination of market equilibrium (potatoes: monthly)
Supply D d
SURPLUS
( ) C c
Price (pence per kg) b B a A
Demand
Quantity (tonnes: 000s)

22. The determination of market equilibrium (potatoes: monthly)
Supply D d
Price (pence per kg) b B a A
Demand Qe
Quantity (tonnes: 000s)

23. Effect of a shift in the demand curveP S i
Pe2 g h
Pe1 D2 D1 O
Qe1
Qe2 Q

24. Effect of a shift in the supply curvek
Pe3 j g
Pe1 D O
Qe3
Qe1 Q

25. Surplus and Shortage Surplus – A situation where Qs is greater than Qd
Shortage – A situation where Qd is greater than Qs
No change in Supply
An increase in supply
Decrease in supply
No change in demand
P.Q No change
P down
Q up
P up
Q down
Increase in Demand
P ambiguous
P is up
Q ambiguous
Decrease in demand
P down Q down

26. Production Possibilities Frontier
A graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.
Example
Economy can produce 300 shirts or 100 cakes
Producing at the PPF causes the market to be “efficient”
It is easy to see trade offs and opportunity costs
Opportunity Cost = the slope of the PPF Line
Slope = Change in Y/ Change in X
300-0/100/0 = 3

27. Price Elasticity of Demand
The responsiveness of demand to a change in price
The responsiveness of demand for an individual firm
In a competitive market individual firms are too small to have any influence on the market price.
In some other situation, firms may have some discretion in choosing their prices.
Firms want to know how much the quantity demanded will fall if price is increased. 8

28. Elasticity of Supply and Demand
Price Elasticity of Demand
We use absolute numbers even though Qd is negatively related to its price.
|Ped|= △Q/△P
= 20/10 = 2

29. Different Types of Demand
Perfectly Inelastic Demand
Inelastic Demand
Unitary Elastic Demand
Elastic Demand
Perfectly Elastic Demand

30. Determinants of Price Elasticity
Sustainability
Nature of the Product
Proportion of Income
Definition of Market
The Possibility of new purchases
Time Horizons
Addiction
Complementary goods
Price expectations

31. Market demand curve for an individual firm under perfect competitionPm D O Q

32. The demand (market) for an individual firm’s product10 7 6 6 D2 D1 O O 90
100 50
100 Q Q
Firm A
Firm B

33. Importance of Price Elasticity of Demand to Business Decision Making
Price elasticity of demand and a firm’s sales revenue (TR = P x Q)
Elastic demand and sales revenue
Inelastic demand and sales revenue

34. Consumers’ total expenditure Q (millions of units per period of time)=
firms’ total revenue
£2 x 3m = £6m D
Q (millions of units per period of time)

35. Importance of Price Elasticity of Demand to Business Decision Making
Price elasticity of demand and a firm’s sales revenue (TR = P x Q)
effects of a price change on sales revenue
elastic demand
TR changes in same direction as quantity

36. Elastic demand between two points
Expenditure falls
as price rises
P(£) b 5 10 a 4 20 D
Q (millions of units per period of time)

37. Importance of Price Elasticity of Demand to Business Decision Making
Price elasticity of demand and a firm’s sales revenue (TR = P x Q)
effects of a price change on sales revenue
elastic demand
TR changes in same direction as quantity
inelastic demand
TR changes in same direction as price

38. Inelastic demand between two points
Expenditure rises
as price rises. c 8 15
P(£) a 4 20 D
Q (millions of units per period of time)

39. Importance of Price Elasticity of Demand to Business Decision Making
Price elasticity of demand and a firm’s sales revenue (TR = P x Q)
effects of a price change on sales revenue
elastic demand
TR changes in same direction as quantity
inelastic demand
TR changes in same direction as price
applications to price decisions
special cases
totally inelastic demand

40. Totally inelastic demand (PD = 0)b P1 a O Q1 Q

41. Importance of Price Elasticity of Demand to Business Decision Making
Price elasticity of demand and a firm’s sales revenue (TR = P x Q)
effects of a price change on sales revenue
elastic demand
TR changes in same direction as quantity
inelastic demand
TR changes in same direction as price
applications to price decisions
special cases
totally inelastic demand
infinitely elastic demand

42. Infinitely elastic demand (PD = )b D P1 Q2 O Q1 Q

43. Importance of Price Elasticity of Demand to Business Decision Making
Price elasticity of demand and a firm’s sales revenue (TR = P x Q)
effects of a price change on sales revenue
elastic demand
TR changes in same direction as quantity
inelastic demand
TR changes in same direction as price
applications to price decisions
special cases
totally inelastic demand
infinitely elastic demand
unit elastic demand

44. Unit elastic demand (PD = –1)
Expenditure stays the
same as price changes. a 20 b
100 8 D O 40 Q

45. Other Elasticities of Demand
Income elasticity of demand %QD / %Y
measurement
determinants
degree of ‘necessity’ of the good
rate at which desire is satisfied
level of income of consumers
applications to business
importance of perceptions of the product
repositioning a product 11

46. Other Elasticities of Demand
Cross-price elasticity of demand %QDa / %Pb
measurement
determinants
closeness of complements or substitutes
time period
applications to business
effects of changes in competitors' pricing strategy
strategies to make a product less cross-price elastic 11

47. Price elasticity of supply
Price elasticity of supply refers to the responsiveness of supply to a change in price.
Similar to demand, price elasticity of supply can be elastic or inelastic.

48. Price Elasticity of Supply
Meaning of price elasticity of supply
Measuring price elasticity of supply %QS / %P
elastic and inelastic supply
Determinants of price elasticity of supply
amount that costs rise as output increases
time period
immediate
short run
long run 11

49. Response of supply to an increase in demand
S short-run
S long-run b P2 c P3 P1
Supply is more elastic in the long run. a D2 D1 O Q1 Q2 Q3 Q

50. Q The short-run (retail) supply of freshly cut flowers is much less elastic than that of pot plants because:
households generally keep pot plants much longer before throwing them away.
fresh flowers are more likely to be purchased for special occasions.
the price of freshly cut flowers fluctuates much more than that of pot plants.
supplies of fresh flowers fluctuate much more with the weather and the season.
florists cannot keep freshly cut flowers as long as pot plants.
E. Once they are cut, the supply is virtually fixed. The florist cannot choose to sell a given bunch of flowers next week or next month instead of today if today’s demand is low. Note: A and B refer to demand. C is an effect of supply inelasticity, not a cause. D refers to shifts in the supply curve.