Demand supply and the classic market place - ECON 208 - Microeconomics

Chapter 3

Demand supply and the classical market place

 

The market: set of arrangements whereby buyers and sellers exchange goods and services.

Demand: Quantity of a good or service that buyers wish to purchase at each conceivable price, with all other influences remaining unchanged.

Supply: is the quantity of a good or service that sellers are willing to sell at each possible price, with all other influences on supply remaining unchanged.

Quantity demanded: refers to the amount purchased at a particular price. (Behavior at a particular price)

Quantity supplied: refers to the amount supplied at a particular price. (Behavior at a particular price)

                Note: The demand and supply schedules are constructed on the assumption that, when the prices change other influences remain constant. (Constancy of other variables is described as other things being equal or ceteris paribus)

Equilibrium price: intermediate price where the quantity demanded equals the quantity supplied. Demand curve meets the supply curve at point E.

Excess supply: When the quantity supplied exceeds the quantity demanded at the going price. At any price above the equilibrium, the horizontal distance between the supply and demand curves represents the surplus.

Excess demand: When the quantity demanded exceeds the quantity supplied. At any price below the equilibrium, the horizontal distance between the supply and demand curves represents the shortage.

 

  1. Note: When there is excess demand at prices below the equilibrium Suppliers could force the price upward knowing that buyers will continue to buy at the price sellers are willing to sell. Such upward pressure would continue until the excess demand is eliminated.
  2. If sales do take place above or below the equilibrium price, the quantity traded will always correspond to the short side of the market. Where if trading takes place at prices other than the equilibrium price it will always be the lesser of the quantity demanded or supplied that is traded. Short side dominates.

Demand and supply curves

Demand curve: shows the relation between price and quantity demanded, holding other things constant. The curve is linear and has a negative slope, reflecting the fact that buyers wish to purchase more at lower prices.

                Demand curve influences: shifts in any of these elements will result in a new equilibrium point (E1) either above or below the original equilibrium point (E0)

Comparative static analysis:  examining the impact of changing one of the other variables that are assumed constant in the supply and demand diagrams.

  1. Price of related goods
    1. Complementary good: if the demand for a good is increased as a result of a price reduction of another.
      1.                                                                i.      If a Complementary good’s price increases, we would expect that the demand for all other complementary goods to increase at each price. Therefore, the demand curve would shift in response to the price of the other good.
    2. Substitute: if a price reduction for one good reduces the demand.
      1.                                                                i.      If a substitute’s price increases, we would expect that the demand for all other substitute goods to increase at each price. Therefore, the demand curve would shift in response to the price of the other good.
      2. Consumer incomes
        1. When consumer income increase the demand for most goods increase, therefore the demand curve will shift upward (outward to the right)
          1.                                                                i.      Inferior goods: a good that’s demand will decrease in result of higher income.
          2.                                                              ii.      Normal goods: a good that’s demand will increase in response to higher income.

Note: distribution can be an important factor for the demand of any good.

  1. Tastes and networks
    1. Tastes and networks can influence demand either negatively and positively.
    2. Expectations
      1. Expectations for a specific good can influence the demand either negatively or positively.

Supply curve: shows the relationship between the price and the quantity supplied, holding other things constant. The curve is linear and has a positive slope indicating that suppliers wish to supply more at higher prices.

                Note: If the supply curve is vertical, meaning that supply is constant, the suppliers of such goods will take whatever price results in the market. (Ex homes)

                Supply curve influences: shifts in any of these elements will result in a new equilibrium point (E1) either above or below the original equilibrium point (E0)

Whenever technology, the cost of production or the total amounts of supply for a good change our ceteris paribus (all other things equal) assumption is violated. Such changes generally reflect a shift in the supply curve.

 

  1. Technology: Technological advances allow more output to be produced with the same inputs, or an equal output with fewer inputs. Such a technology savings is represented by moving the supply curve downward or outward to the right therefore the supplier is willing to produce the same quantity at a lower price / suppliers will supply more at a given price than before.
  2. Input costs: If the cost of inputs is impacted the supply curve will shift accordingly .If the costs of inputs are increased than the supply curve will shift leftward or upward. At any given quantity the price is now higher; suppliers are willing to supply less at the going price.
  3. Competing products: If competing products improve in quality or decrease in price, than suppliers of substitute products will be required to follow suit. If the producers of good X1 reduce their price than producers of good X2 resulting in a downward or outward shift of the supply curve.
  4. The number of suppliers and expectations: As a general rule, the greater the number of suppliers, the greater the total supply of a good. If new suppliers enter the market, more goods will be supplied at any given price.

Computing the market equilibrium

Given the following linear equations

Supply curve: Ps = 1200 + 100Q

 Demand Curve: PD = 2800 – 10Q

Set Ps = PD

1200 + 100Q = 2800 – 10Q

110Q = 600

Q = 60

 

Managed markets

Price controls: are government rules or laws that inhibit the formation of market-determined prices.

Quotas: Physical restriction on output.

Price ceilings: If the government decides to impose a price limit beneath the original equilibrium point E0 the resulting price control is called a price ceiling. The resulting problem of course is excess demand because individuals wish to purchase more goods than are on the market. In a free market the price would adjust upward to eliminate the shortage, but as it is a controlled market, it cannot. So some other way of allocating the available supply must evolve. 

Price floors: An effective price floor results when the government imposes a price control above the market equilibrium E0, or market clearing price. This will result in excess supply because suppliers wish to produce more than buyers are willing to purchase.

                Note: for both price ceilings and floors, the actual quantity traded is the lesser of the demand quantity or supply quantity at the going price, short side dominates.

Quotas: represent the right to supply a specific quantity of a good to the market; it is a method of keeping the price higher that the free market equilibrium price. As an alternative to creating a price floor the government can impose a quota/ restrict supply to generate a high price.

Summing individual differences:

Market demand: is the horizontal sum of the individual demands at each price.

Market supply: represent the sum of the producers supply curves at each price in an industry.

What how and for whom

  1. The market decides how much of a good or service should be supplied by finding the price at which quantity demanded equals quantity supplied.
  2. The market determines for who the goods and services are produced
  3. The market determines what goods and services are produced. While nature endows us with natural resource, people engage in costly supply activities only if they are rewarded. The supply curve specifies how much the producers must be paid in order to induce supply, and the demand curve specifies the value that buyers place on any product.

Macroeconomics and microeconomics

  • Macroeconomics studies the multitude of markets for goods and services, factors of production, and financial assets that make up the entire country’s economy.
  • Markets may be rigid and slow to adjust. As a result, the forces of excess supply and excess demand act more slowly and require a longer adjustment period to restore individual markets to equilibrium.
  • An economy moves into a recession if it operates at less than full employment and inside its production possibility frontier.
  • Economies may be pushed temporarily outside the production possibility frontier. High demand raises output levels above the designed capacity of producers and raises production costs. Shortages of labour exert upward pressure on wage rates and costs. If high level of economic activity persists, prices and wages will rise at increasing rates. Financial conditions will tighten, raising the cost of financing expenditures. As a result demand for output will decline as will output, moving the economy back to full employment.
  • Economy experiences cycles in the levels of total output and employment. These cycles cause periods of recession and periods of growth with inflationary pressure. Macroeconomics studies the causes and consequences of these business fluctuations, and the roles government fiscal and monetary policies can play to stabilize output and inflation.

Imperative

StudyUp Author: James Bagshaw
Business Administration, Accounting and Management Technology
Major: Business Administration

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