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Market: buyers and sellers
Market Equilibrium
• A market is a group of buyers and sellers of a particular good
or service. A market need not be a physical location.
• The term demand refers to the behavior of people
(consumers, buyers) in markets.
The term supply refers to the behavior of people
(producers, sellers) in markets.
Perfectly competitive markets
Prices Communicate
• A competitive market is a market in which there are many
• When the price of a good is rising, buyers will reduce their quantity
buyers and sellers so that each has a negligible impact on the
market price: Buyers and sellers are (behave as) price takers.
• Products are homogeneous: Many firms sell identical products
to many consumers.
• Other market structures:
• Monopoly : One seller, and seller controls price.
• Oligopoly : Few sellers, and not always aggressive competition.
• Monopolistic Competition : Many sellers, slightly
differentiated products, each seller may set price for its own
product.
demanded and substitute other goods.
• They economize on the use of scarce goods or resources. Therefore,
scarce goods are used most efficiently.
• No announcement on radio or TV has to be made.
• Buyers find out about the relative scarcity of a good through its price.
• Each buyer then decides what to do him/herself; decision making is
decentralized.
• Similarly, when the price of a good is rising, sellers will increase their
quantity supplied of that good. Sellers learn the relative desirability
(consumption value, benefit to consumers etc) of the good through its
price.
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Market Equilibrium
 Equilibrium price is the price at which the quantity
Market Equilibrium
Price of
Ice-Cream
Cone
Supply
demanded is equal to the quantity supplied.
 At the equilibrium price, the demanders buy the amount
they demand and the suppliers sell the amount they supply:
neither demanders nor suppliers have an incentive to change
their actions.
Equilibrium
Equilibrium price
$2.00
Equilibrium
quantity
0
1
2
3
4
5
6
7
8
Demand
9 10 11 12 13
Quantity of Ice-Cream Cones
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Marginal Value
What Determines Price?
 Price is related to marginal value not to total value.
 Price does not reflect importance.
 The price of water can be very low, even though its initial
 Price only reflects supply and demand.
value is immense.
 The marginal value is why the price of water is relatively low
in Alaska and relatively high in New Mexico.
 Water and diamond paradox
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Price mechanism
Excess supply: Surplus
 If the market price is greater than the equilibrium price, then
The price of any good adjusts to bring the quantity supplied
and the quantity demanded for that good into balance.
quantity supplied is greater than the quantity demanded.
 There is excess supply or a surplus.
 Suppliers will lower the price to increase sales, thereby moving toward
equilibrium.
Excess demand: Shortage
(a) Excess Supply
Price of
Ice-Cream
Cone
 If the market price is less than the equilibrium price, then
Supply
Surplus
quantity supplied is less than the quantity demanded.
 There is excess demand or a shortage.
 Suppliers will raise the price due to too many buyers chasing too few
$2.50
goods, thereby moving toward equilibrium.
2.00
Demand
0
4
Quantity
demanded
7
10
Quantity
supplied
Quantity of
Copyright©2003 Southwestern/Thomson Learning
Ice-Cream
Cones
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Figure 9 Markets Not in Equilibrium
Three Steps to Analyzing Changes in Equilibrium
 Decide whether the event shifts the supply or demand curve
(b) Excess Demand
Price of
Ice-Cream
Cone
Supply
(or both).
 Decide whether the curve(s) shift(s) to the left or to the
right.
 Use the supply-and-demand diagram to see how the shift
$2.00
affects equilibrium price and quantity.
1.50
Shortage
Demand
0
4
Quantity
supplied
7
10
Quantity of
Quantity
Ice-Cream
demanded
Cones
Copyright©2003 Southwestern/Thomson Learning
Shifts vs Movements Revisited
Price of
Ice-Cream
Cone
1. Hot weather increases
the demand for ice cream . . .
 Shifts in Curves versus Movements along Curves
 A shift in the supply curve is called a change in supply.
Supply
New equilibrium
$2.50
 A movement along a fixed supply curve is called a change in
quantity supplied.
 A shift in the demand curve is called a change in demand.
 A movement along a fixed demand curve is called a change in
2.00
2. . . . resulting
in a higher
price . . .
quantity demanded.
Initial
equilibrium
D
D
0
7
3. . . . and a higher
quantity sold.
10
12
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
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Figure 11 How a Decrease in Supply Affects the Equilibrium
Food Price Increases Revisited
Price of
Ice-Cream
Cone
1. An increase in the
price of sugar reduces
the supply of ice cream. . .
S2
S1
 Remember the reasons:
 Increasing consumption of dairy products in the developing
countries
 Agricultural productivity
New
equilibrium
$2.50
 Production of agro-fuels (ethanol and biodiesel)
 The reduction of food stocks (particularly in the EU)
Initial equilibrium
2.00
 The increase in the oil prices
2. . . . resulting
in a higher
price of ice
cream . . .
 Weather (La Nina-cooling of equatorial Pacific, flood in Australia,
Demand
etc.)
 Export restrictions on food by governments
 Speculation
0
4
Quantity of
Ice-Cream Cones
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3. . . . and a lower
quantity sold.
Copyright©2003 Southwestern/Thomson Learning
Food Price Increases Revisited
 Let us consider the effect of increasing consumption of dairy
Food Price Increases Revisited
 Actually, all the other factors
products on the food price.
 agricultural productivity,
• Less amount of land is allocated to agriculture.
 production of agro-fuels (ethanol and biodiesel),
• Some portion of the total grain production is sold to the meat
 the reduction of food stocks (particularly in the EU),
producers.
 the increase in the oil prices,
Price of
grain
S2
 weather (La Nina-cooling of equatorial Pacific, flood in Australia,
S1
etc.),
 export restrictions on food by governments,
affect the food prices via a shift in the supply to the left, hence
increasing it.
E1
E0
D
Quantity of grain
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Efficiency
• The equilibrium of the competitive market is efficient. (Roughly
speaking this means that scarce resources are not wasted.)
• More precisely, it means
(i) The sum of seller profits and buyer profits are maximized.
or
(ii) It is not possible to produce more of one good without
producing less of another good. It is not possible to make one
person better off without making someone else worse off.
This second definition is known as Pareto efficiency
An Example
 The price of coal fell and the quantity sold also fell.
Everything else being equal, which of the following
three events could be the reason:
(A) Decrease in the price of oil (assume that oil and
coal are substitute goods),
(B) Large increase in the wages of coal miners,
(C) Installation of more efficient coal mining
equipment.
[Draw one well-labeled demand-supply diagram for
each event to check.]
Summary
Summary
 Economists use the model of supply and demand to analyze
 The demand curve shows how the quantity of a good
competitive markets.
 In a competitive market, there are many buyers and sellers,
each of whom has little or no influence on the market price.
depends upon the price.
 According to the law of demand, as the price of a good falls, the
quantity demanded rises. Therefore, the demand curve slopes
downward.
 In addition to price, other determinants of how much
consumers want to buy include income, the prices of
complements and substitutes, tastes, expectations, and the
number of buyers.
 If one of these factors changes, the demand curve shifts.
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Summary
Summary
 The supply curve shows how the quantity of a good supplied
 Market equilibrium is determined by the intersection of the
depends upon the price.
 According to the law of supply, as the price of a good rises, the
quantity supplied rises. Therefore, the supply curve slopes
upward.
 In addition to price, other determinants of how much
producers want to sell include input prices, technology,
expectations, and the number of sellers.
 If one of these factors changes, the supply curve shifts.
supply and demand curves.
 At the equilibrium price, the quantity demanded equals the
quantity supplied.
 The behavior of buyers and sellers naturally drives markets
toward their equilibrium.
Summary
 To analyze how any event influences a market, we use the
supply-and-demand diagram to examine how the event
affects the equilibrium price and quantity.
 In market economies, prices are the signals that guide
economic decisions and thereby allocate resources.
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