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Unit 2
Markets and Competition
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A market is a group of buyers and sellers of a particular good or service
The group of buyers determine the demand for the product, while the group of suppliers
determine the supply of the product
Markets can be either organized or disorganized
More often than not, markets are not organized
○ For example, sellers of bread are in different locations, and offer somewhat
different products
○ The price and quantity of the product are determined by the buyers and the
sellers
A ​Competitive Market ​is a market where there are many buyers and sellers, so that
each individual person or firm has a negligible impact on the overall market price
○ A seller has no reason to increase price because then no buyers would come to
his/her store
○ A seller has no reason to decrease price because s/he is already selling at
maximum capability
Perfect Competition
○ Identified by two main characteristics: that the goods offered for sale are the
exact same, and that there are so many buyers and sellers that each one does
not affect price or quantity - these individuals are called ​Price Takers
■ For example, the wheat market has thousands of farmers that all sell the
same product. Because no single person can affect the price or quantity
of the wheat market, each one takes the price as given
A ​monopoly​ occurs when a market has only one seller, who sets the price
A ​monopolistically competitive ​market occurs when there are many sellers, each of
whom sells a slightly different product
However, in this unit we will study the perfect competition market
Demand
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The ​Quantity Demanded ​refers to the amount of a good that a buyer is willing and able
to purchase
Determinants of Demand
○ Price:​ If the price of pencils went up to 100$ a box, you would buy less of pencils
and more of pens. But if the price of pencils went down to 10 cents a box, you
would buy more pencils and less pens. Because of this relationship, we say that
the quantity demanded has a negative relationship to price. Also known as the
Law of Demand​, when the price of a good rises, then the quantity demanded
falls.
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Income: ​If the demand for a good falls when your income falls, the good is called
a ​Normal Good ​(Example, cars). If the demand for a good rises when your
income falls, that good is called an ​Inferior Good ​(Example, bus)​.
○ Price of Related Good​: Let’s say that you have apples and oranges. Suppose
that the price for apples decreases. The law of demand states that you would
then buy more apples. Because of scarce resources, at the same time, you
would buy less oranges. Because apples and oranges are both fruits, they satisfy
similar desires. When a fall in the price of one good reduces the demand for the
other good, the two goods are called ​Substitute Goods​. The opposite can also
occur, so that a fall in the price of good, increases the demand for the other good
(known as ​Complement Goods​).
○ Tastes​: If you like more of a good, you are more willing to buy that good.
○ Expectations​: Your expectations about the future can also affect your demand
for a good or service. If you expect the price of a good to fall tomorrow, you
would be less willing to buy that good today.
Demand Schedule​: A table that shows the relationship between the price of a good, and
the quantity demanded
Demand Curve​: The downward sloping line that relates price and quantity demanded
Ceteris Paribus​: assume that all things are being held constant, except for the thing
being studied
○ Only used as models, because in reality, many things can change and vary
Market Demand vs. Individual Demand: ​Market Demand ​is derived from individual
demand, as all of the individual demands are added together.
Horizontal Summation​: The sum of all of the individual demands to obtain the market
demand
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Shifts in the Demand Curve
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Any change in a determinant of demand, besides price, will result in a shift of the
demand curve
Variables that Affect the Quantity
Demanded
A Change in This Variable...
Price
Represents a movement along the demand
curve
Income
Shifts the demand curve
Price of Related Good
Shifts the demand curve
Tastes
Shifts the demand curve
Expectations
Shifts the demand curve
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Number of Buyers
Shifts the demand curve
Supply
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The ​Quantity Supplied ​of any good or service is the amount that sellers are willing and
able to sell
Determinants of Supply
○ Price​: When the price is high, the returns of selling an item is greater. Thus,
selling would be profitable. If the price is low, selling would not be profitable.
Because as price rises the quantity supplied rises, there is a positive relationship
between the two. Known as the ​Law of Supply​, when other things are equal, as
the price rises, the quantity supplied also rises
○ Input Prices​: To produce ice cream, sellers need cream, sugar, flavoring, etc. If
the prices of those inputs increase, then your profits selling ice cream
decreases.Thus, a higher input price leads to a lower quantity supplied.
○ Technology​: If technology improves, then the amount of labor and time required
to produce the goods will decrease. An improvement in technology leads to a
greater quantity supplied.
○ Expectations​: If you expect prices to rise in the future, you might save some of
your supply to sell for later.
Supply Schedule​: A table that shows the quantity supplied of a good at a given price
point
Supply Curve​: Upward sloping curve that relates quantity supplied to price
Market Supply vs. Individual Supply​: Market supply is simply all of the individual
supply amounts added together (also known as ​Horizontal Summation​).
Shifts in the Supply Curve
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Any change in a determinant of supply, besides price, will result in a shift of the supply
curve
Variables that Affect the Quantity
Demanded
A Change in This Variable...
Price
Represents a movement along the demand
curve
Input Prices
Shifts the supply curve
Technology
Shifts the supply curve
Expectations
Shifts the supply curve
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Number of Sellers
Shifts the demand curve
Supply and Demand Together
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Market Equilibrium​: The point where the quantity demanded and the quantity supplied
meet
At the equilibrium point, all sellers are able to sell all they want, and all buyers are able to
buy all they want
Through the ​Invisible Hand​, the actions of buyers and sellers move the market toward
equilibrium
If the market price is ABOVE the equilibrium price, then there is a ​Surplus​. Suppliers will
be unable to sell all they want at this price, because not all buyers want to buy at such a
price. The sellers respond by cutting prices. Prices fall until they reach equilibrium prices.
If the market price is BELOW the equilibrium price, then there is a ​Shortage.
Demanders are unable to buy all they want at this price, because not all sellers want to
sell at such a price. The sellers respond by raising prices. Prices rise until they reach
equilibrium prices.
Surplus and Shortages are usually temporary because prices eventually move toward
equilibrium prices
Law of Supply and Demand​: Prices will adjust to bring the supply and demand of that
good into balance.
Analyzing Changes in Supply and Demand
1. Decide whether the event will shift the supply curve or the demand curve (or both).
2. Decide in which direction the curve will shift.
3. Use the Supply and Demand diagram to determine how the shift changes the
equilibrium.