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Markets, Demand and Supply
Lecture 2.
CONTENT

Classifying economic systems

Problems of a command economy

Interdependence of markets

How the market works – examples

Problems of a free market economy

Mixed economy
ECONOMIC SYSTEMS

Classifying economic systems

methods of classification

classification by degree of government control
 command
economies
 free-market
 mixed

economies
economies
other classifications
 the
informal economy
 the
not-for profit sector
ECONOMIC SYSTEMS

The command economy
features of a command economy
 planning

 consumption
and investment
 matching of inputs and outputs
 distribution of output

Advantages of a command economy
high investment, high and stable growth
 social goals pursued
 low unemployment

ECONOMIC SYSTEMS

Problems of a command economy

problems of gathering information

expensive to administer

inefficient allocation of resources
 inappropriate
 no
incentives
system of prices

shortages and surpluses

lack of response to consumer demand
ECONOMIC SYSTEMS

The free-market economy
based on free decision making by individuals and firms
 demand and supply decisions
 the price mechanism

 shortages


and surpluses
shortage  price rises
surplus  price falls
 equilibrium

price
where demand equals supply
 response
to change in demand and supply
DEMAND - DEFINITION
The amount of a particular
economic good or service
that a consumer or group of
consumers want to purchase
at a given price.
SUPPLY - DEFINITION

The total amount of
a good or service
available for
purchase.
ECONOMIC SYSTEMS

Interdependence of markets
 effect
of a rise in demand
 effect
in market for that good
The price mechanism:
the effect of a rise in demand
Goods Market
Dg
shortage
(Dg > Sg)
Pg
Sg
Dg
until Dg = Sg
ECONOMIC SYSTEMS

Interdependence of markets
 effect
of a rise in demand
 effect
in market for that good
 effect in factor markets
The price mechanism:
the effect of a rise in demand
Goods Market
Dg
shortage
(Dg > Sg)
Sg
Pg
Dg
until Dg = Sg
Factor Market
Sg
Df
shortage
(Df > Sf)
Pf
Sf
until Df = Sf
Df 
ECONOMIC SYSTEMS

Interdependence of markets
 effect
of a rise in demand
 effect
in market for that good
 effect
in factor markets
 effect
in other goods markets
ECONOMIC SYSTEMS

Interdependence of markets
 effect
of a rise in demand
 effect
in market for that good
 effect
in factor markets
 effect
in other goods markets
 effect
in other factor markets
ECONOMIC SYSTEMS

Interdependence of markets
 effect

of a rise in demand
 effect
in market for that good
 effect
in factor markets
 effect
in other goods markets
 effect
in other factor markets
Competitive markets
ECONOMIC SYSTEMS

Interdependence of markets
 effect

of a rise in demand
 effect
in market for that good
 effect
in factor markets
 effect
in other goods markets
 effect
in other factor markets
Competitive markets
 perfectly
competitive markets
ECONOMIC SYSTEMS

Interdependence of markets


effect of a rise in demand
 effect
in market for that good
 effect
in factor markets
 effect
in other goods markets
 effect
in other factor markets
Competitive markets

perfectly competitive markets

everyone is a price taker
ECONOMIC SYSTEMS

Interdependence of markets

effect of a rise in demand
 effect
in market for that good
 effect in factor markets
 effect in other goods markets
 effect in other factor markets

Competitive markets
perfectly competitive markets
 everyone is a price taker
 why study perfect markets?

DEMAND


The relationship between demand and price

the income effect

the substitution effect
The demand curve

assumptions

the axes

illustrates how much would be demanded at each price
MARKET DEMAND FOR POTATOES (MONTHLY)
Market demand
Point
Price
(pence per kg) (tonnes 000s)
100
Price (pence per kg)
A
20
700
80
60
40
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
MARKET DEMAND FOR POTATOES (MONTHLY)
Market demand
Point
Price
(pence per kg) (tonnes 000s)
Price (pence per kg)
100
80
A
20
700
B
40
500
60
B
40
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
MARKET DEMAND FOR POTATOES (MONTHLY)
Market demand
Point
Price
(pence per kg) (tonnes 000s)
Price (pence per kg)
100
80
A
20
700
B
C
40
60
500
350
C
60
B
40
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
MARKET DEMAND FOR POTATOES (MONTHLY)
Market demand
Point
Price
(pence per kg) (tonnes 000s)
Price (pence per kg)
100
D
80
C
60
A
20
700
B
C
D
40
60
80
500
350
200
B
40
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
MARKET DEMAND FOR POTATOES (MONTHLY)
100
Price (pence per kg)
Market demand
Point
Price
(pence per kg) (tonnes 000s)
E
D
80
C
60
A
20
700
B
C
D
E
40
60
80
100
500
350
200
100
B
40
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
DEMAND

Other determinants of demand
tastes
 number and price of substitute goods
 number and price of complementary goods
 income
 distribution of income
 expectations


Movements along and shifts in the demand curve
An increase in demand
Price
P
D0
O
Q0
Q1
Quantity
D1
SUPPLY

Relationship between supply and price

as price rises, firms supply more
 it
is worth incurring the extra unit costs
 they switch from less profitable goods
 in the long run, new firms will be encouraged to enter the
market

The supply curve
assumptions
 the axes
 illustrates how much would be supplied at each price

Market supply of potatoes (monthly)
100
Supply
P
80
Price (pence per kg)
a
20 100
60
40
a
20
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
Q
800
Market supply of potatoes (monthly)
100
Supply
P
Price (pence per kg)
80
a
b
20 100
40 200
60
b
40
a
20
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
Q
800
Market supply of potatoes (monthly)
100
Supply
P
Price (pence per kg)
80
a
b
c
c
60
20 100
40 200
60 350
b
40
a
20
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
Q
800
Market supply of potatoes (monthly)
100
Supply
d
Price (pence per kg)
80
a
b
c
d
c
60
P
Q
20
40
60
80
100
200
350
530
b
40
a
20
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Market supply of potatoes (monthly)
100
e
Supply
d
Price (pence per kg)
80
P
a 20
b 40
c 60
d 80
e 100
c
60
b
40
a
20
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
Q
100
200
350
530
700
SUPPLY


Other determinants of supply

costs of production

profitability of alternative products

profitability of goods in joint supply

nature and other random shocks

aims of producers

expectations of producers
Movements along and shifts in the supply curve
SHIFTS IN THE SUPPLY CURVE
P
S0
S1
Increase
O
Q
SHIFTS IN THE SUPPLY CURVE
P
S2
Decrease
O
S0
S1
Increase
Q
THE DETERMINATION OF PRICE

Equilibrium price and output
 response
to shortages and surpluses
 significance

of “equilibrium”
Demand and supply curves
THE DETERMINATION OF MARKET EQUILIBRIUM
(POTATOES: MONTHLY)
E
e
100
Price (pence per kg)
Supply
d
D
80
Cc
60
b
40
a
20
B
A
A
a
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
THE DETERMINATION OF PRICE

Equilibrium price and output
 response
to shortages and surpluses
 significance

of “equilibrium”
Demand and supply curves
 effect
of price being above equilibrium
THE DETERMINATION OF PRICE

Equilibrium price and output
 response
to shortages and surpluses
 significance

of “equilibrium”
Demand and supply curves
 effect
of price being above equilibrium
 surplus
 price falls
THE DETERMINATION OF MARKET EQUILIBRIUM
(POTATOES: MONTHLY)
E
e
100
Price (pence per kg)
Supply
D
80
SURPLUS
d
(330 000)
Cc
60
b
40
B
a
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
THE DETERMINATION OF PRICE

Equilibrium price and output
 response
to shortages and surpluses
 significance

of “equilibrium”
Demand and supply curves
 effect
of price being above equilibrium
 surplus
 effect
 price falls
of price being below equilibrium
THE DETERMINATION OF PRICE

Equilibrium price and output
 response
to shortages and surpluses
 significance

of “equilibrium”
Demand and supply curves
 effect
of price being above equilibrium
 surplus
 effect
 price falls
of price being below equilibrium
 shortage
 price rises
THE DETERMINATION OF MARKET EQUILIBRIUM
(POTATOES: MONTHLY)
E
e
100
Price (pence per kg)
Supply
d
D
80
Cc
60
b
40
B
a
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
THE DETERMINATION OF MARKET EQUILIBRIUM
(POTATOES: MONTHLY)
E
e
100
Price (pence per kg)
Supply
d
D
80
Cc
60
b
40
SHORTAGE
B
(300 000)
a
A
20
Demand
0
0
100
200
300
400
500
Quantity (tonnes: 000s)
600
700
800
THE DETERMINATION OF PRICE

Equilibrium price and output
response to shortages and surpluses
 significance of “equilibrium”


Demand and supply curves

effect of price being above equilibrium
 surplus

 price falls
effect of price being below equilibrium
 shortage

 price rises
equilibrium: where D = S
THE DETERMINATION OF MARKET EQUILIBRIUM
(POTATOES: MONTHLY)
E
e
100
Price (pence per kg)
Supply
d
D
80
60
b
40
B
a
A
20
Demand
0
0
100
200
300
Qe 400
500
Quantity (tonnes: 000s)
600
700
800
THE DETERMINATION OF PRICE

Effects of shifts in the demand curve
 movement
 rise
 fall
along S curve and new D curve
in demand (rightward shift)  P rises
in demand (leftward shift)  P falls
EFFECT OF A SHIFT IN THE DEMAND CURVE
P
S
g
Pe1
D1
O
Q e1
Q
EFFECT OF A SHIFT IN THE DEMAND CURVE
P
S
g
Pe1
D1
O
Q e1
Q
EFFECT OF A SHIFT IN THE DEMAND CURVE
P
S
g
Pe1
D2
D1
O
Q e1
Q
EFFECT OF A SHIFT IN THE DEMAND CURVE
P
S
i
Pe2
g
h
Pe1
D2
D1
O
Q e1
Q e2
Q
THE DETERMINATION OF PRICE

Effects of shifts in the demand curve
 movement
 rise
 fall

along S curve and new D curve
in demand (rightward shift)  P rises
in demand (leftward shift)  P falls
Effects of shifts in the supply curve
THE DETERMINATION OF PRICE

Effects of shifts in the demand curve
 movement
 rise
 fall

along S curve and new D curve
in demand (rightward shift)  P rises
in demand (leftward shift)  P falls
Effects of shifts in the supply curve
 movement
along D curve and new S curve
THE DETERMINATION OF PRICE

Effects of shifts in the demand curve
 movement
 rise
 fall

along S curve and new D curve
in demand (rightward shift)  P rises
in demand (leftward shift)  P falls
Effects of shifts in the supply curve
 movement
 rise
along D curve and new S curve
in supply (rightward shift)  P falls
THE DETERMINATION OF PRICE

Effects of shifts in the demand curve
 movement
 rise
 fall

along S curve and new D curve
in demand (rightward shift)  P rises
in demand (leftward shift)  P falls
Effects of shifts in the supply curve
 movement
 rise
 fall
along D curve and new S curve
in supply (rightward shift)  P falls
in supply (leftward shift)  P rises
EFFECT OF A SHIFT IN THE SUPPLY CURVE
P
S1
g
Pe1
D
O
Q e1
Q
EFFECT OF A SHIFT IN THE SUPPLY CURVE
P
S1
g
Pe1
D
O
Q e1
Q
EFFECT OF A SHIFT IN THE SUPPLY CURVE
P
S2
S1
g
Pe1
D
O
Q e1
Q
EFFECT OF A SHIFT IN THE SUPPLY CURVE
P
S2
S1
k
Pe3
j
g
Pe1
D
O
Q e3
Q e1
Q
THE FREE-MARKET ECONOMY

Advantages of a free-market economy
 transmits
information between buyers and
sellers
 no
need for costly bureaucracy
 incentives
to be efficient
 competitive
wishes
markets respond to consumer
THE FREE-MARKET ECONOMY

Problems of a free-market economy
 competition
may be limited
 inequality
 environment

and social goals may be ignored
The mixed economy
 types
 use
of intervention
of taxes, subsidies and benefits
 legislation
 direct
and regulation
provision by the government
LITERATURE
1.
D.Begg, S.Fisher, R.Dornbusch, Economics,
8th Edition, McGRaw-Hill 2005.
2.
P.Krugman, R.Wells, Macroeconomics, 2nd
Edition, Worth Publishers, New York 2009.