Download Supply and Demand

Chapter-3
Markets and Market
Participants
(Supply and Demand)
In This Chapter….
3.1. Market Participants, their Goals, and
Interactions in the Market Place
3.2. The Representation (Characterization) of
Market Participants
 Supply and demand
 Individual and Market
3.3. The formation of Market Signals that
guide us in Allocating the Scarce Resources
3.1. Identifying Markets, Market
Participants and their Behavior
 Who?
 Millions of people (domestic or
foreign), firms, and government
institutions participate directly or
indirectly in the market (a given
country’s economy).
 We can identify three broad groups of
market participants
3.1. Identifying Markets, Market
Participants and their Behavior
 Consumers (Households):
 Those economic agents who go to the
marketplace to buy goods and services and
satisfy their needs (wants) from their limited
resources.
 Producers (Businesses or firms):
 Economic agents who go to the marketplace to
sell goods and services so as to make profits
from their limited outputs (services)
 Government (Government Institutions):
 Serve the public needs interest by using the
available resources
3.1. Identifying Markets, Market
Participants and their Behavior
 The Purpose (Goal) of Market Participants?
 Consumers (Households):
 maximize their utility (satisfaction) given limited
resources.
 Producers (Businesses):
 maximize profits by using resources efficiently in
producing goods.
 Government Institutions:

maximize general welfare of the society.
Maximizing Behavior
3.1. Identifying Markets, Market
Participants and their Behavior
 Maximizing Behavior
 The basic goals of utility maximization,
profit maximization, and welfare
maximization thus explain most market
activity.
 How do Markets enable Participants to
Achieve the goal Maximization?
3.1. Identifying Markets, Market
Participants and their Behavior
 Economic interactions …the opportunity for
specialization and exchange.
 Our economic interactions with others in
the market place is necessitated by two
constraints:
1. Our absolute inability as individuals to do
(produce) all the things we need or desire.
2. The limited amount of time, energy, and
resources we have producing those things we
could make for ourselves…scarcity
3.1. Identifying Markets, Market
Participants and their Behavior
 Markets thus refer to a place where consumers
and producers come together and where
exchange takes place.
 Although identifiable and peculiar in some
cases, there is no specific place where markets
are located (they could be virtual)
 A market exists wherever and whenever an
exchange takes place.
 Based on the items for exchange, however, we
can identify TWO MAIN types of markets
3.1. Identifying Markets, Market
Participants and their Behavior
1. Factor Markets:
… are any place where factors of
production (e.g., land, labor, capital)
are bought and sold.
2. Product Markets:
… are any place where finished (final)
goods and services (products) are
bought and sold.
3.1. Interaction in the Market Place
Goods and services
demanded
Consumers
(Households)
Product
Markets
Governments
Factors of
production supplied
International
participants
Factors
Markets
The Circular Flow
International
participants
Goods and services
supplied
Producers
(Firms)
Factors of
production demanded
Dollars and Exchange
 Every market transaction involves an
exchange of dollars for goods (in
product markets) or resources (in
factor markets).
3.1. Interaction in the Market Place
International
participants
Household Expenses
Goods and services
demanded
Consumers
(Households)
Incomes
Product
Markets
Goods and services
supplied
Producers
(Firms)
Governments
Factors of
production supplied
International
participants
Revenue
Factor
Markets
Factors of
production demanded
The Circular Flow
Costs of Production
3.2. Characterization of the
Activities of Market Participants
 Market is a place that brings together
Consumers (Buyers) and Producers
(Sellers).
 For every market transaction, there must
be a buyer and a seller.
 The sellers represent the supply side of the
market.
 The buyers represent the demand side of the
market.
3. 2. Supply and Demand
Demand
3. 2. Supply and Demand
 What is Demand ?
 is the ability and willingness of
consumers (buyers) to buy specific
quantities of a good at alternative prices
in a given time period, ceteris paribus.
 Quantity Demanded:
 The amount of a good that a consumer is
willing and able to buy at given time and
price level, ceteris paribus
3.2. Supply and Demand
 A demand exists only if someone is
willing and able to pay for a good.
Thus…
 “Demand” is an expression of
consumer buying intentions – of a
willingness and ability to buy – not a
statement of actual purchases.
Individual Demand
 Three different ways to present
demand:
1. Using A table (Demand Schedule)
2. Using A graph (Demand Curve)
3. Using A Mathematical Equation (Demand
Function)
Individual Demand
 Demand schedule:
 is a table showing the quantities of a
good a consumer is willing and able to
buy at alternative prices in a given time
period, ceteris paribus.
Individual Demand
 Demand curve:
 is a curve (graph) describing the
quantities of a good a consumer is willing
and able to buy at alternative prices in a
given time period, ceteris paribus.
Demand Schedule and Curve
Demand Schedule
Quantity
Price
Demanded
1
$50
2
45
3
40
5
35
7
30
9
25
12
20
15
15
20
10
PRICE
$50
45
40
35
30
25
20
15
10
5
A
B
C
D
E
F
G
H
I
0 2 4 6 8 10 12 14 16 18 20
Quantity of Tutoring Demanded (hours)
Individual Demand
 Demand Function:
 an algebraic representation of the
quantities of a good a given consumer is
willing and able to buy at alternative prices
in a given time period, ceteris paribus.
Qd= f ( P)
Individual Demand
 The Law of demand:
 The quantity of a good demanded in a
given time period increases as its price
falls, ceteris paribus.
Determinants of Demand
 Determinants of market demand
include:
 Tastes — desire for the particular good
under consideration and other goods.
 Income — of the consumer.
 Other goods — their availability and
price.
 Expectations — for income, prices,
tastes.
 Number of buyers.
Types of Demand
 We can identify two types of demand:
 Individual demand
 Market demand :
 is the total quantities of a good or service
people are willing and able to buy at
alternative prices in a given time period.
 It is the sum of individual demands.
Market Demand
 Market demand is determined by the
number of potential buyers and their
respective tastes, incomes, other
goods and expectations.
The Market Demand Curve
 Market demand represents the
combined demands of all market
participants.
 The separate demands of individual
consumers is added up to determine
the total quantity demanded at any
given price.
Construction of the Market
Demand Curve
Price
Morke’s
demand curve
Stacy’s demand
curve
Leah’s
demand
curve
$50
Negassa’s
demand
curve
Price
40
30
+
20
+
+
=
10
0
4 8 12 16
0 4 8 12 16 20 24 28
0 4 8 12
Quantity Demanded
0 4 8 12
Construction of the Market
Demand Curve
The market demand curve
$50
A
B
=
Price
40
C
D
30
E
F
20
G
H
10
0
4
12
20
28
36
I
Quantity Demanded
Shifts in Demand Vs Movements
along the Demand Curve
 The determinants of demand can and do
change.
 A Change in demand is indicated by a shift
in the demand curve.
 Represents a change in the quantity demanded at
every given price level.
 Results from changes in one or more factors in the
determinants of demand (due to changes in tastes,
income, other goods, or expectations), except own
price of the good
Shifts in Demand Vs Movements
along the Demand Curve
Changes in quantity demanded :
 Is indicated by movements along a
demand curve, and it results only as a
response to changes in the price of the
good itself.
Changes in Demand
Change in Demand is indicted by a shift in the
Demand Curve
An increase in demand shifts
the demand curve to the
right when:
A decrease in demand shifts
the demand curve to the left
when:
The good is normal and
income increases
The good is normal and
income decreases
The good is inferior and
income decreases
The good is inferior and
income increases
The price of a substitute
good increases
The price of a substitute good
decreases
The price of a
complementary good
decreases
The price of a complementary
good increases
Market Effects of
Changes in Demand
Changes in Demand Shift the Demand Curve
An increase in demand
shifts the demand curve to
the right when:
A decrease in demand
shifts the demand curve
to the left when:
Population increases
Population decreases
Consumer tastes shift in
favor of the product
Consumer tastes shift
away from the product
Consumers expect a higher
price in the future
Consumers expect a lower
price in the future
Movements vs. Shifts
PRICE
$45
40
35
30
25
20
15
10
5
0
Shift in
demand
d2
d1
g1
Movement
along curve
D2 increased
demand
D1
initial demand
2
4
6
8
10
12
14
16
18
20
22 Quantity
Pizza and Politics: Quiz (True or
False)
 At the Clinton White House whenever
a political crisis erupted, the demand
for pizza increased.
 …we can represent this by a shift in
demand curve for pizza (at the White
House) not by movement along the
same demand curve.
 True
3. 2. Supply and Demand
Supply
3.2. Supply and Demand
 What is Supply?
 is the ability and willingness of a
producer (supplier) to sell specific
quantities of a good at alternative prices
in a given time period, ceteris paribus.
 Quantity Supplied
 The quantity of a given good that the
producer is willing and able to supply at a
given price and time, ceteris paribus
Supply
 Supply is the total quantities of a
good that sellers are willing and able
to sell at alternative prices in a given
time period, ceteris paribus.
Law of Supply
 Larger quantities will be offered for sale at
higher prices.
 Law of supply, the quantity of a good
supplied in a given time period increases as
its price increases, ceteris paribus.
 Supply curves are thus upward-sloping to
the right.
Market Supply
Quantity Supplied By:
Price
Erin
+ Hussein + Miranda =
Market
j
$50
94
35
19
148
i
45
93
33
14
140
h
40
90
30
10
130
g
35
86
28
0
114
f
30
78
12
0
90
e
25
53
9
0
62
d
20
32
7
0
39
c
15
20
0
0
20
b
10
10
0
0
10
Market Supply
Erin’s
Supply
Hussein’s
Supply
Miranda’s
Supply
Market Supply
Determinants of Supply
 The determinants of market supply
include:
– Factor costs
– Taxes and subsidies
– Technology
– Expectations
– Other goods
– Number of sellers
Market Supply
 The market supply curve is just a
summary of the supply intentions of
all producers.
 Market supply is an expression of
sellers’ intentions (willingness and
ability)– an offer to sell – not a
statement of actual sales.
Movements and Shifts of Supply
 Changes in the quantity supplied
— movements along the supply
curve.
 Changes in supply — shifts in the
supply curve.
Equilibrium
Market Price
Equilibrium
 Equilibrium price
 is the price at which the quantity of a
good demanded in a given time period
equals the quantity supplied.
 Equilibrium Quantity
 The quantity of the good purchased and
sold at the equilibrium price
Equilibrium Price
Price
$50
45
40
35
30
25
20
15
10
Quantity Supplied
148
140
130
114
90
62
39
20
10
surplus
surplus
surplus
surplus
surplus
surplus
equilibrium
shortage
shortage
Quantity Demanded
5
8
11
16
22
30
39
47
57
Equilibrium Price
Price
$50
45
40
35
30
25
20
15
10
5
0
Market demand
Market supply
At equilibrium price, quantity demanded
equals quantity supplied
Equilibrium price
25
39
50
75
100
125 Quantity
….Equilibrium Price is a Market
Clearing Price
 Everyone may not be happy with the
prevailing price or quantity at
equilibrium.
 However, it is unique in that the
outcome at market equilibrium is
efficient.
 Resources are put to their best possible
use
The Invisible Hand
 Adam Smith characterized this
market mechanism as the invisible
hand.
 The market mechanism is the use
of market prices and sales to signal
desired outputs (or resource
allocations).
Deviation from the Equilibrium
Price
$50
45
40
35
30
25
20
15
10
Quantity Supplied
148
140
130
114
90
62
39
20
10
surplus
surplus
surplus
surplus
surplus
surplus
equilibrium
shortage
shortage
Quantity Demanded
5
8
11
16
22
30
39
47
57
Market Surplus
 A market surplus is the amount by
which the quantity supplied exceeds
the quantity demanded at a given
price – excess supply.
 A market surplus is created when the
market prices are too high.
Market Shortage
 A market shortage is the amount by
which the quantity demanded
exceeds the quantity supplied at a
given price – excess demand.
 A market shortage is created when
the market prices are too low.
Surplus and Shortage
Price
$50
45
40
35
30
25
20
15
10
5
0
Market demand
Market supply
Surplus
x
y
Shortage
25
39
50
75
100
125 Quantity
Self-Adjusting Prices
 A market surplus will emerge when
the market price is above the
equilibrium price.
 A market shortage will emerge
when the market price is below the
equilibrium price.
Self-Adjusting Prices
 Buyers and sellers will change their
behavior to overcome a surplus or
shortage.
 Only at the equilibrium price will no
further adjustments be required.
Surplus and Shortage
Price
$50
45
40
35
30
25
20
15
10
5
0
Market demand
Market supply
Surplus
x
y
Equilibrium price
Shortage
25
39
50
75
100
125 Quantity
Changes in Equilibrium
 No equilibrium price is permanent.
 The equilibrium price will change
whenever the supply or demand
curve shifts.
 Changes in supply and demand occur
when the determinants of supply and
demand change.
Changes in Equilibrium
 Should the demand curve shift, the
result will be a change in equilibrium
price and quantity.
 Should the supply curve shift, the
result will be a change in equilibrium
price and quantity.
Changes in Equilibrium
Demand Shift
Price
$50
Market supply
40
E2
30
New demand
E1
20
10
0
Initial demand
25
50
75
100
Quantity
Changes in Equilibrium
Supply Shift
Price
$50
Market supply
40
E3
30
E1
20
10
0
Initial demand
25
50
75
100
Quantity
Implications---Outcomes
 In a free market economy, the market
mechanism resolves the basic economic
questions of WHAT, HOW, and FOR
WHOM.
Market Outcomes
 WHAT we produce is determined by the
equilibrium of the markets.
 HOW we produce is determined by profit
seeking behavior and using resources
efficiently.
 FOR WHOM we produce is determined by
those willing and able to pay the
equilibrium price
 Does the Market Outcome Satisfy
Everybody?
 Is it Perfect?
 Is it Optimal?
Optimal, Not Perfect!!
 Not everyone is happy with market
outcomes.
 But we are given the opportunity to
maximize our own satisfaction.
 Thus although the outcomes of the
marketplace are not perfect, they are often
optimal.
 Because Everyone has done the best
possible given their incomes and talents
Real Life Examples…
 People are often upset with the
market outcome.
 In a market-driven economy of the
U.S.A.(California), electricity prices
are set by the forces of supply and
demand.
Real Life Examples…
 In 2000, Electricity prices increased in
California because of two reasons:
 an increase in demand (The demand
curve shifted rightward)
 and a decrease in supply (The supply
curve shifted leftward).
 Sharp Increase in Electricity Price..
Price Ceilings Create Shortages
40
Price Of Electricity
(cent per kilowatt-hour)
35
30
D2
D1
S2
E2
S1
P2
25
20
15
10
E1
5
0
Quantity Of Electricity
(megawatts per hour)
P1
Real Life Examples…
 This led to Government Intervention
in Electricity pricing ….
 The California legislature put a price
ceiling on retail electricity prices.
 A price ceiling is the upper limit
imposed on the price of a good.
Price Ceilings Create Shortages
40
Price Of Electricity
(cent per kilowatt-hour)
35
30
D2
D1
S2
E2
S1
P2
25
20
Price ceiling
15
10
E1
5
0
Quantity Of Electricity
(megawatts per hour)
P1
Consequences of Price Ceilings
 Price ceilings have three predictable
effects:
 Increase the quantity demanded.
 Decrease the quantity supplied.
 Create a market shortage.
Price Ceilings Create Shortages
 Letting prices rise would have:
– Reduced the quantity demanded.
– Increased the quantity supplied.
– Alleviated the market shortage.