Dynamics of Competition

Chapter 3 Supply and DemandPrinciples of Microeconomics

1Why Markets?When individuals specialize in what they do relatively best we can all gain from trade

Trade involves buyers and sellers markets bring those parties together

Markets have various structures, for example:Competitive many buyers, many sellers, identical products, etc.Monopoly one seller, barriers to entryMonopolistic Comp many sellers, differentiated products, etc.Oligopoly few sellersMonopsony one buyer

2Prices Convey Information in Markets Decentralized markets work more efficiently because prices do the heavy lifting

Price (aka money price or nominal price) is amount of currency that must be given up in exchange for good/service

Relative price is ratio of one price to anotherRelative Price of X in terms of Y = Money Price X / Money Price YIs an opportunity cost how much of Y do you have to give up for a unit of X

3Supply & DemandNot just a song by Amos Lee

In a competitive market the price and quantity of a good or service is determined where Supply=Demand

At this point of intersection (and only this point) Qd=Qs, so the market clearsOtherwise will have excess or shortage

4Supply-SideTo be counted in market supply the firm must:1. Have the resources and technology to produce it2. Be able to profit from producing it3. Have plan to produce and sell it

Supply is entire relationship between the price of a good and the quantity supplied

Quantity supplied of a good or service is the amount that producers plan to sell during a given period of time at a particular price

Market supply = sum of all firm Qs at each price

5Law of Supply6

Why is Supply Upward-Sloping?Law of Supply Increase in price => Increase in Qs

As quantity increases marginal cost increases as well

Supply curve also minimum-supply-price-curve

7Change in SupplyOccurs when change in any factor that influences selling plan EXCEPT for price

6 main factors:Prices of factors of productionPrices of related goods producesExpected future pricesNumber of suppliersTechnologyState of nature8Shifts in Supply Curve9

Change in Supply vs. Change in Qs10

Directional Impact of 6 Main FactorsPrices of factors of productionIncrease => Pushes up MCDecrease in SupplyShift left

Prices of related goods producesFor Substitutes in Production goods that can be produced using same resourcesIncrease in Price of Y => Pushes up OC for XDecrease in Supply of XShift leftFor Complements in Production goods must be produced togetherIncrease in Price Y => Pushes down OC for XIncrease in Supply of XShift right

11Directional Impact of 6 Main FactorsExpected future pricesIncrease => Pushes up OCDecrease in SupplyShift left

Number of suppliersMarket supply is sum of all firm supply curvesIncrease => Increase in SupplyShift right

12Directional Impact of 6 Main FactorsTechnologyIncrease => Pushes down MCIncrease in SupplyShift right

State of natureEverything elseAs economists like to sayit depends

13Demand-SideTo be counted in market demand the individual must:1. Want the product2. Be able to afford the product3. Have plan to buy it

Demand is entire relationship between the price of a good and the quantity demanded

Quantity demanded of a good or service is the amount that consumers plan to buy during a given period of time at a particular price

Market demand = sum of all individual Qd at each price

14Law of Demand15

Why is Demand Downward-Sloping?Law of Demand Increase in price=>Decrease in Qd

Due to two effects:Substitution EffectWhen price of good rises, its relative price rises (ceteris paribus); Incentive to switch to substitutes increasesIncome EffectWhen price of good rises, real income rises (ceteris paribus); Feel wealthier so will purchase more normal goods fewer inferior goods

Demand curve also maximum-willingness & ability-to-pay curve & marginal benefit curve

16Change in DemandOccurs when change in any factor that influences buying plan EXCEPT for price

6 main factors:Prices of related goodsExpected future pricesIncomeExpected future income and creditPopulationPreferences17Shifts in Demand Curve18

Change in Demand vs. Change in Qd19

Directional Impact of 6 Main FactorsPrices of relatedFor Substitutes goods that can be consumed in its placeIncrease in Price of Y => Increase in Demand for XShift rightFor Complements goods that must be consumed togetherIncrease in Price of Y => Decrease in Demand for XShift left

Expected future pricesOC of purchasing later increases relative price today decreasesIncrease future prices => Increase in Demand todayShift right

20Directional Impact of 6 Main FactorsIncomeIncome effect able to afford more units of all goodsIf Normal Goods - Increase in DemandShift rightIf Inferior Goods - Decrease in DemandShift left

Expected future income & creditIncome effect expect to be able to afford more stuffIncrease => Could increase Demand (if normal good)Shift right

21Directional Impact of 6 Main FactorsPopulation (i.e. number of consumers)Market demand is sum of all individual demand curvesIncrease => Increase in DemandShift right

PreferencesEverything elseit depends

22Supply Meets Demand23

Market EquilibriumWhere the supply and demand curves meet

Solve for Equilibrium Price balances buying and selling plansEquilibrium Quantity is amount bought and sold at equilibrium price

Situation in which opposing forces balance each other

Natural resting place because:Price regulates buying and selling plansPrice adjusts when plans dont match

24Why We Call It Market Equilibrium25

Predicting Changes in Price and QuantityChange in P and Q could arise from any of following:Shift in SupplyShift in DemandShift in Supply & Demand

How P and Q are impacted depends upon both:Direction of shiftsRelative sizes of these shifts

26Increase in Demand27Increase in Demand => Shift right

Holding Supply constant, can predict for sure:Increase in PIncrease in Q

E.g. Could arise with increase in population

Decrease in Demand28Decrease in Demand => Shift left

Holding Supply constant, can predict for sure:Decrease in PDecrease in Q

E.g. Could arise with decrease in price of substitute

Increase in Supply29Increase in Supply => Shift right

Holding Demand constant, can predict for sure:Decrease in PIncrease in Q

E.g. Could arise with increase in technology

Decrease in Supply30Decrease in Supply => Shift left

Holding Demand constant, can predict for sure:Increase in PDecrease in Q

E.g. Could arise with decrease in number of suppliers

Both Curves Move in Same Direction31

Curves Move in Opposite Directions32

Market Equilibrium Using Linear EquationsSupply has positive slope Demand has negative slope

Example: Market for wheat Supply: Qs = 1800 + 240PDemand: Qd = 3550 266P

Solve for price at which Qs = Qd1800 + 240P = 3550 266P506P = 1750P = $3.46 per bushel ($3.458498.to be exact)

Plug P back into Supply and/or Demand for Q:Qs = 1800 + 240P = 1800 + 240(3.458498) = 2630Qd = 3550 266P = 3550 - 266(3.458498 ) = 2630

33Shown Graphically34

Market Equilibrium Using Linear EquationsNow consider the gluten-free revolution.which curve shifts and in what direction?

Example: Market for wheat Unchanged Supply: Qs = 1800 + 240PDecrease in Demand: Qd = 2580 194P

Solve for new price at which Qs = Qd1800 + 240P = 2580 194P 434P = 4380P = approx $1.80 per bushel ($1.797235.to be exact)

Plug P back into Supply and/or Demand for Q:Qs = 1800 + 240P = 1800 + 240(1.797235) = 2231Qd = 2580 194P = 2580 - 194(1.797235) = 2231

35Shown Graphically36