Supply, Demand and Supply, Demand and CompetitionCompetition

Basic factsBasic facts

• Consumers have a great influence on Consumers have a great influence on the price of goods and services.the price of goods and services.

• Market: Represents the freely Market: Represents the freely chosen action between buyers and chosen action between buyers and sellers.sellers.

• Voluntary exchange: Buyers and Voluntary exchange: Buyers and sellers work out a deal that suits both sellers work out a deal that suits both sides.sides.

Law of Demand Law of Demand

• Explains the amount people are Explains the amount people are willing to buy as prices change.willing to buy as prices change.

• Demand can only occur if a buyer is Demand can only occur if a buyer is willing and able to buy.willing and able to buy.

• Three factors that affect what and Three factors that affect what and how much people buy are how much people buy are diminishing marginal utility, real diminishing marginal utility, real income, and substitution. income, and substitution.

Price goes up

Demand goes down

Demand goes up

Price goes down

Diminishing Marginal Utility Diminishing Marginal Utility (DMU)(DMU)

• Utility: Power of a good or service to Utility: Power of a good or service to satisfy.satisfy.

• Total satisfaction rises with additional Total satisfaction rises with additional units purchased, but additional units purchased, but additional satisfaction diminishes.satisfaction diminishes.

• People will buy until price exceeds People will buy until price exceeds satisfaction.satisfaction.

• Price decreases, people will buy more.Price decreases, people will buy more.

Real Income EffectReal Income Effect

• Income limits the amount of money people Income limits the amount of money people can spend.can spend.

• People cannot keep buying the same People cannot keep buying the same amount if price increases and income amount if price increases and income stays the same. (Real income effect).stays the same. (Real income effect).

• People are forced to trade-off if price People are forced to trade-off if price increases.increases.

• If price decreases and you buy the same If price decreases and you buy the same amount, your real income has increased.amount, your real income has increased.

Substitution Substitution

• If two items satisfy the same want or If two items satisfy the same want or need, people can substitute.need, people can substitute.

• If price rises on one, people will buy If price rises on one, people will buy the other.the other.

Big Mac Whopper

Price Elasticity Price Elasticity

• How consumers react when prices change.How consumers react when prices change.– Elastic:Elastic:

• Many competing brands.Many competing brands.• Price increases, people choose a substitute.Price increases, people choose a substitute.

– Inelastic:Inelastic:• Not much competition.Not much competition.• Price increases, demand does not change.Price increases, demand does not change.

• Elasticity is determined by:Elasticity is determined by:– Existence of substitutes.Existence of substitutes.– Percentage of income spent on a good or Percentage of income spent on a good or

service.service.– Time allowed to adjust to a change.Time allowed to adjust to a change.

Determinants of Demand Determinants of Demand

• Characteristics that will affect the amount Characteristics that will affect the amount people will buy. Includes changes in people will buy. Includes changes in population, income, and preferences.population, income, and preferences.– Substitutes:Substitutes:

• If price for one item increases, demand for a If price for one item increases, demand for a substitute will increase.substitute will increase.

• If price of a substitute increases, demand for original If price of a substitute increases, demand for original will increase.will increase.

– Complimentary goods: Items used together.Complimentary goods: Items used together.• If price of one decreases, people will buy more. They If price of one decreases, people will buy more. They

also buy more of its compliment.also buy more of its compliment.• If price of one increases, people buy less. They also If price of one increases, people buy less. They also

buy less of its compliment.buy less of its compliment.

Law of Supply Law of Supply

• The amount producers are willing to The amount producers are willing to provide at various prices.provide at various prices.– As price increases, supply increases.As price increases, supply increases.– As price decreases, supply decreases.As price decreases, supply decreases.

• Law of diminishing returns: Law of diminishing returns: Adding units of a factor of Adding units of a factor of production will increase output for production will increase output for a time. Eventually output will a time. Eventually output will decrease.decrease.

Supply and Demand Supply and Demand

• If price falls, demand will increase and supply will If price falls, demand will increase and supply will decrease.decrease.

• If price rises, demand will decrease and supply If price rises, demand will decrease and supply will increase.will increase.

• Equilibrium price: Point where supply and Equilibrium price: Point where supply and demand meet.demand meet.

• Shortage and surplus:Shortage and surplus:– When demand is greater than supply, a shortage occurs.When demand is greater than supply, a shortage occurs.– When supply is greater than demand, a surplus occurs.When supply is greater than demand, a surplus occurs.– Prices will rise in a shortage and fall in a surplus.Prices will rise in a shortage and fall in a surplus.

Competition Competition

• Competition will exist if different Competition will exist if different businesses produce similar products.businesses produce similar products.

• Perfect CompetitionPerfect Competition1.1. Large MarketLarge Market2.2. Similar ProductSimilar Product3.3. Easy entry and exitEasy entry and exit4.4. Information obtainableInformation obtainable5.5. No control over priceNo control over price

– Market Price is equilibrium price.Market Price is equilibrium price.

Imperfect CompetitionImperfect Competition

• One group can have an impact on price.One group can have an impact on price.– MonopolyMonopoly– OligopolyOligopoly– Monopolistic CompetitionMonopolistic Competition

• Barriers to entry:Barriers to entry:– Government regulations: Some goods and Government regulations: Some goods and

services are protected from duplication by the services are protected from duplication by the government.government.

– Cost of getting started: Large amount of capital Cost of getting started: Large amount of capital is needed to begin.is needed to begin.

– Ownership of raw materials: Companies control Ownership of raw materials: Companies control materials and do not sell to competitors.materials and do not sell to competitors.

MonopolyMonopoly

• One group controls the market.One group controls the market.1.1. Single sellerSingle seller

2.2. No substitutesNo substitutes

3.3. No entryNo entry

4.4. Complete control over priceComplete control over price

• Suppliers can raise prces without Suppliers can raise prces without losing business.losing business.

Types of MonopolyTypes of Monopoly

1.1. Natural: Control of resources.Natural: Control of resources.

2.2. Geographic: Control of locationGeographic: Control of location

3.3. Technological: Patent on technologyTechnological: Patent on technology

4.4. Government: Created by the Government: Created by the government. Illegal to enter.government. Illegal to enter.

5.5. Cartel: International form of Cartel: International form of monopoly (OPEC).monopoly (OPEC).

OligopolyOligopoly

• A few businesses in competition.A few businesses in competition.1.1. Domination of a few sellersDomination of a few sellers

2.2. Barriers to entryBarriers to entry

3.3. Identical or slightly different productsIdentical or slightly different products

4.4. Some control of priceSome control of price

• Price wars are common place.Price wars are common place.

Monopolistic CompetitionMonopolistic Competition

1.1. Numerous sellersNumerous sellers

2.2. Easy entryEasy entry

3.3. Different productsDifferent products

4.4. CompetitionCompetition

5.5. Some control of priceSome control of price

• Substitution and advertising are Substitution and advertising are factors.factors.

Mergers Mergers

• One company joins with another.One company joins with another.– Horizontal: Companies in the same Horizontal: Companies in the same

business.business.– Vertical: Company joins with one it buys Vertical: Company joins with one it buys

from.from.– Conglomerate: Buying of un-related Conglomerate: Buying of un-related

businesses. businesses.

Government policies Government policies

• Late 1800’s the railroad industry was Late 1800’s the railroad industry was the biggest in the United States.the biggest in the United States.

• Theodore Roosevelt set out to stop Theodore Roosevelt set out to stop monopolies with his “trust-busting” monopolies with his “trust-busting” policy, which would break up large policy, which would break up large businesses.businesses.

• All mergers must be approved by the All mergers must be approved by the Government.Government.