1.1: Competitive markets: Demand & Supply

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    Definitions

     

    1. Microeconomics is the study of behavior of firms, individual consumers and industries and the determination of market prices and quantities of goods and services, and factors of production.
    2. Market is a situation where potential buyers and potential sellers come together to establish an equilibrium price and quantity for a good or service. This allows an exchange to take place, and it enables the needs and wants of both parties to be fulfilled.
    3. Demand is the willingness and ability to purchase a good or service at a certain price over a given time period.
    4. Law of demand states as the price of a good falls, the quantity demanded of the product normally increases, ceteris paribus.
    5. Change in demand is caused by a change in non-price factor, and it is represented by a shift of the demand curve.
    6. Change in quantity demanded is caused by a change in price, and it is represented by a movement along the demand curve.
    7. Supply is the willingness and ability to produce a quantity for a good or service at a given price, in a given time period.
    8. Law of supply states as the price of the good rises, the quantity supplied of the product normally increases, ceteris paribus.
    9. Change in supply is caused by a change in non-price factor, and it is represented by a shift of the supply curve.
    10. Change in quantity supplied is caused by a change in price, and it is represented by a movement along the supply curve.
    11. Market equilibrium is a situation where prices are stable, and the quantity of goods and services supplied is equal to the quantity demanded.
    12. Consumer surplus is the extra satisfaction gained by consumers from paying a price that is lower than that which they were prepared to pay. It is shown by an area under the demand curve and above the equilibrium price.
    13. Producer surplus is the excess of actual earnings that a producer makes from a given quantity of output, over and above the amount the producer would be prepared to accept for that output. It is shown by an area above the supply curve and under the equilibrium price.
    14. Allocative efficiency is when resources are allocated in the most efficient way from society’s point of view, and occurs when demand equals supply and community surplus is maximized.

    Law of Demand

     

    As price of a product falls, the quantity demanded of the product will usually increase, ceteris paribus.

    Non-Price Determinants of Demand

     

    1. Income

    ●       Normal goods

    • As income rises → Demand for the product also rises.
    • Small increase in demand for necessities, such as food, clothes etc.
    • Large increase in demand for other products, such as cinemas, cars etc.

    ●       Inferior goods

    • As income rises → Demand for the product falls.
    • Consumers starts to buy higher priced substitutes in place of inferior goods.
    • Examples include cheap wine, store’s own cookies or baked goods.

     

     

     

     

     

     

     

     

    2. Price of other goods

    ●       Substitute goods

    • Two products that are similar to each other.
    • Examples include Big Mac and Quarter Pounder.
    • Fall in price for Big Mac → Increase in quantity demanded for Big Mac →

    Decrease in quantity demanded for Quarter Pounder.

    • Increase in price for Big Mac → Decrease in quantity demanded for Big Mac →

    Increase in quantity demanded for Quarter Pounder.

    ●       Complement goods

    • Products that are often purchased together.
    • Examples include shoes and socks.
    • Fall in price for shoes → Increase in quantity demanded for shoes →

    Increase in quantity demanded for socks as well.

    • Increase in price for shoes → Decrease in quantity demanded for shoes →

    Decrease in quantity demanded for socks as well.

    ●       Unrelated goods

    • If products are unrelated, then changes in price of one product will have no effect to the price for another product.
    • For example, change in the price of Big Mac will not have an effect on the price of iPhone 7 Plus.

     

    3. Tastes/Preferences

    • Marketing may influence buyers to buy the product → Increased demand for the product.

     

    4. Size of population

    • Growing population → Increase in demand for most products.

     

    5. Changes in age structure of the population

    • Altering age structure affects demand for certain products.
    • If a country has more young people living there → Increase in demand for education.

     

    6. Changes in income distribution

    • Better pay for poor and worse pay for the rich → Increase in demand for necessities.

     

    7. Government policy changes

    • Changes in direct taxes → Changes in consumer spending → Changes in demand.
    • Some policies such as ban of cigarettes and alcohol affect demand in relevant markets.

     

     

    8. Seasonal changes

    • Changes in seasons → Changes in pattern of demand in the economy.
    • For example, there will be more demand for ice cream during summer than winter.

     

    Law of Supply

     

    As price of a product rises, the quantity supplied of the product will usually increase, ceteris paribus.

    Non-Price Determinants of Supply

     

    1. Costs of factors of production

    • Increase in costs of factors of production → Increase the firm’s costs.
    • Fall in costs of factors of production → Increases supply of the product.

     

    2. Price of other products

    • Producers have a choice as to what they are going to produce.
    • For example, cloth producers may be able to produce shoes with a minimal change in production facilities.
    • If price of cloth rises → producers will sell more cloth and fewer shoes.

     

    3. State of technology

    • Improvements in state of technology in a firm or industry → Increase in supply.
    • Natural disasters might cause state of technology to deteriorate → Decrease in supply.

    4. Expectations

    • Producers make decisions about what to supply based on expectations of future prices.
    • Producers may assume that higher demand → higher price, so producers will supply more of the product to meet up with the expectations.
    • If demand for product falls → Producers will reduce the supply of the product.
    • Expectations and confidence has a strong influence on production decisions.

     

    5. Government intervention

    • Most common ways governments intervene in a market is through imposing indirect taxes or providing subsidies.

     

    ALWAYS REMEMBER!!

    • CHANGE IN PRICE OF GOOD → MOVEMENT ALONG THE DEMAND OR SUPPLY CURVE.
    • CHANGE IN OTHER DETERMINANTS OF DEMAND OR SUPPLY → SHIFTING THE DEMAND OR SUPPLY CURVE TO THE LEFT OR RIGHT.

     

    Market equilibrium

    Changes in equilibrium by change in demand

    Changes in equilibrium by change in supply

    1. Plot the demand and supply curves, and identify the equilibrium price and quantity on your graph.

    1. When P = 2 and P = 6, determine whether there’s an excess demand or excess supply and calculate the amount of this in each case.

    1. Due to an increase in resource prices, 15 thousand fewer units of Z are supplied at each price. State the new supply curve and plot the new supply curve on your graph.

    1. Determine the new equilibrium price and quantity mathematically and on graph.