Supply and Demand in Market Economies

Supply and Demand: How Markets Work

• Supply and demand are the forces driving market economies.
• Supply and demand determine prices and allocate scarce resources.
• Market models are based on assumptions.

Assumptions of the Market Model

• Supply and demand represent people interacting in markets.
• A market is a group of buyers and sellers of a specific good or service.
• A competitive market has many buyers and sellers, each with a negligible impact on price.

Assumptions for Efficient Outcomes

• Many buyers and sellers
• Perfect information for all
• Freedom of entry and exit
• Identical goods
• Buyers and sellers act in self-interest
• Clearly defined property rights

Competitive Market

• A market with numerous buyers and sellers, where each has little impact on market price.
• All goods are the same.
• No buyer or seller can influence the market price on their own.
• Buyers and sellers are price takers.

Demand

• Quantity demanded is the amount of a good that buyers are willing and able to purchase.
• The law of demand states that, ceteris paribus, quantity demanded decreases as price increases.

The Demand Curve

• A graph showing the relationship between price and quantity demanded.
• It slopes downward, reflecting the law of demand.

Market Demand versus Individual Demand

• Market demand is the sum of all individual demands for a particular good or service.
• Graphically, individual demand curves are summed horizontally to find the market demand curve.

Shifts Versus Movements Along the Demand Curve

• Ceteris paribus: other demand factors are held constant.
• A shift in the demand curve is caused by a factor other than price change.
• Movement along the demand curve is caused by a price change.

Shifts in the Demand Curve

• Factors affecting demand (other than price) cause shifts in the demand curve.
  • Prices of related goods (substitutes and complements)
    • Substitutes: higher price of one good increases demand for the other.
    • Complements: higher price of one good decreases demand for the other.
  • Income
    • Normal goods: demand increases with income
    • Inferior goods: demand decreases with income
  • Tastes
  • Number of buyers (population)
  • Advertising
  • Expectations of future income and prices.

Changes in Quantity Demanded

• A movement along a fixed demand curve, caused by a change in price.

Supply

• Quantity supplied is the amount of a good that sellers are willing and able to sell.
• The law of supply claims that, ceteris paribus, quantity supplied increases as price increases.

The Supply Curve

• A graph showing the relationship between price and quantity supplied.
• It slopes upward, reflecting the law of supply.

Market Supply versus Individual Supply

• Market supply is the sum of all individual supplies for a good or service.

Shifts in the Supply Curve

• Factors affecting supply (other than price) cause shifts in the supply curve.
  • Input Prices
  • Technology
  • Prices of related goods in joint supply
  • Expectations of future costs and market conditions
  • Number of sellers

Changes in Quantity Supplied

• A movement along a fixed supply curve, caused by a change in price.

Variables That Influence Sellers

• Price: movement along the supply curve
• Input Prices: shift the supply curve
• Technology: shift the supply curve
• Expectations: shift the supply curve
• Number of sellers: shift the supply curve

Supply and Demand Together

• Equilibrium price: balances quantity supplied and quantity demanded.
• Equilibrium quantity: quantity supplied and quantity demanded at equilibrium price.
• Equilibrium occurs where supply and demand curves intersect.

Markets Not in Equilibrium

• Excess supply (surplus): quantity supplied > quantity demanded.
• Excess demand (shortage): quantity demanded > quantity supplied.
  • In a surplus, suppliers lower prices to increase sales towards equilibrium.
  • In a shortage, suppliers raise prices due to high demand toward equilibrium.

Law of Supply and Demand

• The price for any good adjusts to balance the quantity supplied and demanded.

Three Steps to Analyzing Changes in Equilibrium

1. Decide whether the event shifts supply or demand (or both).
2. Decide whether the curves shift to the left or right.
3. Use the supply and demand diagram to see how the shift affects equilibrium price and quantity.

How an Increase/Decrease in Supply/Demand Affects Equilibrium

• Analyze the shift in supply or demand curves to predict how it impacts equilibrium price and quantity.

Example Analysis (Hybrid Cars)

• Provide examples of applying the three-step method to analyze changes in various market scenarios.

Active Learning Examples

• Analyze different scenarios using the supplied examples, showing shifts in supply and demand curves.
• Include examples of how changes to music/tax preparation software affect market equilibrium.
• Include questions and diagrams to support understanding.