MARKETS AND COMPETITION

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1 In this chapter, look for the answers to these questions: What factors affect buyers demand for goods? What factors affect sellers supply of goods? How do supply and demand determine the price of a good and the quantity sold? How do changes in the factors that affect demand or supply affect the market price and quantity of a good? How do markets allocate resources? MARKETS AND COMETITION and demand are the two words that economists use most often. and demand are the forces that make market economies work. Modern microeconomics is about supply, demand, and market equilibrium. What Is a Market? A market is a group of buyers and sellers of a particular good or service. The terms supply and demand refer to the behavior of people... as they interact with one another in markets. Buyers determine demand. Sellers determine supply. A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price. What Is Competition? Competition: erfect and Otherwise erfect Competition roducts are the same Numerous buyers and sellers so that each has no influence over price Buyers and Sellers are price takers Monopoly One seller, and seller controls price Oligopoly Few sellers Not always aggressive competition Monopolistic Competition Many sellers Slightly differentiated products Each seller may set price for its own product DEMAND uantity demanded is the amount of a good that buyers are willing and able to purchase. Law of The law of demand states that, other things equal, the quantity demanded of a good falls when the price of the good rises. 1

2 The Curve: The Relationship between rice and uantity ed Schedule The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. The Curve: The Relationship between rice and uantity ed Curve The demand curve is a graph of the relationship between the price of a good and the quantity demanded. Figure 1 Catherine s Schedule and Curve 1. A decrease in price... $ Market versus Individual Market demand refers to the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve s increases quantity of cones demanded. The market demand curve is the horizontal sum of the individual demand curves! Ice- Cream When the price is $2., When the price is $2., Catherine will demand Nicholas 4 will demand 3 ice-cream cones. ice-cream cones. Catherine s + Nicholas s = Market Ice- Cream Ice- Cream The market demand at $2. will be 7 ice-cream cones. Shifts in the Curve Change in uantity ed Movement along the demand curve. Caused by a change in the price of the product s s s When the price is $1., When the price is $1., Catherine will demand 8 Nicholas will demand 5 ice-cream cones. ice-cream cones. 13 The market demand at $1., will be 13 icecream cones. 2

3 Changes in uantity ed Ice- Cream s $ B A tax on sellers of icecream cones raises the price of ice-cream cones and results in a movement along the demand curve. 8 A D s Shifts in the Curve Change in A shift in the demand curve, either to the left or right. Caused by any change that alters the quantity demanded at every price. Consumer income rices of related goods Tastes Expectations Number of buyers Figure 3 Shifts in the Curve Increase in demand Decrease in demand curve, D 3 curve, curve, D 2 s Shifts in the Curve Consumer Income As income increases the demand for a normal good will increase. As income increases the demand for an inferior good will decrease. Consumer Income Normal Good Consumer Income Inferior Good Ice- Cream $ Increase in demand An increase in income... D 2 s Ice- Cream $ Decrease in demand An increase in income... D s 3

4 Shifts in the Curve rices of Related Goods When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. When a fall in the price of one good increases the demand for another good, the two goods are called complements. Table 1 Variables That Influence Buyers SULY uantity supplied is the amount of a good that sellers are willing and able to sell. Law of The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good rises. The Curve: The Relationship between rice and uantity Supplied Schedule The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied. The Curve: The Relationship between rice and uantity Supplied Curve The supply curve is the graph of the relationship between the price of a good and the quantity supplied. Figure 5 Ben s Schedule and Curve $3. 1. An increase in price s increases quantity of cones supplied. 4

5 Market versus Individual Market supply refers to the sum of all individual supplies for all sellers of a particular good or service. Graphically, individual supply curves are summed horizontally to obtain the market supply curve. Shifts in the Curve Change in uantity Supplied Movement along the supply curve. Caused by a change in anything that alters the quantity supplied at each price. Change in uantity Supplied Shifts in the Curve Ice- Cream $3. 1. A C 1 5 S A rise in the price of ice cream cones results in a movement along the supply curve. s Change in A shift in the supply curve, either to the left or right. Caused by a change in a determinant other than price. Input prices Technology Expectations Number of sellers Figure 7 Shifts in the Curve curve, S 3 Decrease in supply curve, curve, S 2 Table 2: Variables That Influence Sellers Increase in supply s 5

6 SULY AND DEMAND TOGETHER Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. SULY AND DEMAND TOGETHER Equilibrium rice The price that balances quantity supplied and quantity demanded. On a graph, it is the price at which the supply and demand curves intersect. Equilibrium uantity The quantity supplied and the quantity demanded at the equilibrium price. On a graph it is the quantity at which the supply and demand curves intersect. SULY AND DEMAND TOGETHER Schedule Schedule Figure 8 The Equilibrium of and $2. Equilibrium price Equilibrium At $2., the quantity demanded is equal to the quantity supplied! Equilibrium quantity s Equilibrium Figure 9 Markets Not in Equilibrium Surplus When price > equilibrium price, then quantity supplied > quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium. $ (a) Excess Surplus 4 uantity demanded 7 1 uantity supplied s 6

7 Equilibrium Figure 9 Markets Not in Equilibrium Shortage When price < equilibrium price, then quantity demanded > the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium. $ (b) Excess Shortage uantity uantity supplied demanded s Equilibrium Law of supply and demand The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance. Table 3: Three Steps for Analyzing Changes in Equilibrium Figure 1 How an Increase in Affects the Equilibrium $ resulting in a higher price Hot weather increases the demand for ice cream... Initial equilibrium New equilibrium and a higher s quantity sold. D D Three Steps to Analyzing Changes in Equilibrium Shifts in Curves versus Movements along Curves A shift in the supply curve is called a change in supply. A movement along a fixed supply curve is called a change in quantity supplied. A shift in the demand curve is called a change in demand. A movement along a fixed demand curve is called a change in quantity demanded. 7

8 Figure 11 How a Decrease in Affects the Equilibrium EXAMLE: The Market for Hybrid Cars S 2 1. An increase in the price of sugar reduces the supply of ice cream... price of hybrid cars $ New equilibrium Initial equilibrium resulting in a higher price of ice cream and a lower s quantity sold. quantity of hybrid cars EXAMLE 1: Event to be analyzed: Increase in price of gas (change in price of a complement) A Change in D 2 EXAMLE 1: A Change in STE: D curve shifts because price of gas affects demand for hybrids. S curve does not shift, because price of gas does not affect cost of producing hybrids. STE 2: D shifts right because high gas price makes hybrids more attractive relative to other cars. STE 3: The shift causes an increase in price and quantity of hybrid cars. EXAMLE 1: A Change in EXAMLE 2: A Change in Notice: When rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted. Always be careful to distinguish b/w a shift in a curve and a movement along the curve D 2 EVENT: New technology reduces cost of producing hybrid cars. 2 S

9 EXAMLE 2: A Change in STE: S curve shifts because event affects cost of production. D curve does not shift, because production technology is not one of the factors that affect demand. STE 2: S shifts right because event reduces cost, makes production more profitable at any given price. STE 3: The shift causes price to fall and quantity to rise. EXAMLE 3: EVENTS: price of gas rises AND new technology A Change in Both and 2 reduces production costs 1 S 2 2 D 2 EXAMLE 3: A Change in Both and STE: Both curves shift. STE 2: Both shift to the right. STE 3: rises, but effect on is ambiguous: If demand increases more than supply, rises. But if supply increases more than demand, falls. Changes in supply and demand Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads. Event A: A fall in the price of compact discs Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell. Event C: Events A and B both occur. 51 A. fall in price of CDs The market for music downloads B. fall in cost of royalties The market for music downloads STES 1. D curve shifts 2. D shifts left 2 STES 1. S curve shifts (royalties are part of sellers costs) 2. S shifts right 2 S 2 3. and both fall. 2 1 D 2 3. falls, rises

10 C. fall in price of CDs AND fall in cost of royalties Table 4: What Happens to rice and uantity When or Shifts? STES 1. Both curves shift (see parts A & B). 2. D shifts left, S shifts right. 3. unambiguously falls. Effect on is ambiguous: The fall in demand reduces, the increase in supply increases. 54 1