BackChapter 4: The Market Forces of Supply and Demand – Principles of Microeconomics
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The Market Forces of Supply and Demand
Introduction
This chapter explores how supply and demand interact to determine prices and allocate resources in competitive markets. It examines the factors influencing buyers' demand and sellers' supply, the behavior of market participants, and the mechanisms by which markets reach equilibrium.
Markets and Competition
Definition of Market
Market: A group of buyers and sellers of a particular good or service.
Buyers: Determine the demand for the product.
Sellers: Determine the supply of the product.
Types of Markets
Competitive Market: Many buyers and sellers, each with negligible impact on market price.
Perfectly Competitive Market:
Goods are identical.
All participants are price takers—no one can influence the market price.
At the market price, buyers can purchase all they want, and sellers can sell all they want.
Demand
Quantity Demanded and Law of Demand
Quantity Demanded: The amount of a good that buyers are willing and able to purchase.
Law of Demand: Other things being equal, the quantity demanded of a good falls when the price rises, and rises when the price falls.
Demand Schedule and Demand Curve
Demand Schedule: A table showing the relationship between the price of a good and the quantity demanded.
Demand Curve: A graph of the relationship between the price of a good and the quantity demanded.
Example: Sofia’s Demand for Muffins
Price of Muffins | Quantity Demanded |
|---|---|
$0.00 | 16 |
$1.00 | 14 |
$2.00 | 12 |
$3.00 | 10 |
$4.00 | 8 |
$5.00 | 6 |
$6.00 | 4 |
Graphical Representation: The demand curve slopes downward, illustrating the law of demand.
Market Demand
Market Demand: The sum of all individual demands for a good or service.
Market Demand Curve: Obtained by summing individual demand curves horizontally (adding quantities at each price).
Example: Market vs. Individual Demand
Price | Sofia's Qd | Diego's Qd | Market Qd |
|---|---|---|---|
$0.00 | 16 | 8 | 24 |
$1.00 | 14 | 7 | 21 |
$2.00 | 12 | 6 | 18 |
$3.00 | 10 | 5 | 15 |
$4.00 | 8 | 4 | 12 |
$5.00 | 6 | 3 | 9 |
$6.00 | 4 | 2 | 6 |
Shifts in the Demand Curve
Non-Price Determinants of Demand
Number of buyers
Income
Prices of related goods
Tastes
Expectations
Changes in these factors shift the demand curve.
Changes in Number of Buyers
Increase: Shifts demand curve to the right.
Decrease: Shifts demand curve to the left.
Changes in Income
Normal Good: Demand increases as income increases.
Inferior Good: Demand decreases as income increases.
Changes in Prices of Related Goods
Substitutes: An increase in the price of one increases demand for the other (e.g., pizza and hamburgers).
Complements: An increase in the price of one decreases demand for the other (e.g., smartphones and apps).
Changes in Tastes
Shifts in consumer preferences toward a good increase demand and shift the curve right.
Example: Advertising that promotes health benefits of orange juice increases its demand.
Expectations about the Future
If people expect higher future income or prices, current demand increases.
Example: Anticipation of a promotion may increase current demand for luxury goods.
Shift vs. Movement Along the Demand Curve
Change in Demand: Shift of the demand curve due to non-price determinants.
Change in Quantity Demanded: Movement along the demand curve due to price change.
Summary Table: Variables that Influence Buyers
Variable | A Change in This Variable... |
|---|---|
Price of the good itself | Represents a movement along the demand curve |
Income | Shifts the demand curve |
Prices of related goods | Shifts the demand curve |
Tastes | Shifts the demand curve |
Expectations | Shifts the demand curve |
Number of buyers | Shifts the demand curve |
Supply
Quantity Supplied and Law of Supply
Quantity Supplied: Amount of a good sellers are willing and able to sell.
Law of Supply: Other things being equal, the quantity supplied of a good rises when the price rises, and falls when the price falls.
Supply Schedule and Supply Curve
Supply Schedule: Table showing the relationship between price and quantity supplied.
Supply Curve: Graph of the relationship between price and quantity supplied.
Example: Starbucks’ Supply of Muffins
Price of Muffins | Quantity Supplied |
|---|---|
$0.00 | 0 |
$1.00 | 3 |
$2.00 | 6 |
$3.00 | 9 |
$4.00 | 12 |
$5.00 | 15 |
$6.00 | 18 |
Graphical Representation: The supply curve slopes upward, illustrating the law of supply.
Market Supply
Market Supply: Sum of the supplies of all sellers of a good or service.
Market Supply Curve: Obtained by summing individual supply curves horizontally.
Example: Market vs. Individual Supply
Price | Starbucks Qs | Peet's Qs | Market Qs |
|---|---|---|---|
$0.00 | 0 | 0 | 0 |
$1.00 | 3 | 2 | 5 |
$2.00 | 6 | 4 | 10 |
$3.00 | 9 | 6 | 15 |
$4.00 | 12 | 8 | 20 |
$5.00 | 15 | 10 | 25 |
$6.00 | 18 | 12 | 30 |
Shifts in the Supply Curve
Non-Price Determinants of Supply
Input prices
Technology
Number of sellers
Expectations about the future
Changes in these factors shift the supply curve.
Changes in Input Prices
Examples: Wages, ingredients, raw materials.
Fall in Input Prices: Reduces production costs, increases profitability, shifts supply curve to the right.
Changes in Technology
Improved technology reduces input requirements and production costs, shifting the supply curve to the right.
Changes in Number of Sellers
Increase: Shifts supply curve to the right.
Decrease: Shifts supply curve to the left.
Expectations about the Future
If sellers expect higher future prices, they may reduce current supply, shifting the supply curve to the left.
Shift vs. Movement Along the Supply Curve
Change in Supply: Shift of the supply curve due to non-price determinants.
Change in Quantity Supplied: Movement along the supply curve due to price change.
Summary Table: Variables that Influence Sellers
Variable | A Change in This Variable... |
|---|---|
Price of the good itself | Represents movement along the supply curve |
Input prices | Shifts the supply curve |
Technology | Shifts the supply curve |
Expectations | Shifts the supply curve |
Number of sellers | Shifts the supply curve |
Supply and Demand Together
Market Equilibrium
Equilibrium: The price at which quantity supplied equals quantity demanded.
Equilibrium Price (Peq): The price that balances supply and demand.
Equilibrium Quantity (Qeq): The quantity supplied and demanded at equilibrium price.
Graphical Representation: The intersection of the supply and demand curves.
Markets Not in Equilibrium
Surplus (Excess Supply): Quantity supplied exceeds quantity demanded. Price falls toward equilibrium.
Shortage (Excess Demand): Quantity demanded exceeds quantity supplied. Price rises toward equilibrium.
The Law of Supply and Demand
The price of any good adjusts to bring quantity supplied and quantity demanded into balance.
At equilibrium, there is no further pressure for price to change.
Three Steps to Analyzing Changes in Equilibrium
Decide whether the event shifts the supply curve, the demand curve, or both.
Decide the direction of the shift(s).
Use the supply-and-demand diagram to compare the initial and new equilibrium.
Example: Effects of Shifts
Increase in price of a substitute (e.g., doughnuts): Demand for muffins increases, shifting demand curve right; equilibrium price and quantity rise.
Technological improvement: Supply curve shifts right; equilibrium price falls, quantity rises.
Both demand and supply increase: Quantity rises; effect on price depends on relative magnitude of shifts.
How Prices Allocate Resources
In market economies, prices serve as signals that guide economic decisions and allocate scarce resources.
Equilibrium prices ensure supply and demand are balanced, determining consumption and production levels.
Key Formulas and Concepts
Demand Function:
Supply Function:
Equilibrium Condition:
Summary
Supply and demand analysis is fundamental to understanding competitive markets.
Demand and supply curves show how quantity demanded and supplied depend on price.
Non-price determinants shift the curves, while price changes cause movement along the curves.
Market equilibrium occurs where supply equals demand, and prices allocate resources efficiently.
