Microeconomics: Demand, Supply, and Market Equilibrium

Competitive Markets

Definition and Characteristics

A competitive market is any arrangement that brings buyers and sellers together to exchange goods, services, or resources. In such markets, there are so many buyers and sellers that no individual participant can influence the market price.

• Physical or Virtual: Markets may be physical locations or virtual spaces where transactions occur.

• Price Takers: In competitive markets, all participants are price takers.

Example: The global market for wheat, where thousands of farmers and buyers interact.

Demand

Quantity Demanded and the Law of Demand

Quantity demanded is the amount of a good, service, or resource that people are willing and able to buy during a specified period at a specified price.

• Law of Demand: Other things remaining the same, if the price of a good rises, the quantity demanded decreases; if the price falls, the quantity demanded increases.

Equation:

$Q_d = f(P)$

where $Q_d$ is quantity demanded and $P$ is price.

Demand Schedule and Demand Curve

• Demand Schedule: A table showing quantities demanded at different prices.

• Demand Curve: A graph showing the relationship between price and quantity demanded, holding other factors constant.

Example: If the price of bottled water decreases from $1.50 to $1.00, the quantity demanded increases from 9 million to 11 million bottles.

Individual and Market Demand

• Market Demand: The sum of all individual demands in a market.

• Market Demand Curve: The horizontal sum of all individual demand curves.

Changes in Demand

A change in demand occurs when any factor other than the price of the good changes, resulting in a new demand schedule and curve.

• Factors Affecting Demand:

  • Prices of related goods: Substitutes and complements.

  • Expected future prices

  • Income

  • Expected future income and credit

  • Number of buyers

  • Preferences

Substitutes and Complements

• Substitute: A good that can be consumed in place of another (e.g., apples and oranges).

• Complement: A good consumed with another (e.g., ice cream and fudge sauce).

Normal and Inferior Goods

• Normal Good: Demand increases as income increases.

• Inferior Good: Demand decreases as income increases.

Change in Quantity Demanded vs. Change in Demand

• Change in Quantity Demanded: Caused by a change in the price of the good (movement along the demand curve).

• Change in Demand: Caused by changes in other factors (shift of the demand curve).

Supply

Quantity Supplied and the Law of Supply

Quantity supplied is the amount of a good, service, or resource that sellers are willing and able to sell during a specified period at a specified price.

• Law of Supply: Other things remaining the same, if the price of a good rises, the quantity supplied increases; if the price falls, the quantity supplied decreases.

Equation:

$Q_s = f(P)$

where $Q_s$ is quantity supplied and $P$ is price.

Supply Schedule and Supply Curve

• Supply Schedule: A table showing quantities supplied at different prices.

• Supply Curve: A graph showing the relationship between price and quantity supplied, holding other factors constant.

Individual and Market Supply

• Market Supply: The sum of all individual supplies in a market.

• Market Supply Curve: The horizontal sum of all individual supply curves.

Changes in Supply

A change in supply occurs when any factor other than the price of the good changes, resulting in a new supply schedule and curve.

• Factors Affecting Supply:

  • Prices of related goods: Substitutes and complements in production.

  • Prices of resources and other inputs

  • Expected future prices

  • Number of sellers

  • Productivity

Substitutes and Complements in Production

• Substitute in Production: A good that can be produced in place of another (e.g., trucks and SUVs).

• Complement in Production: A good produced along with another (e.g., cream and skim milk).

Change in Quantity Supplied vs. Change in Supply

• Change in Quantity Supplied: Caused by a change in the price of the good (movement along the supply curve).

• Change in Supply: Caused by changes in other factors (shift of the supply curve).

Market Equilibrium

Definition and Determination

Market equilibrium occurs when the quantity demanded equals the quantity supplied. The equilibrium price is the price at which this occurs, and the equilibrium quantity is the amount bought and sold at that price.

• At equilibrium, buyers' and sellers' plans are consistent.

Equation:

$Q_d = Q_s$

Shortages and Surpluses

• Shortage: Quantity demanded exceeds quantity supplied; price rises.

• Surplus: Quantity supplied exceeds quantity demanded; price falls.

Effects of Changes in Demand and Supply

• Change in Demand: Shifts the demand curve; equilibrium price and quantity change in the same direction as demand.

• Change in Supply: Shifts the supply curve; equilibrium price changes in the opposite direction to supply, equilibrium quantity changes in the same direction as supply.

• Change in Both: The effect on equilibrium price is ambiguous; equilibrium quantity changes depending on the relative magnitude of shifts.

Three Questions for Predicting Price Changes

1. Does the event change demand or supply?

2. Does the event increase or decrease demand or supply?

3. What are the new equilibrium price and quantity?

Case Study: The Price of Avocados

Why Does the Price Fluctuate?

Seasonal changes in supply, such as the transition from Californian to Mexican crops, can cause fluctuations in the price of avocados. If Mexican production does not fully replace the Californian crop, supply decreases and prices rise.

• If the quantity bought decreases while price rises, the supply must have decreased.

• If both price and quantity bought increase, demand must have increased.

Example: In July 2018, the price of avocados rose from $1.03 to $1.39 per pound, and the quantity bought decreased from 48 million to 36 million pounds per week, indicating a decrease in supply.

Summary Table: Factors Affecting Demand and Supply

Factor	Effect on Demand	Effect on Supply
Price of Good	Movement along demand curve	Movement along supply curve
Prices of Related Goods	Substitutes (+), Complements (-)	Substitutes (-), Complements (+)
Income	Normal (+), Inferior (-)	No direct effect
Expected Future Prices	Increase (+), Decrease (-)	Increase (-), Decrease (+)
Number of Buyers/Sellers	More buyers (+)	More sellers (+)
Preferences/Productivity	Change in preferences (+/-)	Increase in productivity (+), Decrease (-)

Additional info: Academic context and examples have been expanded for clarity and completeness.