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1 Markets - Basic Rules of Supply & Demand
Understanding the Global Economy (ECON151)
University of Auckland
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Markets
Group of buyers & sellers of a particular g&s “supply” and “demand” refer to the behaviour of people in their market interaction Buyers determine demand Sellers determine supply
Market System
¤ Supply & demand together determine the prices of the economy’s goods and services ¤ In market economies, prices are the signals that guide allocation of resources
Market price
¶ market economy, we exchange goods & services for money ¶ Prices used by participants in the economy to communicate with each other ¶ Determine by buyers & sellers ¶ assume that people are “price-takers” ¶ many buyers and sellers so each has no influence over price causing competitive markets
Demand Curve
downward- sloping/ negatively sloped line relating price to quantity demanded ceteris paribus, lower prices imply a greater quantity demanded
Change in Demand
shift in the demand curve
Caused by change in a determinant except price. Determinant ‡ Consumer income (Ability to pay) ‡ Prices of related goods (Willingness to pay)
- Substitutes
- Complements
- Tastes (Willingness to pay)
Quantity demanded
amount of g&s buyers willing & able to purchase at every price Determinant ~ Movement along the demand curve ~ Caused by change in price of product
Shape factor
Diminishing marginal benefit (utility/happiness/satisfaction) ۞ As consumption increases, satisfaction derived from each additional unit of g&s decreases
Opportunity cost ۞ As prices of product increases, cost of choosing that product over others increases
Income Effect ۞ Price increase effectively lowers your disposable income
Substitution Effect ۞ Prices of substitute product relatively cheaper to current product with increased price
Simplifications
Quantity supplied
amount of g&s producers willing & able to sell at every price Determinant ®Movement along the supply curve ®Caused by a change in the market price of product
Shape Factor
Law of diminishing returns marginal costs increase as a firm produces more of g&s. Firms charge higher prices to maintain, marginal profits = marginal costs
Increasing profits Higher prices allows producers opportunity to gain more revenue by increase quantity sold
Simplifications
when market is “thick” with lots of seller then steps are relatively small, then the linear approximation X sacrifice much accuracy
Interactions
Market Allocation
Allocation of resources determined by competitive markets/ free markets/ Laissez-faire
Equilibrium Price
price that balances supply and demand. On a graph, it is the price at which the supply and demand curves intersect
Called market clearing price
Buyers want to buy at the lowest possible price... Sellers want to sell at the highest possible price... Essentially trying to “split the difference” between the “buy price” and the “sell price” Leads to equilibrium price
Equilibrium Quantity
quantity that balances supply and demand. On a graph it is the quantity at which the supply and demand curves intersect
Market Equilibrium
quantity demanded by consumers at prevailing price equals to quantity supplied by producers willing to sell at that price At (stable) equilibrium no incentive/ tendency for market to change behaviour, ceteris paribus In equilibrium, those buyers with valuation greater than the market price buy and those sellers with costs less than the market price sell. Others are unable to trade
Market Adjustment
Excess Supply (Surplus)
when quantity sellers wish to sell exceeds that which buyers want to buy
Excess Demand (Shortage)
when quantity buyers wish to buy exceeds that which sellers wish to sell at a given price
Market forces
1 Markets - Basic Rules of Supply & Demand
Course: Understanding the Global Economy (ECON151)
University: University of Auckland
