Supply,
Demand and
Competition
Essential Question:
How are prices set?
Both
Buyer
and
Seller
Setting an Economy’s Price
System
 To
understand how a nation’s economy
functions it is important to understand the
nation’s price system
 The forces that determine price are called
the forces of supply and demand
 The place where these two forces meet is
called the marketplace
Basic facts
 Consumers
have a great influence
on the price of goods and services.
 Why?
 Market: Represents the freely
chosen action between buyers and
sellers.
 Voluntary exchange: Buyers and
sellers work out a deal that suits
both sides.
Demand
 Demand
shows how many of a product
consumers are willing and able to buy at
a particular price during a specified time
period.
 e.g. Swimming suits have a different
price and quantity demanded in
summer vs. winter
 How many of you would like a new car?
 How many of you are able?
Law of Demand
 Explains
the amount people are willing to
buy as prices change.
 Demand can only occur if a buyer is
willing and able to buy.
 Three factors that affect what and how
much people buy are diminishing
marginal utility, real income, and
substitution.
Price goes up – Demand goes down
Price goes down – Demand goes up
Diminishing Marginal Utility
(DMU)
 Utility:
Power of a good or service
to satisfy.
 Total satisfaction rises with
additional units purchased, but
additional satisfaction diminishes.
 People will buy until price exceeds
satisfaction.
 Price decreases, people will buy
more.
Real Income Effect
 Income
limits the amount of money
people can spend.
 People cannot keep buying the same
amount if price increases and income
stays the same. (Real income effect).
 People are forced to trade-off if price
increases.
 If price decreases and you buy the
same amount, your real income has
increased.
Demand Curve
Demand
Curve is a line graph that shows
the amount of a product that will be
purchased at each price; it shows an
inverse relationship and is always
downsloping

p
D
Qd
Remember:
A
change along the curve
indicates a change in price and a
change in quantity demanded
A
change of the curve (right or left)
indicates an across the board
change in demand
Law of Demand
 As
price decreases, the quantity demanded
increases. As the price rises, the quantity
demanded decreases
P
QD
Price per gallon Bottles per week
of water
$
Jo
Pat
.75
90
50
.50
130
70
.35
180
100
.25
290
130
Demand for hot chocolate in
December at the skating rink
Price
$.50
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
Quantity
Demanded
30
25
20
15
10
5
0
Demand Determinants
 Characteristics
that will affect the amount
people will buy. Includes changes in
population, income, and personal
preferences.
Prices of related goods, income,
preference/taste, consumer expectations,
population change
Demand Determinants
 Prices
of Related Goods
 Substitutes: Goods that are related in
such a way that an increase in the price
of one leads to an increase in the
demand for the other [goods that can be
consumed in place of one another]
(Pepsi and Coke)
 Compliments: Goods that are related in
such a way that an increase in the price
of one leads to a decrease in the
demand for the other [goods that are
normally consumed together]
(hamburgers and french fries)
Determinants cont.
 Income
 Normal
Good: a good for which demand
increases as consumer incomes rise (milk)
 Inferior Good: A good for which demand
decreases as consumer incomes rise
(ground chuck, bus rides)
 As income rises consumers tend to switch
from consuming these inferior goods to
consuming normal goods (ex. steak,
car/plane)
Determinants cont.
 Preference/Taste
 Likes
and dislikes in consumption
 Consumer Expectations
 Change in future price of goods
 Change in future income
 Population Change
 As the number of consumers in a market
changes the demand will change
Law of Supply
 The
amount producers are willing to
provide at various prices.
 As price increases, supply increases.
 As price decreases, supply decreases.
 Law of diminishing returns: Adding units of
a factor of production will increase output
for a time. Eventually output will decrease.
Supply Schedule & Curves
A
Supply Schedule displays the
quantity of a product supplied at
each price
Price Per
Bottle
Bottles
Supplied
.75
.50
.35
.25
200
130
75
50
Supply of shovels before a large
snowstorm sold at Lowes
Price
$4.00
$8.00
$12.00
$14.00
Quantity
Supplied
5
10
15
20
Determinants of Supply
 Technology
 If
more efficient technology is
discovered production costs will fall
 So suppliers will be more willing and
able to supply more of the good at
each price
 Price of Relevant Resources
 Those resources employed in the
production of a good.
Determinants con’t
 Prices
of Alternative Goods
 Price of a good that uses some of the
same resources as used to produce the
good in question
 Producer Expectations
 Shift production according to future
prices
 Number of Producers
 # of Prod. Increases # of supply
 Government Restrictions
 Taxes, quotas, licenses, etc.
Supply and Demand
 If
price falls, demand will increase and
supply will decrease.
 If price rises, demand will decrease and
supply will increase.
 Equilibrium price: Point where supply and
demand meet.
 Shortage and surplus:
 When demand is greater than supply, a
shortage occurs.
 When supply is greater than demand, a
surplus occurs.
 Prices will rise in a shortage and fall in a
surplus.
Price Controls
 Price
Ceiling – Gov’t set maximum
price that can be charged for a
good or service
 Price
Floor -- Gov’t set minimum
price that can be charged for a
good or service
Price Elasticity
 How
consumers react when prices
change.
 Elasticity
is determined by:
 Existence of substitutes.
 Percentage of income spent on a
good or service.
 Time allowed to adjust to a
change.
Types
Elastic:
Many competing brands.
Price increases, people choose a
substitute.
Inelastic:
Not much competition.
Price increases, demand does not
change.
Steak: Elastic or Inelastic ?
Elastic
Why?
People as
a whole can do
without steak
and will
substitute
chicken or other
protein for
expensive steak
Milk: Elastic or Inelastic ?
Inelastic
Why?
The
population as a
whole can do without
steak….but can not do
as easily without
milk…especially families
with children
Gasoline: Elastic or Inelastic ?
What Products are Subject to
Elastic Demand ?
 Luxury
Items – Most customers want luxuries and will
consider buying them if price drops
 If Price Represents a Large Portion of Family Income
 e.g. Mortgage Rates drop from 6.5 to 5.5% people
will “refinance”
 Availability of Substitute Items
 e.g. Steak /chicken
 Durable Goods
 Computers, cars, washers, dryers will be in greater
demand if the price drops
What Products are Subject to
“Inelastic Demand”?
 Necessities
(milk, gasoline)
 Drugs
 Legal
(heart medicine antibiotics)
 Illegal (heroin, cocaine)
 Products with no good substitute
 insulin, cancer drugs, etc.
 salt in Middle Ages (preservative)
Why is Elasticity of Demand
Important ?
 What
happens if a florist increases the price
of roses 400 % in October ? Will sales go up
or down ?
 A. Probably, down
 What happens if a florist increases the price
of roses on February 14th? Will sales go
down or up?
 A. Probably up Why ? Frantic husbands
and boyfriends will pay exorbitant prices for
a dozen roses on Valentine’s Day.
Competition


Competition will exist if different
businesses produce similar products.
Perfect Competition
1. Large Market
2. Similar Product
3. Easy entry and exit
4. Information obtainable
5. No control over price
 Market Price is equilibrium price.
(decided by supply and demand)
Imperfect Competition
 One
group can have an impact on price.
 Monopoly
 Oligopoly
 Monopolistic Competition
 Barriers to entry:
 Government regulations: Some goods
and services are protected from
duplication by the government.
 Cost of getting started: Large amount of
capital is needed to begin.
 Ownership of raw materials: Companies
control materials and do not sell to
competitors.
Monopoly


One group controls the market.
1. Single seller
2. No substitutes
3. No entry
4. Complete control over price
Suppliers can raise prices without
losing business.
Types of Monopoly
1.
Natural: Control of resources.
Water company
2.
Geographic: Control of location
Dick’s is the only sports store in the area
3.
4.
Technological: Patent on
technology
Government: Created by the
government. Illegal to enter. Post
office
5.
Cartel: International form of
monopoly (OPEC).
Oligopoly


A few businesses in competition.
1. Domination of a few sellers
2. Barriers to entry
3. Identical or slightly different products
4. Some control of price
Price wars are common place.
Oligopoly Examples
 Movie
Studios
 Columbia, 20th Century Fox, Warner Bros.,
Paramount, Universal, and MGM
 Television
 Disney/ABC, CBS Corp., NBC Universal,
Time Warner, and News Corporation
 Food Processing
 Kraft Foods, PepsiCo, and Nestle
 Telecommunications
 AT&T, Verizon, Sprint, and T-Mobile
Monopolistic Competition
Numerous sellers
2. Easy entry
3. Different products
4. Competition
5. Some control of price
Substitution and advertising are
factors.
1.

Mergers
 One
company joins with another.
 Horizontal: Companies in the
same business.
 Vertical: Company joins with one
it buys from.
 Conglomerate: Buying of unrelated businesses.
Vertical or Horizontal?
 Google
and Bing
 Horizontal
 Paper
Company and Saw Mill
 Vertical
 Tostitos
and Corn Fields
 Vertical
 Harris
Teeter and Ace Hardware
 Conglomerate
 Pepsi
and Coke
 Horizontal
Government policies
 Late
1800’s the railroad industry was
the biggest in the United States.
 Theodore Roosevelt set out to stop
monopolies with his “trust-busting”
policy, which would break up large
businesses.
 All
mergers must be approved by
the Government.