ECONOMICS LECTURE 2:
COMPETITIVE MARKETS:
Market – group of buyers and sellers of a particular good or service
• Physical or virtual place e.g. internet, e-bay, Westfield
• Formal or informal e.g. fish market, local ice-cream stand
Competitive market – market in which there are so many buyers and sellers that each has a
negligible impact on the market
• Smaller the ability of each buyer/seller to affect the market price = more
competitive
• Perfectly competitive
1. Goods are essentially the same
2. So numerous no buyer or seller can influence market price =
“price takers” – cant by their own actions change the market price
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Some markets in which the assumptions of perfect competition e.g. agriculture
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Most real world markets = somewhere in between
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Some markets = no competition at all – in markets with only one seller (a monopoly)
the seller sets the price “price setter” – Supply and demand theory does not apply
SUPPLY AND DEMAND THEORY:
• Buyers determine demand
• Sellers determine supply
Demand:
Quantity demanded – the quantity of a good that buyers are willing and able (enough
income to) to purchase
• Affected by price, tastes, income etc.
• Price increases = quantity declines (law of demand)
• Ceteris parabis (everything else equal) if price increases, generally demand will
decline e.g. if ice-cream is free one may consume 12, while if it is $5 , demand will
generally decline
2 ways of representing relationship between price and demand:
1. Demand schedule
2. Demand curve – downward slope represents law of demand (negative relationship)
Market demand vs. individual demand:
• Many buyers in the market
Market demand – sum of all individual demands for a particular good or service
• Demand curves are summed horizontally
• Movement along demand curve = change in quantity demanded – caused by
change in price
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If price remains constant and other factors change, curve will shift = change in
demand
Factors changing demand:
Relationship between income and demand:
• Depends on product
Normal good – good for which other things equal, increased income = increase demand
Inferior good – good for which other things equal, increased income = decrease demand
e.g. cheaper foods
• Most goods are normal
Prices of related goods: ***** IMPORTANT*****
Relationship between the price of a related good and demand depends on type of product
Substitutes – two goods for which a decease in the price of one good = decrease in demand
for another
• Fulfill the same need
e.g. brands of cars, televisions, pepsi/coke
e.g. decrease in price of Toyota = decrease demand for other car companies
Complements – two goods for which a decrease in the price of one good leads to an
increase in demand for another
e.g. decrease in petrol price = increase use of cars
Also affecting the demand curve:
Tastes – e.g. shift in alcohol consumption
Expectations – e.g. future income, about the future price of good
CASE STUDY:
1. Policy to discourage smoking e.g. health warnings, advertising
2. Increase price of cigarettes e.g. taxes on tobacco
1 = change of people’s tastes = shift in demand
2 = change in demand = movement along curve
Supply:
Quantity supplied – amount of good that sellers are willing and able (right resources and
technology to be able to sell that product) to sell
Law of supply – supply will increase as price rises
Two representations:
1. Supply table
2. Supply curve
• Upward sloping = positive
• Price change = movement along supply curve = change in quantity supplied
• Demand curve will shift when factors other than price change have an effect
e.g. change in efficient production – new technology
Input prices – quantity supplied is negatively related to the price of inputs used to make the
good – if input prices rises = supply decrease
Technology
Expectations – if suppliers expect to rise, might delay selling stock
Equilibrium – situation in which demand and supply have been brought into balance
• Demand and supply together
Equilibrium price – price that balances the quantity supplied and quantity demanded
• Market-clearing price
• When the demand and supply curve intersect
• Surplus – market price = higher than equilibrium price – quantity supplied = larger
than quantity demanded \ incentive to decrease price
• Shortage – market price = lower than equilibrium price (excess demand)
Law of supply and demand – the claim that the price of any good adjusts to bring the supply
and demand for that good into balance
• Once equilibrium reached = all buyers and sellers are satisfied = no pressure on price
• Analysis of change in equilibrium = comparative statics
Comparative statics:
1. Decide whether event shifts supply and/or demand curve
2. Decide which direction curve shifts
3. How does this shift change equilibrium (price and quantity)
e.g. hot weather = increased demand = change in equilibrium (price will rise, quantity rise)
e.g. flooding = lack of supply, increase in price
PRICE DECIDES EVERYTHING! – rationing function of prices
LECTURE 3:
ELASTICITY:
• Allows for the analysis of supply and demand with greater precision (that does not
depend on units of measurements
• Able to compare across different goods and services
Elasticity of demand:
• Measures how much demand responses to changes in its determinants
- Price elasticity of demand
- Income elasticity of demand
- Cross-price elasticity of demand (how much does the price of one good
change when related good changes)
Price elasticity of demand:
• Measure of how much the quantity demanded of a good responds to a change in
price
• = % change in quantity demanded/%change in price
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Just a number
Allows us to compare the responsiveness to price of goods with different
quantities/currencies e.g. kg, litres
Number that tells you how quantity demanded changes in proportion to a given
change in price e.g. if elasticity is 2, then if 4% increase in price then 8% decrease in
quantity demanded
Higher the elasticity = higher responsiveness
3 categories:
1. Elastic demand (>1) – buyers responding strongly
2. Inelastic demand (<1)
3. Unitary elasticity (=1)
Determinants of price elasticity:
• Availability of close substitutes (other goods with the same function) = higher e.g.
weet-bix vs. vitabrits
• Necessities or luxury = higher for luxury
• Definition of market = higher when defined narrowly e.g. food vs. ice cream
• Time horizon = higher for longer period
Demand curve:
• Elasticity = closely related to slope of curve
• The steeper the demand curve = the lower the price elasticity demand
Two extreme cases:
- Vertical = no elasticity - perfectly inelastic e.g. an addiction good – even if
price changes = still demand same amount
- Horizontal = infinity elasticity – perfectly elastic
Total revenue and the price of demand:
• TR = P x Q
• If demand = inelastic – increase in P = less than proportional decrease in Q =
increase in TR
• If demand = elastic – increase in P = a proportionally larger decrease in Q = decrease
in TR
• If demand = unit elasticity – change in P – proportionally equal change in Q = TR
unaffected
Income elasticity of demand:
• Measures how much the quantity of a good demanded responds to a change in
income
- Normal goods = positive elasticity (> 0)
- Inferior goods = negative income elasticity (< 0)
\ Necessities tend to be income inelastic (< 1) e.g. food, fuel
\ Luxuries = income elastic (> 1)
Cross-price elasticity of demand:
• Measures how much the quantity demanded of a good responds to a change in
price of a related good
• = % change in quantity demanded of good 1/ % change in price of good 2