Week 2: Demand and Supply in a
Competitive Market
Agenda for this week:
- Overview of the competitive market
model
- What is a market?
- What is competition?
- Demand
- Supply
- Equilibrium
- Shifts in Demand or Supply: how they
affect equilibrium
1
Price
$60
$50
Supply
$30
$25
Demand
0
100,000
300,000
350,000 Quantity
Price
Per month
Market for 4’ x 8’ sheets of ¾” plywood
2
Price
Supply
$25
$23
Demand
$15
$11
0
100,000
300,000
350,000
Market for 4’ x 8’ sheets of ¾” plywood
3
Quantity
Per month
Demand curve – behaviour of buyers
Supply curve – behaviour of sellers
Equilibrium occurs when the behaviour of
buyers and sellers matches (the amount
buyers want to buy matches the amount
sellers want to sell)
Price brings behaviours into equilibrium
Demand has negative slope
Supply has positive slope in SR
SR = now, before productive capacity
changes
4
What is a market?
Institutional arrangements that bring
buyers and sellers together to negotiate
the terms for exchanging goods or
services
Good = tangible
Service = intangible
5
What is competition? (competitive
market)
1. many buyers, many sellers (price
takers)
2. product is homogeneous (little brand
loyalty)
3. perfect information (no one is fooled)
4. freedom of entry and exit in LR (no
barriers to entry or exit)
Therefore, producers have no market
power, and price is main form of
competition.
6
Demand Curve – negatively sloped (what
does this mean?)
Law of Demand
QD = 600,000 – 10,000P or
P = 60 - .0001QD
(doesn’t have to be linear; could be QD =
1000P-1)
7
Is Price the only factor that affects
Demand?
No, quantity demanded is a function of:
Own price (P) – movement along demand
curve
Price of a substitute (PS) – shift demand
curve (butter/margarine)
8
Price of a complement (PC) – shift demand
curve (popcorn/cola)
Incomes of Consumers (I) – shift demand
curve
Normal good
Inferior good
9
If I Had A Million Dollars
by Barenaked Ladies
Lyrics:
If I had a million dollars
We wouldn't have to walk to the store
If I had a million dollars
We'd take a limousine 'cause it costs more
If I had a million dollars
We wouldn't have to eat Kraft Dinner
But we would eat Kraft Dinner. Of course
we would, we'd just eat more. And buy
really expensive ketchups with it. That's
right, all the fanciest Dijon ketchups! Mmm.
Mmm-hmm.
10
Population (Pop) – shift demand curve
Tastes – shift demand curve
11
Supply curve upward sloping because:
In SR, marginal costs of production rise
as output increases
Note: In real world, we have
manufacturers, wholesalers, retailers,
etc. (therefore, producer may be
different from seller).
We assume producer = seller, for
simplicity.
12
Supply curve – positively sloped in SR
(what do points on supply curve mean?)
QS = -275,000 + 25,000P or
P = 11 + .00004QS
(doesn’t have to be linear;
could be QS = P2)
13
Is Price the only factor that affects
Supply?
No, quantity supplied is a function of:
Own price (P) – movement along supply
curve
Price of labour (PL) – shift supply curve
(Major input to production)
14
Price of capital goods (PK) – shift supply
curve. (tools, equipment, machinery,
factory)
Changes in technology (Z) – shift supply
curve. (usually cost-saving)
15
“Equilibrium” – what is it?
- a stable situation with no forces
promoting change in the price or
quantity traded
- situation where the quantity that
consumers wish to buy is equal to the
quantity that sellers wish to sell
- i.e., when quantity demanded =
quantity supplied, market will be in
equilibrium (QD = QS).
- Is a market ever really in equilibrium?
16
Price
$60
Supply
$30
$25
$15
$11
0
Demand
100,000
300,000
350,000
Market for 4’ x 8’ sheets of ¾” plywood
17
475,000
450,000 Quantity
Per month
Notice how price acts as a signaling
device providing information (and
pressure) to encourage consumers to
change behaviour and sellers to change
behaviour so that competitive market
moves into equilibrium.
Price acts to allocate resources in a
competitive market. Determines which
demanders are successful and which
suppliers.
18
Changes in anything except P cause shifts
in demand curve or supply curve. Use
this to analyze effects of possible
events.
Examples:
(a) Rise in Consumer Incomes –normal
good
P
S0
D0
Q
19
(b) Rise in Consumer Incomes – inferior
good
P
S0
D0
Q
(c) Rise in price of substitute
P
S0
D0
Q
20
(d) Rise in price of a complement
P
S0
D0
Q
(e) Fall in population
P
S0
D0
Q
21
(f) Unionization of work force – rise in
wages
P
S0
D0
Q
(g) Rise in price of capital equipment
P
S0
D0
Q
22
(h) Rise in price of oil
P
S0
D0
Q
(i) Fall in tastes for product containing
saturated fats
P
S0
D0
Q
23
(j) Tax on beer producers
P
S0
D0
Q
(k) Two events at same time:
deregulation of university tuitions plus
increased taste for university
education
P
S0
D0
24
Q
Price ceilings and price floors
What can happen when the government
interferes with prices?
e.g., rent controls – a form of price ceiling
P
S0
D0
Q
If market cannot reach equilibrium, lowest
of QD or QS will prevail
25
If price ceiling is rigorously enforced:
- shortages
- black market
- deterioration of properties
- who is better off? Worse off?
26
Price floor – minimum wages, minimum
prices in agriculture
P
S0
D0
Q
27
If price floor is rigorously enforced
- excess supply
- illegal workers
- mechanization of low-skill jobs
- resources will not move to new
occupations
- who is better off? Worse off?
28