Markets
Are a mechanism that brings buyers and sellers together to
exchange goods, services, and resources.
It is a device for allocating or rationing goods, services, and
resources.
• A competitive market:
– Many buyers and sellers; Same good or service
• Product market: where consumer goods are bought and
sold. Business firms are the seller, consumers are the
buyers
• Resource market: where the resource services are bought
and sold. Resource owners(consumers) are the sellers
and business firms are the buyers
• Five key elements:
–
–
–
–
Demand curve, Supply curve
Demand and supply curve shifts
Market equilibrium
Changes in the market equilibrium
Definition: relationship between the price and
the quantity demanded of a good.
• Quantity demanded: amount of an item that
buyers are willing and able to purchase over a
certain time period, at a specific price, ceteris
paribus.
1. Price
2. Income
Normal good: Buy more of a good when income
increases
Inferior good : Buy less of that good when income
increases
3. Tastes and Preferences
4. Prices of related goods
Substitutes:Two goods that perform the same
function (interchangeable)
Complements: Two goods that are used together to
enhance one another
5. Expectations (of future price, expected income, etc.)
6. Number of consumers
1. Price
The variables below this line will be held constant (ceteris Paribus)
2. Income
Normal good: Wish to buy more of a good when
income increases
Inferior good : Wish to buy less of that good when
income increases
3. Tastes and Preferences
4. Prices of related goods
Substitutes:Two goods that perform the same function
(interchangeable)
Complements: Two goods that are used together to
enhance one another
5. Expectations (of future price, expected income, etc.)
6. Number of consumers
1. Price
• By holding all other variables constant we get our first
prediction (hypothesis).
Law of Demand: The price and quantity demanded of
a good are inversely related, ceteris paribus.
• Demand schedule: A list of possible prices with the
corresponding quantity demanded at that price.
It is a representation of the law of demand.
• What if the price was..., then what would be quantity
demanded at that price.
• Think of it like answering a survey…
…no other variable changes except the one you ask
about
Example: A demand schedule
For Coffee
Price (per pound) Quantity Demanded (pounds per week)
$7.00
1,000
$6.50
2,000
$6.00
3,000
$5.50
4,000
$5.00
5,000
$4.50
6,000
$4.00
7,000
$3.50
8,000
$3.00
9,000
Demand curve - a curve representing the law of demand.
Price
$7.00
Plot the demand schedule on the graph.... Price
Connect the dots and we get...
$7.00
A Demand Curve!
$6.50
$6.00
$5.50
$5.00
$4.50
$4.00
$3.50
This is called an increase in $3.00
$6.00
$5.00
$4.00
$3.00
$2.00
Quantity
Demanded
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
quantity demanded.
$1.00 As the price of a good decreases, buyers are willing and able
0
to purchase more of this good, all other variables constant
1
2
3
4
5
6
7
8 9 10
Quantity Demanded (QD)
(In thousands)
Pay More, Pump Less…
Price of
gasoline
(per gallon)


Because of high taxes, gasoline and
diesel fuel are more than twice as
expensive in most European
countries as in the United States.
According to the law of demand,
Europeans should buy less gasoline
than Americans, and they do:
Europeans consume less than half
as much fuel as Americans, mainly
because they drive smaller cars with
better mileage.
Germany
$8
7
6
United Kingdom
Italy
France
Spain
Japan
5
Canada
4
3
0
United States
0.2
0.6
1.0
1.4
Consumption of gasoline
(gallons per day per capita)
What about the other variables?
• To construct a single demand curve a number
of variables are held constant...
(Income, Expectations, prices of related goods, etc)
• What would happen to the demand curve if
one of these variables were to change?
• Example: Suppose consumers income
increases and coffee is a normal good.
People will want to buy more coffee...
...not just at one specific price but at all prices!
If the price were $5.00, coffee drinkers would by
6,000 pounds instead of 5,000…
If one point can be shifted off a
Price
demand curve then all of them can be
$7.00
Increase in Demand
$6.00
$5.00
Price
Quantity
QD
Demand (new)
$7.00
1,000
2,000
$6.50
2,000
3,000
$6.00
3,000
4,000
$5.50
4,000
5,000
$5.00
5,000
6,000
$4.50
6,000
7,000
$4.00
7,000
8,000
$3.50
8,000
9,000
$3.00 9,000
10,000
$4.00
$3.00 When this occurs we call it
a shift in the demand curve.
$2.00 In this case it shifts to the
right which is an increase
since more coffee is desired
$1.00 at any price
0
1
2
3
4
Demand Curve
(after income increase)
Demand Curve
5
6
7
8 9 10
Quantity Demanded (QD)
(In thousands)
Changes in demand vs. Changes in quantity demanded
Price
Changes in quantity demanded
(caused by the price of the good)
Original Demand curve
Quantity Demanded
Changes in Demand (caused by a “ceteris paribus”
variable changing).
Will shift the position of the demand curve.
Don’t confuse changes in quantity demanded with changes in
demand
Both a reduction in price and
Price
an increase in demand will
$7.00
cause sales to increase, but
the reason they do so is
$6.00
different.
$5.00
$4.00
This difference
$3.00 is important and
will become
$2.00 clearer after
Supply is
$1.00 introduced
0
1
2
3
4
New Demand
Curve
Demand Curve
5
6
7
8 9 10
Quantity Demanded (QD)
(In thousands)
How do the other “ceteris paribus” variables
affect the demand curve?
1. Prices of related goods
Substitutes
• If the price of tea increases, then consumers will wish
to buy more coffee...since coffee is now relatively
cheaper compared to tea.
In general, as the price of a substitute good
increases, the demand for the other good increases.
• Therefore, there is a direct relationship between the
demand for a good and the price of a substitute good.
• Other examples: Foreign cars - American cars,
chicken - beef, Coke - Pepsi, etc.
• Consumers always purchase more of the good that is
now cheaper relative to the other good.
“Ceteris paribus” Variables
1. Prices of related goods
Complements
• If the price of sugar and cream were to increase, then
consumers will desire to buy less coffee because the
two joined products (Coffee-(sugar-cream)) now are
more expensive.
As the price of a complementary good increases, the
demand for the other good decreases.
• Therefore, there is an inverse relationship between
the demand for a good and the price of a
complementary good.
• Other examples: Cars - gasoline, Computers software, Compact discs - Compact disc players,
hot dogs - mustard
“Ceteris paribus” Variables
2. Tastes & Preferences
If consumers prefer a good there is an increase in
demand. If a good falls out of favor there is a decrease
in demand
Advertising could have an effect on tastes &
preferences
3. Expectations
Of future prices, availability of goods, income.
If you believe that prices will increase in the future,
you will want to buy more today before the price
increase (increase in demand)
Important for prices of commodities, stocks, and
bonds
4. # of consumers: more consumers, increase in
demand
• Definition: relationship between the price of a
good and the quantity supplied of a good.
• Quantity supplied: amount of an item that
sellers are willing and able to make available
to market over a certain period, at a specific
price, ceteris paribus.
1. Price of the good
2. Price of inputs (resources)
3. Technology
4. Prices of other goods that can be produced
by the firm
5. Expectations of future price
6. Number of Firms
7. Taxes and Subsidies
1. Price of the good
The variables below this line will be held constant (ceteris paribus)
2. Price of inputs (resources)
3. Technology
4. Prices of other goods that can be produced
by the firm
5. Expectations of future price
6. Number of Firms
7. Taxes and Subsidies
1. Price
• By holding all other variables constant we get our
second prediction (hypothesis).
Law of Supply: The price and quantity supplied of a
good are directly related, ceteris paribus.
• Supply schedule: A list of possible prices with the
corresponding quantity supplied at that price.
It is a representation of the law of supply.
• What if the price was... then what would be quantity
supplied at that price.
Example: A supply schedule
For Coffee
Price (per pound)
$7.00
$6.50
$6.00
$5.50
$5.00
$4.50
$4.00
$3.50
$3.00
Quantity Supplied (pounds per week)
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
Supply curve...a curve representing the law of supply
Plot the supply schedule on the graph... Price
Price
Connect the dots and we get…
$7.00
$6.00
A Supply Curve
$5.00
$4.00
$3.00
$2.00
This is called an increase
in quantity supplied.
$7.00
$6.50
$6.00
$5.50
$5.00
$4.50
$4.00
$3.50
$3.00
Quantity
Supplied
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
$1.00 As the price of a good increases, business firms are willing
to make more of the good available for sale, ceteris paribus
0
1
2
3
4
5
6
7
8 9 10
Quantity Supplied (QS)
(In thousands)
Changes in quantity supply vs. Changes in supply
Price Changes in quantity Supplied
(caused by the price of the
good)
Original Supply curve
Decrease in Supply
Increase in Supply
Quantity Supplied
Changes in Supply (caused by a “ceteris paribus” variable)
Will shift the position of the Supply curve.
How do the “ceteris paribus” variables
affect the Supply curve?
• Price of inputs (resources)
If the price of an input increases (labor, materials,etc)
this makes a good more expensive to produce (raises
costs).
This lowers the potential profit of the firm so they will
wish to decrease the supply of the good
• Opposite example: The decline in the price of
computer processors and chips makes costs decline
for computer manufacturers and they increase
supply
• Summary: A decline in input prices increases supply.
A rise in input prices decreases supply.
“Ceteris paribus” variables (Supply)
• Technology...allows a firm to produce the same
amount of a good with less resources, which results in
lower costs and an increase in supply
• Price of other goods the firm can produce...
Example: If a farmer who grows coffee beans finds
that another crop will pay them more…
… they devote less land to coffee(a decrease in
supply of coffee) and more land to the other crop
• Expectations...of future prices
If firms expect higher prices in the future they will
make less available today (decrease in supply).
Why?
So they will have more to sell in the future (at the
higher prices
“Ceteris paribus” variables (supply)
• Number of firms
The more firms that produce the good the greater is
the supply of the good (more it shifts to the right)
• Taxes and Subsidies
Excise taxes...a tax on a good (gas, cigarette,etc)
• An increase in excise taxes will raise the cost of the
good, lower potential profits, cause a decrease in
supply
• A subsidy gives money (directly or indirectly) to firms,
lowers the cost of the good and will increase
supply.
• Examples: Public colleges and universities receive
money from state governments.
• Immunizations are also subsidized by the government
Market Equilibrium
• Equilibrium: Definition At rest, no tendency to change, forces in
balance.
• Market equilibrium.
− the price, once reached, when there will be no
tendency to change.
− Also the price the market comes to rest at and
where there are forces in balance.
• This can only occur when
Quantity demand (QD) = Quantity supplied (QS)
• Price is a rationing device…
…based on willingness and ability to pay
Price
Supply curve
$7.00
$6.00
$5.00
$4.00
$3.00
Price
$7.00
$6.50
$6.00
$5.50
$5.00
$4.50
$4.00
$3.50
$3.00
QD
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
QS
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
Demand Curve
$2.00
$1.00
0
1
2
3
4
5
6
7
8
Quantity Demanded & Supply
of Coffee(in thousands)
9 10
Quantity demanded = Quantity supplied occurs where the
demand curve intersects the supply curve.
This will determine the equilibrium price and quantity. Equilibrium
price = $5.00 and 5,000 pounds of coffee are bought and sold at
that price
Price
Supply curve
$7.00
$6.00
$5.00
$4.00
$3.00
Shortage
(Excess Demand)
$2.00
Price
$7.00
$6.50
$6.00
$5.50
$5.00
$4.50
$4.00
$3.50
$3.00
QD
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
QS
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
Demand Curve
$1.00
0
1
2
3 4
5
6 7 8
Quantity Demanded & Supply
of Coffee(in thousands)
9 10
Economically (not graphically), how would equilibrium be reached?
Suppose that the price for coffee were $3.50 instead...
...At the price of $3.50 QS = 2,000 and QD = 8,000 ( QD > QS)
• Consumers wish to buy more coffee than firms are willing to
make available at $3.50. This means we have a...
an auction,
Price Like
these consumers
Supply curve
$7.00 will bid up the
price in order to
$6.00 get coffee...
$5.00
$4.00
$3.00
$2.00
$1.00
Shortage
(Excess Demand)
Some consumers
are going without
coffee when the
price is $3.50…
Price
$7.00
$6.50
$6.00
$5.50
$5.00
$4.50
$4.00
$3.50
$3.00
QD
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
QS
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
Demand Curve
Quantity Demanded & Supply
0
of Coffee(in thousands)
1
2 3 4 5 6 7 8
9 10
Some of these consumers are willing to pay more for coffee than go without
As the price is bid up some consumers drop out of the bidding. QD
decreases and coffee growers put more of their product on the market (QS
increases) This will continue consumers are able to buy all they wish to.
Only when QD = QS can this occur. Which is at the equilibrium price!
Economics in Action
The Price of Admission:
• Compare the box office price for a recent Justin Timberlake
concert in Miami, Florida, to the StubHub.com price for seats
in the same location: $88.50 versus $155.
• Why is there such a big difference in prices? For major
events, buying tickets from the box office means waiting in
very long lines. Ticket buyers who use Internet resellers have
decided that the opportunity cost of their time is too high to
spend waiting in line. For those major events with online box
offices selling tickets at face value, tickets often sell out within
minutes.
• In this case, some people who want to go to the concert badly
but have missed out on the opportunity to buy cheaper tickets
from the online box office are willing to pay the higher Internet
reseller price.
Supply curve
Price
$7.00
Surplus
(Excess Supply)
$6.00
$5.00
$4.00
At the price
of $6.00
some coffee
growers are
not able to
sell all they
wish to…
$3.00
$2.00
$1.00
0
1
2
3
4
5
6
Price
$7.00
$6.50
$6.00
$5.50
$5.00
$4.50
$4.00
$3.50
$3.00
QD
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
QS
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
Demand Curve
7 8
Quantity Demanded & Supply
of Coffee(in thousands)
9 10
Suppose that the price for coffee were $6.00 instead...
At the price of $6.00 QS = 7,000 and QD = 3,000 (QD < QS)
Coffee growers would like to sell more coffee than consumers
wish to buy at $6.00. This means we have a…
Some growers will want to sell more and to do so will cut prices!
Supply curve
Price
Surplus
$7.00
(Excess Supply)
$6.00
$5.00
$4.00
$3.00
$2.00
Price
$7.00
$6.50
$6.00
$5.50
$5.00
$4.50
$4.00
$3.50
$3.00
QD
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
QS
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
Demand Curve
$1.00
0
1
2
3
4
5
6
7 8
Quantity Demanded & Supply
of Coffee(in thousands)
9 10
As prices are decreased, consumers will wish to buy more
(QD increases), and some coffee growers will take their
product off the market (QS decreases)
This will continue until all growers are able to sell all they wish to.
Only when QS = QD can this occur. It is at the Equilibrium price!
Supply curve
Price New Equilibrium
$7.00
Think of the graph as
a “snapshot” of the
Market.
If the price of a substitute
good increases, there is
an increase equilibrium
price and quantity.
$6.00
$5.00
$4.00
New Demand Curve
$3.00
$2.00
Demand Curve
$1.00
0
1
2
3
4
5
6
7
8
Quantity of Coffee
9 10 (In thousands)
The increase in Demand causes both equilibrium
If something changes(the
Supply or
Demand
curve shifts) in
price and quantity
to go
up:
the Market
the “snapshot”
change...
Increase
in Income
(Normal will
good),
Decrease in price of a
Example: If the price
tea(a substitute
good) in
increases,
complementary
good,ofExpected
higher prices
the future,
more
consumers,
Increase
in preferences
good.
consumers
will want
more coffee
(increasefor
in the
demand)
Supply curve1
Price
$7.00
Let’s return to our
original equilibrium.
Supply curve2
$6.00
$5.00
New
Equilibrium
$4.00
$3.00
$2.00
The decline in the
price of an input
increases the
equilibrium
quantity and
decreases the
equilibrium price
Demand Curve
$1.00
0
1
2
3
4
5
6
7
8
Quantity of Coffee
9 10 (In thousands)
The increase in supply causes an increase in equilibrium quantity
Suppose
the price
of land(for
growing coffee) decreases...
and a decrease
in equilibrium
price:
...the
declineinintechnology,
the price ofaan
increase
the
An increase
fallinput
in thewill
price
of other
goods
profitability
of coffee expected
growers who
wantprice,
to produce
that
can be produced,
fall inwill
future
more
firms
producing
a fall in taxes or an increase in
more
(increasethe
in good,
supply)…
subsidies
Supply curve1
Supply curve2
Price
$7.00
$6.00
$5.00
$4.00
On the other hand,
suppose a
hurricane destroys
a fair amount of the
coffee
crop in Central
America...
$3.00
$2.00
Demand Curve
$1.00
0
1
2
3
4
5
6
7
8
Quantity of Coffee
9 10 (In thousands)
…would expect that supply of coffee would have to be
reduced...
...which will shift the supply curve to the left...
...This results in a decrease in equilibrium quantity and an
increase in equilibrium price.
The Great Tortilla Crises:
• A sharp rise in the price of tortillas, a staple food of
Mexico’s poor, which had gone from 25 cents a
pound to between 35 and 45 cents a pound in just a
few months in early 2007.
Why were tortilla prices soaring?
• It was a classic example of what happens to
equilibrium prices when supply decreases.
• Tortillas are made from corn; much of Mexico’s corn
is imported from the United States, with the price of
corn in both countries basically set in the U.S. corn
market.
• U.S. corn prices were rising rapidly thanks to surging
demand in a new market: the market for ethanol.
• This increase in the price of an input caused the
supply of tortillas to decrease and equilibrium price to
increase.
Other Examples
Making predictions about
price and quantity
7
Price
Question: How would an increase in the price of oil affect
S2
the price and quantity of cars?
S1
$3.00
Suppose the price of oil
were to increase... ...the price of gasoline
will increase
$2.00
D1
Q2
Q1
If the price of a complement
increases this will cause a
decrease in demand for the
other good...
Quantity of Gasoline
...since oil is an important input in the production of gas...
...the increase in it’s price will raise the cost of producing
gas...
...this lowers potential profit and firms reduce production...
..the supply curve shifts to the left...
How are gasoline and cars related?
They are complements!
Price
of
Cars
Question: How would an increase in the price of oil affect
the price and quantity of cars?
S1
If the price of a complement
increases this will cause a
decrease in demand for the
other good...
…a decrease in the demand for cars!
P1
P2
D2
Q2 Q1
D1
Quantity of Cars
The result is a decline in the price of cars as well as a decline in
the amount of cars bought and sold.
This example is to show you how markets are related to one
another. Other examples for you to think about:
If the price of Coke increases, what happens to the price of
Pepsi?
If the price of computers decrease, what happens to the price
of computer software?
Example:
Both Demand and Supply
curves shifting
at the same time
Around 1988, the cellular phone was just
beginning to be used....it’s price was very
high, and only wealthy individuals used
them..
S1988
Price
$800
S2008
$40
D1988
Q1
D2008
Q2
Quantity of Cellular phones
Today, many people besides the wealthy have a cellular phone..
..in other words there has been a large increase in demand the
last 20 years
According to this graph the price of cellular phones should be
over $1,000. Yet good ones today are around $50. Yet we
know that demand has increased...How to explain this?
There has also been a large increase in Supply
as well the last 20 years!
S1988 The increase in supply causes prices to decrease
Price
S2008
$800
$40
D2008
1. Decrease in price of inputs
2. Increase in technology
3. Increase in number of firms
making cellular phones
Q2
Quantity of Cellular phones
D1988
Q1
The increase in supply is greater than the increase in demand.
Increase in Demand: Increase Price, Increase Quantity
Increase in Supply: Decrease Price, Increase Quantity
Add together: We observe the quantity increases, both supply and
demand cause quantity to go up (re-enforce one another)
Since we know price goes down it must be that the force pushing
price down( supply) > force pushing the price up(demand).
Simultaneous Shifts of Supply and Demand
We can make the following predictions about the outcome when
the supply and demand curves shift simultaneously:
Simultaneous
Shifts of
Supply Increases Supply Decreases
Supply and
Demand
Price: up
Price: ambiguous
Demand
Quantity:
Increases
Quantity: up
ambiguous
Price: down
Price: ambiguous
Demand
Quantity:
Decreases
Quantity: down
ambiguous
Demand and Supply Shifts at Work in the Global Economy
• A recent drought in Australia reduced the amount of grass
on which Australian dairy cows could feed, thus limiting the
amount of milk these cows produced for export.
• At the same time, a new tax levied by the government of
Argentina raised the price of the milk the country exported,
thereby decreasing Argentine milk sales worldwide.
• These two developments produced a supply shortage in
the world market, which dairy farmers in Europe couldn’t
fill because of strict production quotas set by the European
Union.
• In China, meanwhile, demand for milk and milk products
increased, as rising income levels drove higher per-capita
consumption.
• All these occurrences resulted in a strong upward
pressure on the price of milk everywhere in 2007.
Summary
1. The supply and demand model illustrates how a
competitive market works.
2. The demand schedule shows the quantity
demanded at each price and is represented
graphically by a demand curve. The law of demand
says that demand curves slope downward.
3. A movement along the demand curve occurs when
a price change leads to a change in the quantity
demanded. When economists talk of increasing or
decreasing demand, they mean shifts of the
demand curve—a change in the quantity demanded
at any given price.
Summary
4. There are five main factors that shift the demand
curve:
• A change in the prices of related goods or services
• A change in income
• A change in tastes
• A change in expectations
• A change in the number of consumers
5. The market demand curve for a good or service is the
horizontal sum of the individual demand curves of
all consumers in the market.
6. The supply schedule shows the quantity supplied
at each price and is represented graphically by a
supply curve. Supply curves usually slope upward.
Summary
7. A movement along the supply curve occurs when a
price change leads to a change in the quantity
supplied. When economists talk of increasing or
decreasing supply, they mean shifts of the supply
curve—a change in the quantity supplied at any given
price.
8. There are five main factors that shift the supply curve:
• A change in input prices
• A change in the prices of related goods and
services
• A change in technology
• A change in expectations
• A change in the number of producers
9. The market supply curve for a good or service is the
horizontal sum of the individual supply curves of all
producers in the market.
Summary
10. The supply and demand model is based on the
principle that the price in a market moves to its
equilibrium price, or market-clearing price, the price
at which the quantity demanded is equal to the quantity
supplied. This quantity is the equilibrium quantity.
When the price is above its market-clearing level, there
is a surplus that pushes the price down. When the
price is below its market-clearing level, there is a
shortage that pushes the price up.
11. An increase in demand increases both the equilibrium
price and the equilibrium quantity; a decrease in
demand has the opposite effect. An increase in supply
reduces the equilibrium price and increases the
equilibrium quantity; a decrease in supply has the
opposite effect.
12. Shifts of the demand curve and the supply curve can
happen simultaneously.