Chapter 3 Supply and Demand A Model of A competitive Market market a group of producers and consumers who exchange a good or service for payment competitive market a market in which there are many buyers and sellers of the same good or service none of whom can influence the price at which the good or service is sold key feature no individual s actions have a noticeable effect on the price at which the good or service is sold supply and demand model a model of how a competitive market behaves Five key elements 1 demand curve 2 supply curve 3 set of factors that cause the demand curve to shift and the set of factors that cause the supply curve to shift 4 market equilibrium which includes the equilibrium price and equilibrium quantity 5 the way the market equilibrium changes when the supply curve or demand curve shifts the supply and demand model is a graphical model that helps us to understand the working of a competitive market The Demand Curve the higher the price the less of the good or service people want to purchase alternatively the lower the price the more they want to purchase The Demand Schedule and the Demand Curve demand schedule shows how much of a good or service consumers will want to buy at different prices specific price as price rises the quantity demanded falls quantity demanded the actual amount of a good or service consumers are willing to buy at some demand curve a graphical representation of the demand schedule It shows the relationship between quantity demanded and price if the curve slopes downwards it shows that a higher price reduces the quantity demanded law of demand says that a higher price for a good or service other things equal leads people to demand a smaller quantity of that good service Shifts of the Demand Curve shift of the demand curve is a change in the quantity demanded at any given price represented by the change of the original demand curve to a new position denoted by a new demand curve movement along the demand curve a change in the quantity demanded of a good arising from a change in the good s price shift right increase in demand shift left decrease in demand markets have different structures based on a couple of criteria particularly number of sellers and type of product two polar extremes perfect competition many sellers many buyers homogeneous products free entry and exit monopoly single seller unique product entry bainer in perfect competition we set the result that no single buyer or seller can impact the market price buyers and sellers take the price as given Where does the price come from it comes from the market which all buyers and sellers participate key every single buyer and seller is so small that they can t affect the market price Let s begin by examining the behavior of buyers Demand we are going to examine the factors that determine the demand for some good or service most importantly there is an inverse relationship between the relative price of a good and the quantity of that good demanded all else equal as the relative price of a good falls its quantity demanded increases Relative Price P QD Quantity Demanded 100 1 000 90 1 200 80 1 400 70 1 600 60 1 800 50 2 000 P 100 80 50 If the price changes we just move along a demand curve that is a change in the quantity demanded some factors alter the relationship between P and QD For example something may cause buyers to demand more at a give price an increase in demand or vice versa Understanding Shifts of the Demand Curve increase in demand is a rightward shift of the demand curve at any given price consumers demand a larger quantity of the good or service than before decrease in demand is a leftward shift of the demand curve at any given price consumers demand a smaller quantity of the good or service than before Demand Curve 1 000 1 400 2 000 D QD economists believe that there are five principal factors that shift the demand curve for a good or service 1 changes in the prices or related goods or services 2 changes in income 3 changes in taste 4 changes in expectations 5 changes in the number of consumers when we say that the quantity of a good or service demanded falls as its price rises other things equal we are in fact stating that the factors that shift demand are remaining unchanged Let s examine these factors 1 Income of Buyers when individuals have more income they are normally more likely to purchase a good at any given price all else equal as buyers income increases the demand for a good increases assuming the good is normal normal good when a rise in income increases the demand for a good however the demand for some products falls when income rises inferior goods when a rise in income decreases the demand for a good inferior goods example Ramen noodles these are goods such that demand decreases as income increases when people can afford to they will stop buying inferior goods and switch their consumption to the preferred more expensive alternative when a good is inferior a rise in income shifts the demand curve to the left a fall in income shifts the demand curve to the right P Increase in Demand D1 D Decrease in Demand D2 QD 2 Changes in the Prices of Related Goods or Services two goods are substitutes if a rise in the price of one of the goods leads to an increase in the substitutes are usually goods that in some way serve a similar function coffee and tea muffins and demand for the other goods doughnuts pairs are known as complements the other good sometimes a rise in the price of one good makes consumers less willing to buy another good such two goods are complements if a rise in the price of one good leads to a decrease in the demand to Example milk and cookies A The demand for a good increases is the price of a complement to that good decreases shifting the demand curve to the left Example pepsi and coke B The demand for a good decreases if the price of a substitute to that good decreases P Kool Aide Price of Kool Aide increases Demand for Lemonade increases D1 D Q Lemonade 3 Changes in Taste All else equal as buyer s taste for a good increases demand for that good increases 4 Changes in Expectations Buyers Expected Future Price all else equal if buyers expect the future price to rise current demand increases if you expect your income to rise in the future you will typically borrow today and increase your demand for certain goods if you expect your income to fall in the future you are likely to save today and reduce your demand for some goods 5 Changes in