UMD ECON 200 - The Market Forces of Supply and Demand

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Chapter 4The Market Forces of Supply and DemandMarkets and Competitiono Supply and demand: behavior of people as they interact with one another in competitive marketso Market: group of buyers and sellers of a particular good or service Sometimes markets are highly organized. (Ex. Markets for agricultural commodities. Buyers and sellers meet at specific time and place, where auctioneer helps set prices and arrange sales) More often, markets are less organized (Ex. Market for ice cream. No set time or location, each seller posts its own price, each buyer decides how much to buy)o Competitive market: a market in which there are many buyers and many sellers so that each has a negligible impact on the market price Each seller of ice cream has limited control over price because other sellers are offering similar products Perfectly competitive: highest form of competition (ex. Wheat) The goods offered for sale are all exactly the same The buyers and sellers are so numerous that no single buyer or seller has any influence over market price Price takers: buyers and sellers must accept the price the market determines Monopoly: Market with one seller, who sets own price (Ex. Onelocal cable television company per town)Demando Demand Curve: Relationship between price and quantity demanded Quantity demanded: amount of a good that buyers are willing to purchase Law of demand: other things equal, quantity demanded of a good falls when the price of the good rises Demand schedule: table that shows relationship between price of a good and quantity demanded Demand curve: graph of relationship between price of a good and quantity demandedo Market demand vs. individual demand Market demand: sum of all the individual demands for a particular good or serviceo Shifts in demand curve Increase in demand: shifts curve to the right Decrease in demand: shifts curve to the left Variables that shift demand curve Income: lower income means you have less to spend, so you have to spend less on most goods. If the demand fora good falls when income falls, the good is a normal good. An inferior good is if the demand rises when income falls. (Ex. As income falls, you are less likely to buy a car or take a cab, and more likely to ride a bus) Prices of related goods: frozen yogurt and ice cream: if price of frozen yogurt falls, you will buy more yogurt, and less ice cream. The two goods are called substitutes.Complements are pairs of goods that are used together. When a fall in the price of one good raises demands in another. (Ex. Gasoline and automobiles) Tastes: If you like ice cream, you buy more of it. Expectations: expectations about future affect demand for good or service today. (Ex. If you expect to earn higher income next month, you may choose to save less now and spend more of current income buying ice cream) Number of Buyers: If number of buyers increases, the quantity demand in market would be higher at every price, and market demand would increaseSupplyo The Supply curve: the relationship between price and quantity supplied Quantity supplied: amount of a good that sellers are willing and able to sell Law of supply: claim that, other things equal, quantity suppliedof a good rises when price of good rises Supply schedule: table that shows relationship between price of good and quantity supplied Supply curve: graph of relationship between price of good and quantity suppliedo Market supply vs. individual supply Market supply is the sum of the supplies of all sellers (usually 2)o Shifts in the supply curve Input prices: To produce output of ice cream, sellers use various inputs: cream, sugar, flavoring, machines, buildings, labor of workers, etc. when price of one or more of these inputsrises, producing ice cream is less profitable, and firm supplies less ice cream. Technology: Invention of mechanized ice cream machine reduces amount of labor necessary. By reducing firms’ costs, advance in technology raises supply of ice cream. Expectations: If a firm expects price of ice cream to rise in future, it will put some of current production into storage and supply less to market today. Number of sellers: if Ben and Jerry were to retire from ice cream business, supply in market would fall Supply curve shows what happens to quantity supplied of a good when its price varies, holding constant all other variables that influence sellers. When one variable changes, supply curveshifts. Curve shifts only when there is a change in a relevant variable that is not named on either axis. Price is on vertical axis, so a change in price represents movement along supply curve. Because input, prices, technology, etc, are not measured on either axis, a change in one of them shifts the supply curve.Supply and Demand Togethero Equilibrium Equilibrium: a situation in which the market price has reached the level at which quantity supplied equals quantity demanded Where supply and demand curves intersect Price at the intersection is equilibrium price (the price that balances quantity supplied and quantity demanded). The quantity at the intersection is equilibrium quantity (the quantity supplied and the quantity demanded at the equilibrium price). At equilibrium price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell. Surplus: a situation in which quantity supplied is greater than quantity demanded. Sometimes called a situation of excess supply.  Sellers respond to surplus by cutting prices. Falling prices increase quantity demanded and decrease quantity supplied Prices continue to fall until market reaches equilibrium Shortage: a situation in which quantity demanded is greater than quantity supplied. Sometimes called a situation of excess demand Demanders are unable to buy all they want at going price. Sellers raise prices without losing sales As price rises, quantity demanded falls, quantity supplied rises, and market moves toward equilibrium Law of supply and demand: the claim that the price of any goodadjusts to bring the quantity supplied and quantity demanded for that good into balanceo 3 steps for analyzing changes in equilibrium 1. Decide whether the event shifts the supply or demand curve (or perhaps both). 2. Decide in which direction the curve shifts. 3. Use the supply and demand diagram to see how


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UMD ECON 200 - The Market Forces of Supply and Demand

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