THE MARKET FORCES OF DEMAND AND SUPPLY. Market is wherever buyers and sellers exchange goods and services, mostly for money. Wherever an economic transaction.

THE MARKET FORCES OF DEMAND AND SUPPLY

• Market is wherever buyers and sellers exchange goods and services, mostly for money.

• Wherever an economic transaction takes

place—it’s a market.

In Economics, demand means your willingness to buy backed by your purchasing power.

Demand must satisfy two conditions: (a) willingness to buy a good, and (b) ability to buy that good

• Law of demand says that, ceteris paribus (other things equal), the quantity demanded (Qd) of a good falls when the price of the good rises, and vice versa.

Quantity demanded (Qd) means the amount of a good that buyers are willing and able to purchase at different prices

Quantity demanded is negatively related to price. This implies that the demand curve is downward sloping.

• Demand schedule is a table that shows the relationship between the price of a good and the quantity demanded.

• In one column we show price and in another column we show quantity demanded

Points Price QdA. $0.0 12B. 0.50 10C. 1.00 8D. 1.50 6

E. 2.00 4F. 2.50 2

G. 3.00 0

• Demand curve is a graphical representation of the demand schedule—

• Like demand schedule, demand curve shows the relationship between the price of a good and the quantity demanded.

• The following figure translates the demand schedule for ice-cream cones into a graph.

• Quantity demanded is negatively related to price. This implies that the demand curve is downward sloping.

• The market demand curve shows, ceteris paribus, the total quantity demanded of a good in the market at various prices.

• Ceteris Paribus means everything else remaining constant or unchanged.

The market demand

• The market demand is the sum of all of the individual demands for a particular good or service.

• That means, individual demand curves are summed up horizontally—that the quantities demanded by individuals are added up for each level of price.

Suppose there are only three customers—Bob, Helen and Art. The market demand is the sum of Bob, Helen and Art’s individual demands for videos at different prices.

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The Market Demand Schedule and Curve for Videos

The market demand is shown in a graph.

Shifts in the Demand Curve

• An increase in demand can be represented by a shift of the demand curve to the right.

• A decrease in demand can be represented by a shift of the demand curve to the left.

Shifts in the Demand Curve/Change in Quantity Demanded

Determinants of Demand—

• any non-price factor can shift demand—that means shift of the entire demand curve—to the right or to the left.

• But change in price cannot shift the demand curve—it can cause changes in Qd only

Any Change in Non-Price factors, as mentioned below, can shift demand curve:

• Income• Price of Related goods• Tastes and Preferences• Expectations• Number of Buyers

A. Income

• Normal Goods--an increase in income leads to an increase in demand.

• Inferior Goods— an increase in income leads to a decrease in demand.

B. Price of Other Goods

• Substitutes--an increase in the price of one good leads to an increase in the demand for the other.

• Complements--an increase in the price of one good leads to a decrease in the demand for the other.

C. Tastes and Preferences of people change all the time—that changes demand for goods and services. If people prefer diet goods, demand curve for diet food will shift to the right.

D. Expectations--Positive versus Negative Expectations. People’s expectation about job, market and economy is positive—demand curve will shift to the right.

E. Number of Buyers –The more buyers, the larger is the demand, and demand curve will shift to the right.

A Change in Demand and a Change in the Quantity Demanded

Supply Schedule and Supply Curve for Videos

Price increases, supply of video also increases. Price and Quantity Supplied move in the same direction

The Market Supply Schedule and Curve for Videos

Suppose there are only three firms in the market—MGA, Motown and Blockmaster. The Market Supply Curve is found by summing up individual supplies of MGA, Motown and Blockmaster at various prices.

The Market Supply Curve for Videos

A Shift of the Supply Curve

Supply Curve shifts to the right or to the left, depending on changes in the following non-price factors: A.Cost of ProductionB.Change in technologyC.People’s expectationsD.Profit considerationsE.Capacity utilization

A Shift of the Supply Curve

Supply Curve shifts to the right means supply has increased

Supply Curve shifts to the right means supply has increased

A Change in Supply and a Change in the Quantity Supplied

A Shift of the Supply Curve to the left means supply has decreased

Equilibrium of Demand and Supply

Market is at equilibrium when Qd equals Qs, and market is cleared. In this graph market is at equilibrium when price is $3, and Qd and Qs are at 66 units.

The Effects of a Shift of the Demand Curve

If supply remains constant, but demand shifts to the left, price will fall and less quantity will be demanded.

The Effects of a Shift of the Supply Curve

If demand remains constant, but supply shifts to the left, price will go up and less will be supplied.

EQUILIBRIUM WITH AND WITHOUT GOVERNMENT INTERVENTION

Dr. DowlahSpring 2009

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• Market equilibrium is a point where the supply and demand curves intersect—it is a situation in which the price has reached the level where quantity supplied equals quantity demanded.

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• Equilibrium price is the price that balances quantity supplied and quantity demanded.

• The equilibrium price is often called the "market-clearing" price because both buyers and sellers are satisfied at this price.

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• Equilibrium quantity is the quantity supplied and the quantity demanded at the equilibrium price.

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The graph shows equilibrium price and quantity in the market for Ice-Cream Cones. The market is at equilibrium at price $2, when 7 ice-cream cones will be demanded and supplied.  

• Surplus and Shortage in Market

• Surplus is a situation in which quantity supplied is greater than quantity demanded.

 • Shortage is a situation in which

quantity demanded is greater than quantity supplied.

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Shortage Surplus Qs is greater than Qd. When price is $2.50, Qd is 4, Qs is 10. Theref0re, market has a surplus of 6 units

Shortage

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Shortage means Qd is greater than Qs.

When price is $1.50, Qd is 10, Qs is 4. Theref0re, market has a shortage of 6 units

• The Invisible Hand of Market•   Whenever a market is in

disequilibrium, in a market economy the invisible hands of market brings the demand and supply to an equilibrium.

• The concept of invisible hands of market was first explained by Adam Smith.

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Figure 8: Equilibrium

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In a market economy, the forces of demand and supply bring market to an equilibrium point.

If Price is above the equilibrium, sellers reduce price, and cut down output. As prices go down, buyers demand more, and market returns to equilibrium.

If price is below equilibrium, sellers raise price and increase output, as price goes up, buyers demand less quantity. Finally, market restores equilibrium.

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Figure 9: The Effects of a Shift of the Demand Curve

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If supply remains constant, but demand decreases, price and Qd will fall.

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Figure 10: The Effects of a Shift of the Supply Curve

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If demand remains constant, but supply decreases, price will increase, but Qd will fall.

Government Intervention in Market

• Governments, however, often try to address the problems of shortages and surpluses through something called Price Controls.

• Common forms of government control of prices are known as Price Ceiling and Price Floor.

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Price Floor • • A price floor is a legal minimum on the price of a good

or service.

• If the price floor is above the equilibrium price, the quantity supplied exceeds the quantity demanded.

• Because of the resulting surplus, buyers’ demands for the good or service must in some way be rationed among sellers.

•

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Minimum Wage • An example is the Minimum Wage Legislation• • The market for labor looks like any other market:

downward-sloping demand, upward-sloping supply, equilibrium price (called a wage), and equilibrium quantity of labor hired.

• If the minimum wage is fixed above the equilibrium wage in the labor market, a surplus of labor will develop.

• As the minimum wage is a binding constraint, employers will be able to discriminate workers.

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Effects of Minimum Wage Legislation

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Price Ceiling• A price ceiling is a legal maximum on the price of

a good or service.

• If the price ceiling is below the equilibrium price, the quantity demanded exceeds the quantity supplied.

• Because of the resulting shortage, sellers must in some way ration the good or service among buyers.

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Rent Control Legislations

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The Market for Apartments in the Absence of Government Controls

Without government intervention, the market for apartments reaches equilibrium at point E with a market rent of $1,000 per month and 2 million apartments rented.

Effects of Rent Control laws

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The Effects of a Price Ceiling

Evaluations of Price Control• Most economists feel that markets are usually a good way to organize

economic activity, and most of them oppose the use of price ceilings and floors.

• If prices are set by laws, they obscure the signals that efficiently allocate scarce resources in a market economy.

• Price ceilings and price floors often hurt the people they are intended to help.

• Rent controls create a shortage of quality housing and provide disincentives for building maintenance.

• Minimum wage laws create higher rates of unemployment for teenage and low skilled workers.

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Other forms of Government control

• Subsidizing socially necessary products and services

• Taxing socially harmful products and services• Nationalization of Industries• Controlling money supply, and interest rates• Use of fiscal policies—taxation and revenue

policies

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