Markets and Market Participants (Supply and Demand)

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Markets and Market Participants(Supply and
Demand)

• Chapter-3

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In This Chapter.

• 3.1. Market Participants, their Goals, and
  Interactions in the Market Place
• 3.2. The Representation (Characterization) of
  Market Participants
• Supply and demand
• Individual and Market
• 3.3. The formation of Market Signals that guide
  us in Allocating the Scarce Resources

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3.1. Identifying Markets, Market Participants and
their Behavior

• Who?
• Millions of people (domestic or foreign), firms,
  and government institutions participate directly
  or indirectly in the market (a given countrys
  economy).
• We can identify three broad groups of market
  participants

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3.1. Identifying Markets, Market Participants and
their Behavior

• Consumers (Households)
• Those economic agents who go to the marketplace
  to buy goods and services and satisfy their needs
  (wants) from their limited resources.
• Producers (Businesses or firms)
• Economic agents who go to the marketplace to sell
  goods and services so as to make profits from
  their limited outputs (services)
• Government (Government Institutions)
• Serve the public needs interest by using the
  available resources

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3.1. Identifying Markets, Market Participants and
their Behavior

• The Purpose (Goal) of Market Participants?
• Consumers (Households)
• maximize their utility (satisfaction) given
  limited resources.
• Producers (Businesses)
• maximize profits by using resources efficiently
  in producing goods.
• Government Institutions
• maximize general welfare of the society.

Maximizing Behavior
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3.1. Identifying Markets, Market Participants and
their Behavior

• Maximizing Behavior
• The basic goals of utility maximization, profit
  maximization, and welfare maximization thus
  explain most market activity.
• How do Markets enable Participants to Achieve the
  goal Maximization?

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3.1. Identifying Markets, Market Participants and
their Behavior

• Economic interactions the opportunity for
  specialization and exchange.
• Our economic interactions with others in the
  market place is necessitated by two constraints
• Our absolute inability as individuals to do
  (produce) all the things we need or desire.
• 2. The limited amount of time, energy, and
  resources we have producing those things we could
  make for ourselvesscarcity

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3.1. Identifying Markets, Market Participants and
their Behavior

• Markets thus refer to a place where consumers and
  producers come together and where exchange takes
  place.
• Although identifiable and peculiar in some cases,
  there is no specific place where markets are
  located (they could be virtual)
• A market exists wherever and whenever an exchange
  takes place.
• Based on the items for exchange, however, we can
  identify TWO MAIN types of markets

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3.1. Identifying Markets, Market Participants and
their Behavior

• 1. Factor Markets
• are any place where factors of production
  (e.g., land, labor, capital) are bought and sold.
• 2. Product Markets
• are any place where finished (final) goods and
  services (products) are bought and sold.

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3.1. Interaction in the Market Place
Goods and services demanded
Goods and services supplied
Factors of production supplied
Factors of production demanded
The Circular Flow
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Dollars and Exchange

• Every market transaction involves an exchange of
  dollars for goods (in product markets) or
  resources (in factor markets).

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3.1. Interaction in the Market Place
Household Expenses
Revenue
Goods and services demanded
Goods and services supplied
Factors of production supplied
Incomes
Factors of production demanded
Costs of Production
The Circular Flow
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3.2. Characterization of the Activities of Market
Participants

• Market is a place that brings together Consumers
  (Buyers) and Producers (Sellers).
• For every market transaction, there must be a
  buyer and a seller.
• The sellers represent the supply side of the
  market.
• The buyers represent the demand side of the
  market.

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3. 2. Supply and Demand

• Demand

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3. 2. Supply and Demand

• What is Demand ?
• is the ability and willingness of consumers
  (buyers) to buy specific quantities of a good at
  alternative prices in a given time period,
  ceteris paribus.
• Quantity Demanded
• The amount of a good that a consumer is willing
  and able to buy at given time and price level,
  ceteris paribus

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Ceteris Paribus

• Ceteris paribus is the assumption of nothing else
  changing (keeping all other unchanged).
• To simplify their models, economists focus on
  only one or two forces at a time and assume
  nothing else changes.

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3.2. Supply and Demand

• A demand exists only if someone is willing and
  able to pay for a good. Thus
• Demand is an expression of consumer buying
  intentions of a willingness and ability to buy
  not a statement of actual purchases.

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Individual Demand

• Three different ways to present demand
• Using A table (Demand Schedule)
• Using A graph (Demand Curve)
• Using A Mathematical Equation (Demand Function)

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Individual Demand

• Demand schedule
• is a table showing the quantities of a good a
  consumer is willing and able to buy at
  alternative prices in a given time period,
  ceteris paribus.

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Individual Demand

• Demand curve
• is a curve (graph) describing the quantities of
  a good a consumer is willing and able to buy at
  alternative prices in a given time period,
  ceteris paribus.

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Demand Schedule and Curve
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Individual Demand

• Demand Function
• an algebraic representation of the quantities of
  a good a given consumer is willing and able to
  buy at alternative prices in a given time period,
  ceteris paribus.

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Individual Demand

• The Law of demand
• The quantity of a good demanded in a given time
  period increases as its price falls, ceteris
  paribus.

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Determinants of Demand

• Determinants of market demand include
• Tastes desire for the particular good under
  consideration and other goods.
• Income of the consumer.
• Other goods their availability and price.
• Expectations for income, prices, tastes.
• Number of buyers.

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Other Goods

• Substitute goods
• Goods that can be used to serve the same purpose
  (Substitute for each other). E.g., Pepsi and Coke
• When the price of good x rises, the demand for
  good y increases, ceteris paribus.
• Complementary goods
• Goods that are frequently consumed in combination
  (E.g., Burger and Cheese).
• When the price of good x rises, the demand for
  good y falls, ceteris paribus.

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Income

• Normal goods
• Goods the consumption of which increases as our
  income level increases, and falls as income
  level falls (E.g., ..)
• Inferior goods
• Goods the consumption of which increases as
  income level falls and decreases as the income
  level rises (E.g., ..).

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Types of Demand

• We can identify two types of demand
• Individual demand
• Market demand
• is the total quantities of a good or service
  people are willing and able to buy at alternative
  prices in a given time period.
• It is the sum of individual demands.

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Market Demand

• Market demand is determined by the number of
  potential buyers and their respective tastes,
  incomes, other goods and expectations.

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The Market Demand Curve

• Market demand represents the combined demands of
  all market participants.
• The separate demands of individual consumers is
  added up to determine the total quantity demanded
  at any given price.

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Construction of the Market Demand Curve
Price




Quantity Demanded
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Construction of the Market Demand Curve

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Shifts in Demand Vs Movements along the Demand
Curve

• The determinants of demand can and do change.
• A Change in demand is indicated by a shift in the
  demand curve.
• Represents a change in the quantity demanded at
  every given price level.
• Results from changes in one or more factors in
  the determinants of demand (due to changes in
  tastes, income, other goods, or expectations),
  except own price of the good

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Shifts in Demand Vs Movements along the Demand
Curve

• Changes in quantity demanded
• Is indicated by movements along a demand curve,
  and it results only as a response to changes in
  the price of the good itself.

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Changes in Demand
Change in Demand is indicted by a shift in the Demand Curve Change in Demand is indicted by a shift in the Demand Curve Change in Demand is indicted by a shift in the Demand Curve
An increase in demand shifts the demand curve to the right when A decrease in demand shifts the demand curve to the left when
The good is normal and income increases The good is normal and income decreases
The good is inferior and income decreases The good is inferior and income increases
The price of a substitute good increases The price of a substitute good decreases
The price of a complementary good decreases The price of a complementary good increases
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Market Effects ofChanges in Demand
Changes in Demand Shift the Demand Curve Changes in Demand Shift the Demand Curve
An increase in demand shifts the demand curve to the right when A decrease in demand shifts the demand curve to the left when
Population increases Population decreases
Consumer tastes shift in favor of the product Consumer tastes shift away from the product
Consumers expect a higher price in the future Consumers expect a lower price in the future
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Market Effects ofChanges in Demand
Changes in Demand Shift the Demand Curve Changes in Demand Shift the Demand Curve
An increase in demand shifts the demand curve to the right when A decrease in demand shifts the demand curve to the left when
Population increases Population decreases
Consumer tastes shift in favor of the product Consumer tastes shift away from the product
Consumers expect a higher price in the future Consumers expect a lower price in the future
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Movements vs. Shifts
Shift in demand
d1
D2
increased demand
Movement along curve
D1
initial demand
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Pizza and Politics Quiz (True or False)

• At the Clinton White House whenever a political
  crisis erupted, the demand for pizza increased.
• we can represent this by a shift in demand curve
  for pizza (at the White House) not by movement
  along the same demand curve.
• True

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3. 2. Supply and Demand

• Supply

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3.2. Supply and Demand

• What is Supply?
• is the ability and willingness of a producer
  (supplier) to sell specific quantities of a good
  at alternative prices in a given time period,
  ceteris paribus.
• Quantity Supplied
• The quantity of a given good that the producer is
  willing and able to supply at a given price and
  time, ceteris paribus

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Supply

• Supply is the total quantities of a good that
  sellers are willing and able to sell at
  alternative prices in a given time period,
  ceteris paribus.

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Law of Supply

• Larger quantities will be offered for sale at
  higher prices.
• Law of supply, the quantity of a good supplied in
  a given time period increases as its price
  increases, ceteris paribus.
• Supply curves are thus upward-sloping to the
  right.

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Market Supply
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Market Supply
Erins Supply
Mirandas Supply
Husseins Supply
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Market Supply
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Determinants of Supply

• The determinants of market supply include

• Factor costs
• Technology
• Other goods

• Taxes and subsidies
• Expectations
• Number of sellers

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Market Supply

• The market supply curve is just a summary of the
  supply intentions of all producers.
• Market supply is an expression of sellers
  intentions (willingness and ability) an offer to
  sell not a statement of actual sales.

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Movements and Shifts of Supply

• Changes in the quantity supplied movements
  along the supply curve.
• Changes in supply shifts in the supply curve.

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• Equilibrium Market Price

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Equilibrium

• Equilibrium price
• is the price at which the quantity of a good
  demanded in a given time period equals the
  quantity supplied.
• Equilibrium Quantity
• The quantity of the good purchased and sold at
  the equilibrium price

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Equilibrium Price
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Equilibrium Price
Price
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Market demand
Market supply
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At equilibrium price, quantity demanded equals
quantity supplied
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30
25
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Equilibrium price
15
10
5
0
25
50
75
100
125
Quantity
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.Equilibrium Price is a Market Clearing Price

• Everyone may not be happy with the prevailing
  price or quantity at equilibrium.
• However, it is unique in that the outcome at
  market equilibrium is efficient.
• Resources are put to their best possible use

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The Invisible Hand

• Adam Smith characterized this market mechanism as
  the invisible hand.
• The market mechanism is the use of market prices
  and sales to signal desired outputs (or resource
  allocations).

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Deviation from the Equilibrium
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Market Surplus

• A market surplus is the amount by which the
  quantity supplied exceeds the quantity demanded
  at a given price excess supply.
• A market surplus is created when the market
  prices are too high.

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Market Shortage

• A market shortage is the amount by which the
  quantity demanded exceeds the quantity supplied
  at a given price excess demand.
• A market shortage is created when the market
  prices are too low.

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Surplus and Shortage
Price
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Market demand
Market supply
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40
35
30
25
20
15
10
5
0
25
50
75
100
125
Quantity
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Self-Adjusting Prices

• A market surplus will emerge when the market
  price is above the equilibrium price.
• A market shortage will emerge when the market
  price is below the equilibrium price.

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Self-Adjusting Prices

• Buyers and sellers will change their behavior to
  overcome a surplus or shortage.
• Only at the equilibrium price will no further
  adjustments be required.

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Surplus and Shortage
Price
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Market demand
Market supply
45
40
35
30
25
20
Equilibrium price
15
10
5
0
25
50
75
100
125
Quantity
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Changes in Equilibrium

• No equilibrium price is permanent.
• The equilibrium price will change whenever the
  supply or demand curve shifts.
• Changes in supply and demand occur when the
  determinants of supply and demand change.

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Changes in Equilibrium

• Should the demand curve shift, the result will be
  a change in equilibrium price and quantity.
• Should the supply curve shift, the result will be
  a change in equilibrium price and quantity.

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Changes in Equilibrium Demand Shift
Market supply
E1
Initial demand
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Changes in Equilibrium Supply Shift
Market supply
E1
Initial demand
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Implications---Outcomes

• In a free market economy, the market mechanism
  resolves the basic economic questions of WHAT,
  HOW, and FOR WHOM.

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Market Outcomes

• WHAT we produce is determined by the equilibrium
  of the markets.
• HOW we produce is determined by profit seeking
  behavior and using resources efficiently.
• FOR WHOM we produce is determined by those
  willing and able to pay the equilibrium price

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• Does the Market Outcome Satisfy Everybody?
• Is it Perfect?
• Is it Optimal?

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Optimal, Not Perfect!!

• Not everyone is happy with market outcomes.
• But we are given the opportunity to maximize our
  own satisfaction.
• Thus although the outcomes of the marketplace are
  not perfect, they are often optimal.
• Because Everyone has done the best possible given
  their incomes and talents

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Real Life Examples

• People are often upset with the market outcome.
• In a market-driven economy of the
  U.S.A.(California), electricity prices are set by
  the forces of supply and demand.

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Real Life Examples

• In 2000, Electricity prices increased in
  California because of two reasons
• an increase in demand (The demand curve shifted
  rightward)
• and a decrease in supply (The supply curve
  shifted leftward).
• Sharp Increase in Electricity Price..

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Price Ceilings Create Shortages
P2
P1
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Real Life Examples

• This led to Government Intervention in
  Electricity pricing .
• The California legislature put a price ceiling on
  retail electricity prices.
• A price ceiling is the upper limit imposed on the
  price of a good.

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Price Ceilings Create Shortages
P2
Price ceiling
P1
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Consequences of Price Ceilings

• Price ceilings have three predictable effects
• Increase the quantity demanded.
• Decrease the quantity supplied.
• Create a market shortage.

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Price Ceilings Create Shortages
shortage
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Price Ceilings Create Shortages

• Letting prices rise would have

• Reduced the quantity demanded.
• Increased the quantity supplied.
• Alleviated the market shortage.