Demand and supply. Market equilibrium.

1.Market and its mechanism.

2.Demand, law of demand, non-price determinants of

the demand. Market and individual demand.

3.Supply, law of supply, non-price determinants of the

supply. Market and individual supply.

4. Market equilibrium and its models. Changes in

demand and supply.

5.Government intervention: price control and the

impact of a tax or subsidy.

An economy that determines What? How? and for Whom? goods and services are produced by coordinating individual choices through markets is called a market economy.

Fundamentals of the Market economy: Private property

Economic freedom

Self-interest

Competition System of markets and prices

Limited government.

A market is an institution or mechanism which brings together buyers and sellers of particular goods and services. Markets exist in many forms: Market of consumer goods and services and resource market (looking to the nature of boons);Local , domestic, regional, national and the world markets ( looking to the location); Market of perfect competition, pure monopoly, oligopoly, monopolistic competition ( looking to the competition); Open market and underground (shadow ) market (looking to the juridical legislation); Market of cars, market of corn and ctr. (looking to the industry).

The most important goal of the market mechanism is to achieve the equilibrium and to establish the market price on the basis of competitive interaction of demand and supply. Adam Smith named that mechanism as the „ invizibile hand”.

The most important components of the market mechanism are following:

demand

supply

competition

market price

The market mechanism is the mechanism of prices

The term Demand refers to the entire relationship between the quantity demanded and the price of a commodity. The amount of a product that consumers are willing and able to purchase in a given period of time at a particular price is called the quantity demanded of a product.

There is a negative or inverse relationship between price and quantity demanded of a product. It is the law of demand. The law of demand states: other things being equal, as price increases, the corresponding quantity demanded falls.

The law of demand can be explained in terms of

income, substitution and diminishing marginal utility:

Income effect (P apples, Qd apples);substitution effect (Papples, Qd apples in comparison

with Qd pears);Diminishing marginal utility effect ( the second wash

machine leads to the lowest satisfaction than the first) scăzute).

Exceptions:

Giffen effect. Giffen boons are lower quality boons, traditionally represented the higher amount in consumer budgets of the poor (în Europe –potatoes, în Asia and South America– mais, rice). If the prices of these commodities increase, the quantity demanded can be raised too (P↑ Qd↑).

Veblen effect or demonstrative ( prestige) consumption. Higher price represents the incentive to purchase a commodity ( luxury goods).

Snob effect. It refers to the desire to own exclusive or unique goods. The quantity demanded of a snob good is higher the fewer the people who own it. Rare works of art, designed sports cars, and made-to-order clothing are snob goods. Purchases do not depend on price.

Relationship between price and quantity demanded can be represented by many methods: in tabular form, on a simple graph and mathematically.

Demand portrays a series of alternative possibilities which can be set down in tabular form. Table 1 shows the quantities of a product X which will be demanded at various prices for a given period of time, ceteris paribus.

Table 1Quantity demanded of a product X at various

pricesPrice of a product X, (m.u.)

50 40 30 20 10

Qd (un.) of product X 20 40 60 80 100

Mathematically, the relationship between the price and quantity demanded can be shown in a forme of functional dependence:

Qd = f(P),

where Qd –quantity demanded of a product X; P – price of a product X.

In the case of linear dependence the demand function is :

Qd = a – bP,

where a, b – are coefficients. Coefficient a measures the quantity demanded when the P = 0. Coefficient b measures the slope of the demand curve and mathematically represents the primary derivative of the demand function.

GraphThis inverse relationship between price of product X and

Qd can be represented on a simple graph, where, by convention, we measure Qd on the horizontal axis and P on the vertical axis (Fig. 1).

Figura 1. Demand curve

The demand curve is down-ward sloping. If the price of a product changes, ceteris paribus, there is a movement along the demand curve and a change in the quantity of the product demanded.

Non-price determinants of demand

Demand is also determined by other variables besides price, called the non-price determinants of the demand:

Looking to these determinants demand function can be represented as following:

Qd = f(P,I,T,Ps,Pc,N,W,A)

Incomes (I). An increase in I increases the D for such

normal goods ( cars, butter);Consumer tastes (T);The prices of related goods: substituted (Ps) and

complementary (Pc);The number of consumers (N);expectations (W);advertaising (A).

A shift in the D curve to the right means an increase in the D (D1);

A shift in the D

curve to the left

means a decrease in

the D (D2).

If the price of a good remains constant but some other non-price determinants changes, we say that there is a change in demand for that good. This change results in a shift in the demand curve and a change in demand:

Figura 2 . A shift in the demand curve of X

Individual demand is the demand of one consumer for a product at a various possible price in a given period of time.

Market demand means the sum of quantities demanded of a product by each consumer at the various possible prices in a given period of time:

where Qi is the market demand,

qij is the individual demand for product i of consumer j,

n – number of consumers in the market

n

jiji qQ

1

The term supply refers to the entire relationship between the quantity supplied and the price of a commodity.

The quantity supplied of a commodity is the amount that producers are willing and able to produce and make available for sale in a given period of time at a particular price.

There is the positive or direct relationship between the price and Qs. The law of supply states, other things being equal, as price rises, the corresponding quantity supplied rises, as price falls, the Qs also falls.

To a supplier, price is revenue per unit. Given production costs, a higher product price means greater profits and an incentive to increase the production.

Supply portrays a series of alternative possibilities which can be set down in tabular form. Table 2 shows the quantities of a product X which will be offered at a various possible prices, all other things equal: Table 2

Table 2Dependence between Px and Qs X

Price of a product (m.u.)

10 20 30 40 50

Qs (un.) 30 60 90 120 150

The supply function is:

where: Qs is quantity supply of a product; P – is its price.

In the case of linear dependence:

where a, b are coefficients.

Coefficient a measures the Qs in conditions when P= 0. Coefficient b measures the slope of supply function and mathematically represent the primary derivative of the supply function.

)(PfQs

Figure 3 shows the supply curve for good X corresponding to the supply schedule of table 2.

Fig 3. Supply curve

The supply curve is sloping up, because reflects the positive relationship between P and Qs, ceteris paribus. The various points on the S curve represent alternative price-quantity combinations. If the price of a good changes but everything else remains the same, there is a movement along the supply curve and a change in the quantity supplied.

Non-price determinants of supply: Resource prices (Pr) tehnology (Teh) Taxes (Tax) or subsidies (Sub) Prices of other goods – substituted (PS) and

complementary (PC) expectations (W) regarding future product price Number of sellers (N).

Looking to the determinants supply function can be represented as following:

),,,,,,,,( NWPPSubTaxTehPPfQ csrs

A shift in the supply curve. If the price of a good remains constant but another determinants influence on supply, there is a change in supply and a shift in the supply curve either to the right (S) or to the left (S).

Figura 4. A shift of the supply curve of X

Individual supply is the amount of a product that

one firm is able to produce and to sell in a given

period of time at a various possible prices.

The market supply reprezents the sum of

quantities supplied of a product by each firm at the

various possible prices in a given period of time.

In order to derive the market supply curve we

are simply summing the individual supply curves

horizontally.

The market equilibrium is a situation in which selling and buying decisions are synchronized or coordinated and in which no one is able to make a better choice given the available resources and actions of others.

Graphically, the intersection of the supply curve and the demand curve for the product will indicate the equilibrium point.

The market clearing or equilibrium price(Pe) is the price at which the Qd = Qs. THERE IS NO REASON FOR THE PRICE TO CHANGE: NEITHER A SHORTAGE, NOR A SURPLUS. The equilibrium quantity is the quantity (Qe) bought and sold at the equilibrium price.

Pe

Qx

Figura 5. Market equilibrium

E – point of equilibrium, Pe – price of equilibrium, Qe – quantity of equilibrium.

No equilibrium:

b) If Ps is higher than Pd at each possible amount of a boon. Costs of production are higher but demand is lower (figura 7).

a) If Qs exeeds Qd at each possible price and a boon is not an economic boon (free boon) (figura 6).

Figura 6. There is not the market equilibrium for free boons

Exemple: the market of sands from the Sahara (P=0).

Figura 7. There is not the market equilibrium , Ps > Pd for each amount

of produced boons (Q)

Mechanism of the formating of the market equilibrium

There are two models of market equilibrium: Walras model and Marshall model.

Economist L. Walras (1834-1910) made attention to the power of

the price as the adjusting mechanism to get back to equilibrium

(fig. 8).

Figura 8. Walras model of the market equilibrium

British economist A. Marshall (1842-1924), an opposite to Walras, made attention to the power of the quantity supplied as the adjusting mechanism to get back to equilibrium (Figura 13).

Figura 9. Marshall model of the

market equilibrium

At the equilibrium point sellers and buyers “bring” the benefits or surpluses.

Producer surplus is the total benefit associated with the production of a product, after the total cost has been paid. Mathematically, producer surplus reprezents a differense between the price of equilibrium and the price of producer. Geometrically, it equals to the rectangle BPeE (fig.10).

Consumer surplus is the total benefit associated with the consumption of a product, after the total expenditures have been covered. Mathematically, consumer surplus reprezents a differense between the highest price wich a consumer is willing to pay and the equilibrium price. Geometrically, it equals to the rectangle PeAE.

Figura 10. Consumer and producer

surpluses

Maximum price or price ceiling is fixing by government. For example, the interest rate for mortgage loans in the USA. A price ceiling occurs when it is set below the equilibrium price by the government (Fig. 11). The price ceiling induces shortage: Qd – Qs.

Figura 11. Price ceiling (maximum price).

Minimum price or price floor is fixing by government in order to support of some industries or agriculture or the well-being of population ( for example, minimum wages) (Figura 12).

Figura 12. Price floor (minimum price).

This price occurs when

the government force

pushes the price for

that good higher than

its equilibrium. A price

floor induces a supply

surplus: Qs – Qd.

Government intervention: the impact of an excise tax. This tool of government intervention is indirect and the most civilized. Suppose that an excise tax T is imposed on a particular good sold by producer. Cost of production increases and supply decreases, supply curve moves to the left: Pe increases, Qe decreases.

Figura 13. The effects on the equilibrium of an excise tax.

The total amount of

collected tax in the State

budget equals to the

rectangle P1 E1 A P2.

The tax burden is divided

between a producer

(rectangle P0 B A P2)

and a consumer (rectangle

P0 P1 E1 B).