The Single Market

Demand , Supply, and Equilibrium

J.F. O’Connor

2/7/00

What is a Market?• Remember that if you are going to have

specialization and division of labor, you are going to need a way for people to sell what they produced but don’t wish to consume and buy what they want to consume but did not produce. We need an arrangement that facilitates exchange, an arrangement that gets potential buyers in contact with potential sellers.

A Modern Market

• In our earlier discussion, we talked about the value of oranges in terms of apples. We could also value all the other goods in the economy in terms of apples. Apples would then be the unit of account. However, we still have a problem in that we need a medium of exchange and apples are not too convenient. So we introduce money.

The Role of Money

• The unit of account

• The medium of exchange

• A store of value

• The importance of money in the market process is that it allows one to sell what one has without having to find a buyer who is selling what you want.

Two Kinds Of Money

• Currency

• Demand deposits - what is in your checking account

• Be careful to distinguish income, wealth, and money.

The Market

• Two kinds of people

– Buyers

– Sellers

• Demand represents the intentions of buyers

• Supply represents the intentions of sellers

Demand

• Demand gives the relationship between the quantity of the good that buyers are willing and able to purchase and the price of the good , while other factors affecting demand held constant.

• We can represent demand in a table, a graph, or an equation. Accordingly, we talk about a demand schedule, curve, or function

Factors Affecting Demand

• Prices of other goods

• Income of buyers

• Preferences or tastes of buyers

• Number of buyers

• Expectations

• Advertising ?

Demand ScheduleP r i c e C a t h N i c k M k t

0 1 2 7 1 9

0 . 5 1 0 6 1 6

1 8 5 1 3

1 . 5 6 4 1 0

2 4 3 7

2 . 5 2 2 4

3 0 1 1

3 . 5 0 0

Demand CurveMarket Demand

0

1

2

3

4

0 2 4 6 8 10 12 14 16 18 20

Pric

e

Quantiy

Supply

• Supply gives the relationship between the quantity of the good that sellers are willing and able to supply and the price of the good, while other factors affecting supply held constant.

• We can represent supply in a table, a graph, or an equation. Accordingly, we talk about a supply schedule, curve, or function

Factors Affecting Supply

• Input prices

• Technology of production

• Number of sellers

• Expectations

Supply Schedule P r i c e B e n J e r r y M a r k e t

0 0 0 0

0 . 5 0 0 0

1 1 0 1

1 . 5 2 2 4

2 3 4 7

2 . 5 4 6 1 0

3 5 8 1 3

Supply Curve

Market Supply

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0 2 4 6 8 10 12 14

Pric

e

Quantity

Market Equilibrium

• Demand and Supply in Balance

• The equilibrium price is the price at which the quantity demanded is equal to the quantity supplied

• If you have excess demand or excess supply the market is not in equilibrium. Why?

Market Equilibrium

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Pric

e

Quantity

Equilibrium

price $2

quantity 7 units

Equilibrium

price $2

quantity 7 units

Increase in Demand

• Means the demand curve shifts right

• Caused by factors other than the price of the good

– For a normal good, an increase in income

– An increase in the price of a substitute or a decrease in the price of a complement

– An increase in the number of buyers

– Change in preferences

Increase in DemandIncrease in Demand

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Demand1

Demand2

Supply

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Pric

e

Quantity

Increase in Demand

• Note that demand increases by 6 units but the new equilibrium quantity is only 3 units greater than old. Why?

• Note that the increase in demand results in a movement up the supply curve.

• You should analyze a decrease in demand

Increase in Supply

• Sellers are willing to supply more units of the good at each price

• Major Causes:– decrease in input prices– improvement in technology of production– increase in the number of sellers

Increase in Supply

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Demand1

Supply

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Pric

e

Quantity

Increase in Supply

• Increase in supply results in an increase in the equilibrium quantity and a decrease in price

• Note that the increase in supply results in a movement down the demand curve.

• You should analyze a decrease in supply