Markets: institutions through which individuals voluntarily exchange their goods and/or services for other individuals’ property or services.
Markets
Most economic activity takes place on markets.
Two forms of exchange:
Barter: direct exchange of goods for goods.
Indirect exchange: using money on one side of the transaction.
Markets
Most economic activity takes place on markets.
Two forms of exchange: barter (direct) and indirect exchange via money.
In economics we reference a particular market in terms of the good or service being exchanged.
Markets
Most economic activity takes place on markets.
Every market involves two sides:
Demanders: individuals desiring to acquire the good.
Suppliers: individuals desiring to offer the good in exchange for other goods or money.
When money is used, we naturally call these buyers and sellers.
Demand is conditional, not unconditional.
An individual’s demand for a good is not some unconditional quantity. Demand is an expression of what quantity the individual desires conditional on a variety of factorsincluding price.
Demand is conditional, not unconditional.
Your demand for a 2022 Corvette Stingray is conditional on:
Your income
The price of the Corvette
The price of substitutes (e.g., a Mustang Shelby GT500)
The price of complements (e.g., gasoline)
The amount of driving you want to do
Supply is also conditional, not unconditional.
An individual’s (or firm’s) supply of a good is an expression of what quantity they desire to offer conditional on a variety of factorsincluding price.
Supply and Demand
Since both supply and demand are conditional, we distinguish them from quantity supplied and demanded.
Demand vs. Quantity Demanded:
Demand: what quantity the individual desires conditional on a variety of factors including price.
Quantity Demanded: the quantity desired given a particular situation (including the price of the good).
Supply vs. Quantity Supplied:
Supply: what quantity the individual/firm desires to offer conditional on various factors including price.
Quantity Supplied: the quantity offered given a particular situation (including the price of the good).
Consider the demand for beer.
Ceteris paribus (all else equal), individuals will demand a greater quantity of a good if its price is lower (and vice versa).
Price of Sam Adams
Quantity Demanded (annual)
$3.00
1,000,000
$3.50
950,000
$4.00
800,000
$4.50
700,000
$5.00
600,000
The Demand Curve
When the relationship between price and quantity demanded is graphed, we call it a demand curve.
A plot of the relationship between price and quantity demanded.
Because individuals demand less when price is higher (ceteris paribus), demand curves are downward-sloping.
The Demand Curve
A demand curve is a relationship between quantity and price only.
But demand for a good is conditional on various factors including price.
If some other factor (besides price) changes, demand shifts, the entire curve moves.
If only the price of the good changes, that is a movement along the demand curve, the curve does not shift.
Example: Sunglasses
If demand for sunglasses increases because summer turns out to be particularly sunny …
… then at each price, the quantity demanded of sunglasses is higher.
The entire demand curve shifts to the right.
What Shifts Demand?
Among factors that will shift demand when they change:
Incomes and population.
Prices of substitutes and complements.
Expectations of future prices and income, plus taxes.
The Supply Curve
When the relationship between price and quantity supplied is graphed, we call it a supply curve.
A plot of the relationship between price and quantity supplied.
Because individuals and firms supply more of a good when the price is higher (ceteris paribus), supply curves are upward-sloping.
Since price is common to both supply and demand, we can represent both on the same graph.
Consider the supply of beer.
Ceteris paribus, individuals and firms will supply a greater quantity of a good if its price is higher (and vice versa).
Price of Sam Adams
Quantity Supplied (annual)
$3.00
500,000
$3.50
700,000
$4.00
800,000
$4.50
850,000
$5.00
900,000
What Shifts Supply?
Among factors that will shift supply when they change:
Input prices and technological innovations.
Taxes, subsidies, and regulations.
Entry/exit of competitors and opportunity costs of alternative production.
Equilibrium
There is a unique price where quantity supplied equals quantity demanded.
This is the competitive (market-clearing) equilibrium price and quantity.
Equilibrium
There is a unique price where quantity supplied equals quantity demanded, the market-clearing equilibrium.
At equilibrium:
Sellers bring to market exactly the amount that buyers are willing to purchase at that price.
No wasteful production occurs.
No one willing to pay for the good is unable to obtain it.
Consumer Surplus
The market demand curve represents many individuals with different valuations of the good.
Every buyer (except the marginal buyer) pays less than they are willing to pay.
The surplus is the difference between the price paid and what a buyer is willing to pay.
Consumer Surplus = the blue shaded triangle above P* and below the demand curve.
Producer Surplus
The market supply curve represents many individuals/firms with different costs of offering the good.
Every seller (except the marginal seller) receives a price higher than their costs of production.
Producer Surplus = the red shaded triangle below P* and above the supply curve.
Total Surplus
The sum of consumer surplus and producer surplus is called total surplus.
At the competitive equilibrium price and quantity, total surplus is maximized.
What happens if P < P*?
When price is below the equilibrium price: QS < QD
There is a shortage (or excess demand).
Sellers respond by raising prices, buyers offer higher prices.
The market tends toward competitive equilibrium.
What happens if P > P*?
When price is above the equilibrium price: QS > QD
There is a surplus (or excess supply).
Sellers cannot sell all they have brought to market.
They respond by lowering prices, buyers buy more in response.
Assuming prices can adjust, we can ask how changes in market conditions alter equilibrium.
This is called comparative statics: comparing one equilibrium to another after some change in conditions.
Comparative Statics: Input Prices Rise
Assume the price of wheat increases.
Production costs have increased.
At every P, sellers can supply less beer profitably.
Supply shifts left.
Result: equilibrium P rises, equilibrium Q falls.
Comparative Statics: Incomes Rise
Assume people’s incomes increase.
At every P, buyers are willing to purchase more beer.