VI. Supply and Demand

* Market is defined as an institution or mechanism which brings together buyers – “demanders” and sellers – “suppliers”.

* Demand is the amount of the good that buyers are willing and able to purchase. * Factors determine the demand for any good are as following:

Price The quantity demanded falls as the price rises and rises as the price falls, so the quantity is negatively related to the price.

Income A lower income means that you have less to spend in total so you would have to spend less on some – and probably most – goods.

Normal good is if the demand for a good falls when income falls.

Inferior good is if the demand for a good rises when income falls.

Price of related goods:

Substitutes are pairs of goods that are used in place of each other.

Compliments are pairs of goods that are used together.

Tastes

Expectations

*Law of demand: other things equal (ceteris paribus in Latin), when the price of a good rises, the quantity demanded of the good falls.

* Law of supply: other things equal, when the price of a good rises, the quantity supplied of the good also rises.

Factors determine the supply for any good are as following:

Price. Because the quantity supplied rises as the price rises and falls as the price falls, we say that the quantity supplied is positively related to the price of the good.

Input prices. The supply of a good is negatively related to the price of the inputs used to make the good.

Technology

Expectations

Taxes and subsidies. By reducing taxes and increasing subsidies the government provides for the increase of the supply of goods and vice versa.

VII. Equilibrium and elasticity

* Equilibrium’ as a situation in which various forces are in balance – and this also describes a market’s equilibrium.

* Equilibrium is the unique price and quantity established at the intersection of the supply and demand curves. Only at equilibrium does quantity demanded equal quantity supplied.

* At the equilibrium price/ market-clearing price, the quantity of the good that buyers are willing and able to buy exactly balances the quantity that sellers are willing and able to sell.

* There is one point at which the supply and demand curves intersect; this point is called the market’s equilibrium. The price at which these two curves cross is called the equilibrium price, and the quantity is called the equilibrium quantity.

* Surplus of the good: suppliers are unable to sell all they want at the going price. Sellers respond to the surplus by cutting their prices. Prices continue to fall until the market reaches the equilibrium.

* Shortage of the good: Demanders are unable to buy all they want at the going price. With too many buyers chasing too few goods, sellers can respond to the shortage by raising their prices without losing sales. As prices rise, the market once again moves toward the equilibrium.

* Surplus or shortage exists at any price where the quantity demanded and the quantity supplied is not equal. When the price of a good is greater than the equilibrium price, there is an excess quantity supplied, or surplus. When the price is less than the equilibrium price, there is an excess quantity demanded, or shortage.

* Law of supply and demand says the price of any good adjusts to bring the supply and demand for that good into balance.

* Elasticity, a measure of how much buyers and sellers respond to changes in market conditions, allows analyzing supply and demand with greater precision.

*Elasticity of demand is the degree to which changes in price cause changes in quantity demanded. It is used to describe the responsiveness of one variable (demand) to another variable (price).

* Reasons for elasticity of demand:

1) the relationship between income and the cost of the product

2) whether or not substitute product is available

* Price elasticity of demand is the degree to which changes in price cause changes in quantity demanded.

* Types of elasticity of demand:

• elastic, very responsive to price changes - greater than 1;

• unit elasticity;

• inelastic, not very responsive to price changes - less than 1.