Markets and Competition

Definition of a Market

A market is a group of buyers and sellers of a particular product. Markets can be local, national, or international in scope.

• Competitive market: Many buyers and sellers, each with negligible influence on price.

• Perfectly competitive market:

  • All goods are identical.

  • Buyers and sellers are so numerous that no single participant can affect the market price; each is a price taker.

Additional info: Most introductory economic models assume perfect competition to simplify analysis.

Demand

Quantity Demanded and the Law of Demand

• Quantity demanded: The amount of a good that buyers are willing and able to purchase at a given price.

• Law of demand: As the price of a good rises, the quantity demanded falls, ceteris paribus (other things equal).

Demand Curves

The demand curve graphically shows the relationship between the price of a good and the quantity demanded.

• Downward sloping: Higher prices lead to lower quantity demanded.

Example Table:

Why Do Demand Curves Slope Down?

• At high prices, only high-value uses are satisfied.

• As price falls, the good is used for lower-value purposes as well.

Demand Curve Shifters

Factors other than price that affect demand are called demand shifters. Changes in these shift the entire demand curve.

• Number of buyers: More buyers increase demand at every price.

• Income:

  • Normal good: Demand rises as income rises.

  • Inferior good: Demand falls as income rises.

• Prices of related goods:

  • Substitutes: Increase in the price of one increases demand for the other (e.g., tea and coffee).

  • Complements: Increase in the price of one decreases demand for the other (e.g., printers and ink).

• Tastes: Changes in preferences can increase or decrease demand.

• Expectations: Expectations of future prices or income can shift demand today.

Active Learning Example: Demand Curve for Music Downloads

• A. Price of AirPods falls: If AirPods and music downloads are complements, a fall in the price of AirPods increases demand for music downloads (demand curve shifts right).

• B. Price of music downloads falls: Movement along the demand curve (increase in quantity demanded).

Supply

Quantity Supplied and the Law of Supply

• Quantity supplied: The amount of a good that sellers are willing and able to sell at a given price.

• Law of supply: As the price of a good rises, the quantity supplied rises, ceteris paribus.

Supply Curves

The supply curve shows the relationship between the price of a good and the quantity supplied.

• Upward sloping: Higher prices incentivize greater production.

Example Table:

Why Do Supply Curves Slope Up?

• At low prices, only low-cost producers supply the good.

• As price rises, higher-cost producers enter the market.

Supply Curve Shifters

Factors other than price that affect supply are called supply shifters. Changes in these shift the entire supply curve.

• Input prices: Lower input costs increase supply (shift right); higher input costs decrease supply (shift left).

• Technology: Technological improvements increase supply.

• Number of sellers: More sellers increase supply.

• Expectations: Expectations of future prices can affect current supply.

Active Learning Example: Supply Curve for Tax Return Software

• A. Technological advance: Lowers production cost, shifting supply curve right (increase in supply).

• B. Professional preparers raise their price: May increase demand for software, indirectly affecting supply decisions.

Supply and Demand Together

Market Equilibrium

• Equilibrium price (P*): The price at which quantity supplied equals quantity demanded.

• Equilibrium quantity (Q*): The quantity supplied and demanded at the equilibrium price.

Example Table:

Surplus and Shortage

• Surplus (excess supply): Quantity supplied > quantity demanded at a given price. Leads to downward pressure on price.

• Shortage (excess demand): Quantity demanded > quantity supplied at a given price. Leads to upward pressure on price.

Market Adjustment

• When there is a surplus, sellers cut prices, increasing quantity demanded and decreasing quantity supplied until equilibrium is restored.

• When there is a shortage, sellers raise prices, decreasing quantity demanded and increasing quantity supplied until equilibrium is restored.

Analyzing Changes in Equilibrium

Three-Step Method

1. Decide whether the event shifts the supply curve, demand curve, or both.

2. Determine the direction of the shift.

3. Use a supply-demand diagram to see how the shift affects equilibrium price and quantity.

Examples

• Example 1: Shift in Demand

  • Event: Increase in price of gas (substitute for electric cars).

  • Result: Demand for electric cars increases (demand curve shifts right), raising both equilibrium price and quantity.

• Example 2: Shift in Supply

  • Event: New technology reduces production cost of electric cars.

  • Result: Supply increases (supply curve shifts right), lowering equilibrium price and increasing equilibrium quantity.

• Example 3: Shift in Both Supply and Demand

  • Events: Price of gas rises and new technology reduces production costs.

  • Result: Both curves shift right; equilibrium quantity rises, but the effect on equilibrium price depends on the relative magnitude of the shifts.

Additional info: This framework is foundational for understanding how markets allocate resources and respond to changes in economic conditions.