Markets and Market Equilibrium

Definition of a Market

A market is a group of economic agents who are trading a good or service, along with the rules and arrangements for trading. Markets facilitate the exchange of goods and services between buyers and sellers.

• Market price: The price at which buyers and sellers conduct transactions.

• Competitive equilibrium price: The price at which the quantity demanded equals the quantity supplied.

• Prices as signals: Prices encourage trade between sellers (who can produce goods at relatively low cost) and buyers (who value the goods highly).

• Perfectly competitive market: Every buyer pays and every seller charges the same market price; no individual buyer or seller can influence the market price.

Demand

Quantity Demanded and Demand Schedule

Quantity demanded is the amount of a good that buyers are willing to purchase at a given price.

• Demand schedule: A table that reports the quantity demanded at different prices.

• Demand curve: A graph showing the quantity demanded at different prices, holding all else equal (ceteris paribus).

Shifts in the Demand Curve

Shifts in demand occur when one of the following changes:

1. Tastes and preferences

2. Income and wealth

3. Availability and prices of related goods

4. Number and scale of buyers

5. Buyers' expectations about the future

• Change in tastes and preferences: A change in what people like, enjoy, or value.

• Change in income and wealth: Affects ability to pay for goods and services.

• Change in availability and prices of related goods: Includes substitutes and complements.

• Change in the number and scale of buyers: More buyers shift demand right; fewer buyers shift demand left.

Movement Along the Demand Curve

• Only a change in the product's own price causes movement along the demand curve.

Supply

Quantity Supplied and Supply Schedule

Quantity supplied is the amount of a good that sellers are willing to sell at a given price.

• Supply schedule: A table that reports the quantity supplied at different prices.

• Supply curve: A graph showing the quantity supplied at different prices.

Shifts in the Supply Curve

Shifts in supply occur when one of the following changes:

1. Input prices

2. Technology

3. Number and scale of sellers

4. Sellers' expectations about the future

• Change in input prices: Inputs are goods or services used to produce other goods.

• Change in technology: New technology can make production easier or cheaper.

• Change in number and scale of sellers: More sellers shift supply right; fewer sellers shift supply left.

• Change in sellers' expectations about the future: Expectations about future prices can affect current supply.

Movement Along the Supply Curve

• Only a change in the product's own price causes movement along the supply curve.

Market Equilibrium, Surplus, and Shortage

• Equilibrium: The state where quantity demanded equals quantity supplied.

• Excess demand (shortage): When consumers want more than suppliers provide at a given price.

• Excess supply (surplus): When suppliers provide more than consumers want at a given price.

On a graph, price is on the Y-axis and quantity is on the X-axis.

Profit and Utility

• Profit:

• Utility: A measure of happiness or satisfaction from consumption.

Consumer Choice and Incentives

The Buyer's Problem

Consumers face three main questions:

1. What do you like?

2. How much does it cost?

3. How much money do you have?

Consumers aim to maximize their utility given their preferences, the prices of goods, and their budget constraints.

Opportunity Cost

• Opportunity cost: The value of the next best alternative foregone when making a choice.

• Example: The opportunity cost of buying a sweater is the loss in jeans you could have bought instead.

Consumer Surplus

• Consumer surplus: The difference between what consumers are willing to pay and what they actually pay.

Elasticity

Definition and Types

Elasticity measures how sensitive one variable is to changes in another.

Price Elasticity of Demand

• Measures how much quantity demanded changes when the good's price changes.

• Mathematically:

Three Insights about Elasticity

• Slope is the same over the entire demand curve (if linear), but elasticity varies.

• Elasticities tend to vary over ranges of the demand curve.

• At the midpoint of a linear demand curve, elasticity is equal to 1.

Determinants of Price Elasticity of Demand

• Closeness of substitutes

• Budget share spent on the good

• Availability of time to adjust

Other Elasticities

• Cross-price elasticity of demand: Measures how much the quantity demanded of one good changes due to a percentage change in the price of another good.

• Mathematically:

• Income elasticity of demand: Measures how much quantity demanded changes when income changes.

• Mathematically: