Module 5 : The market

Customers wants to buy, firms wants to sell

Varies in size and locality, small /large, no of transactions, global/local
For goods, services, resources,
Competition among buyers and sellers.
In Market Economy system of interrelated markets that determine resources
allocation without central planning but by customers preferences.

5.2 Market supply and demand

Market demand curve: Q that customers willing to buy at diff process.
Market supply curve: Q that firms willing to supply at diff prices.
In market exchange both customers and seller benefit
I they see more benefit in good than cash or vice versa.
In example below there is no price at which both customers and sellers are willing to
D=
negotiate ( eg future tech)
S
D>S
S>D
If all prices S>D then good is FREE eg fresh air
Q2 = all available air while largest demand is only Q1 at which price is 0
Even free goods can cost to have them in specific quantity and location eg fresh air
( via air-conditioning) and water.
Excess supple = between S and D at price
At unique price where S = D there is not excess supply or demand
At y there is excess demand

5.3 Operation of Market

Excess supply or demand will force market to change price of Q to eliminate excess
Excess supply suppliers competition in price in demand excess supply
until 0
At lower prices customers unwilling to pay high prices will be willing to buy
Excess demand customers competitions in price in demand excess
demand until zero
When all forces that eliminate excess demand = all forces that eliminate excess
supply
Market is in equilibrium
Equilibrium price Equilibrium quantity
(S=D)

Both consumers and producers gain/benefit in transaction

When consumers obtain goods at cheaper price than willing to pay the additional
gain is Consumer Surplus:
between paid price and willing to pay price at
Consumer surplus is between line AE and demand curve
At CS = ABE triangle
Also at some producers will be selling t higher than they intended and gain
producers surplus.
PS = AE and supply curve
Triangle ACE
Information is key once customers and producers become aware of current sale
prices they provide the forces to increase supply or demand until is reached.

5.4 Changes in Market Equilibrium

If supply conditions remain unchanged an in demand results in an price and
quantity whilst a in demand results in in price and quantity
This change can be due to changes in substitute market.
Supply stays same but demand changes so new and new equilibrium price and
quantities.
Eg: in substitute product cost
consta
increase in demand and represented by shift of demand
nt curve.
Increase in demand ( for reason other than price) shift in position of whole curve.
vs
Increase in quantity demanded movement along demand curve ( if price was
lower)
If supply changes because of cheaper/more expensive resources
IMP:
Change in supply

Shift whole curve

Not caused by price of good

(but maybe price of resource, cost)
If both supply and demand change;

VS

Change in quantity supplies

movement along curve

as cause of price of good

Start with DS. First increase to D1S1 causes inc in Q and dec in P. When S reduced
there is inc in price and dec in Q.
1) Increase in demand and supply always causes increase in equilibrium
quantity but equilibrium price might be or or stay same. Eg going from
DS to D1S1 or to D1S2 directly.
2) If demand and supply the price . The quantity might be or or
stay same
Change
S D
D and S
S and D
S D

Result
Q
P
P
Q

price might be or or stay same

quantity might be or or stay same
quantity might be or or stay same
price might be or or stay same

If both same direction, Q changes in same direction.

IF diff direction P changes same dir as D.
In both cases other variable can change both way or stay same.
DS to D1S1
DS to D1S2
In both cases increase in both supply and demand.
Q always
P can or = . If change is minor it can be justified to ignore.
D and S

quantity might be or or stay same

S and D

quantity might be or or stay same

S D

price might be or or stay same

5.5 Intervention in Market

Or regulation when non market force affect the quantity/price combination that
would occur in open market.
price above or below equilibrium level in open market
5.5.1 Price Ceiling
Price set a below equilibrium level ( demand >supply)
Eg concert tickets at fixed price.

Max willing
to pay

Sale price

Supply is fixed eg 200 tickets ( inelastic)

Demand is > supply and black market can occur to reach equilibrium
Since D>S price is not used to allocate supply but increase maybe a first come first
serves or rotation.

5.5.2 Price floor

Price fixed above equilibrium m
At this price there is sexes supply.

S>D

This causes waste but prices higher income to produces. Used in agriculture.
Excess
supply

Ideally that surplus is stocked by reg agency or pay producers to not produce
Minimum wage is also a price floor. Since price is higher than equilibrium and S>D it
means that there is less demand for higher priced labor and some are unemployed.
Those employed are however better off. Mostly affects low skilled labor. But this
causes in total output.
Q supplied at fixed price.
Q demanded at fixed price.

5.5.3 Taxes and Subsidies

Tax increase marginal cost curve so supply will be equal to a higher cost good ( if
tax is fixed per unit product). Shift up
This causes a reduction in quantity demanded and so an increase in price.

How tax is split between customer and suppliers depends on the elasticity of S and
D curves
Eg pre tax is at DS at price $3 and tax is $1 per unit
If D stays same the new price is $3.75 paid.
Since tax is $1 then customers pay 75c and providers the remaining.
But if D is elastic and changes with increasing price than is at 3.25 which means
customers pay 0.25 and providers pays 0.75 tax.

Both customer and provide lose value and benefit

Tax cost and revenue gains

5.6 Dynamic adjustments in the Market ( Time period

number of moves to reach
Comparative statistics : comparing equilibrium points before and after certain
change in demand and supply.

Customer surplus
lost
Supplier surplus

In a market period (1 day) supply is inelastic and relatively fixed. Supply cannot
adopt to change in demand so price changes.

5.6.1 In short run

Supply is less inelastic because there can be an increase in variable factors and
quantity and price would change.

5.6.2 Effect of changes in long run

Supply is even more elastic. Changes to variable and fixed factors of production and
changes in industry.
prices change least. quantity changes most. ( eg in response to inc demand
more firms open)

If cost of resources dont change with new firms entering market the supply
becomes horizontal and equilibrium price remains same and quantities only vary.

5.6.3 Cyclical patterns

Time lag for adjustments so price of good and resources fluctuates.
Eg in batch process or production that takes time eg farming and high income posts
Cobweb model : diff is that supply curve has time lag.
Although it uses conventional tools of supply and demand, it is different in that the market
being analyzed operates in discrete blocks of time, and the supply curve contains a time
lag, where one periods prices affect the next periods quantities.

If S is steeper than D the market converges to equilibrate.

Price and quantity are based on previous year.
Eg Initial was at PQ
But due to disease Q1 was produced
(demand/supply stay same but quantities change along curve)
At Q1 it fetches P1 on D curve
For next year farmers prices at P1 Q2 etc
If D curve is steeper than S curve.
Means buyer adjust quantity demanded less than producers adjust quantity
supplied.