CHAPTER 3

MARKET DEMAND
The demand for a good or service
 Quantities of good or service that people are ready to buy at various prices within some
given time period, other factors besides price held constant.
Market Demand
 sum of all individual markets
LAW OF DEMAND
 Inverse relationship between price and the quantity demanded.
Down – inversely proportional
Up- directly proportional

Changes in price result in changes in the quantity demanded.

Changes in the nonprice determinants result in changes in demand

Nonprice Determinants of Demand

 Factors that can cause demand to change.
1. Tastes and Preferences – economists use a general purpose category in their list of nonprice
determinants called tastes and preferences to account for the personal likes and dislikes of
consumers for various goods and services.
2. Income – as people’s income rise, it is reasonable to expect their demand for a product to
increase and vice versa.
3. Prices of related products – a good or service can be related to another by being a
substitute or by being a complement.
4. Future expectations – If enough buyers expect the price of good or service to rise (fall) in the
future, it may cause current demand to increase (decrease).

MARKET SUPPLY

The supply for a good or service

 Quantities of good or service that people are ready to sell at various prices within some
given time period, other factors besides price held constant.
 Law of demand states that the quantity demanded is related inversely to price, other factors
held constant. Law of supply states that quantity supplied is related directly to price, other
factors held constant.
LAW OF SUPPLY
 States that quantity supplied is related directly to price, other factors held constant
Changes in price result in changes in the quantity supplied. (Movement along the supply curve)
Changes in the nonprice determinants result in changes in the supply (shift of the supply curve)

Nonprice Determinants of Supply

1. Cost and Technology
o Treated as one. Cost refer to the usual cost of production, such as labor costs, costs
of materials, rents, interest payments, depreciation charges, and general and
administrative expenses – all items usually found in a firm of income statement
 2. Prices of other good or service offered by the seller
o Consumer’s standpoint, any good or service has other goods or services related to it
either as substitutes or as complements. Producer’s standpoint, there can also be
substitutes or complements for a particular good or service offered in the market.
3. Future expectation
o This factors has a similar impact on sellers as on buyers; the only difference is the
direction of the change.
4. Number of sellers
o The number of sellers has a direct impact on supply. The more sellers, the greater
the market supply.
5. Weather conditions
o Bad weather – will reduce the supply of an agricultural commodity.
o Good weather – will have the opposite effect.

MARKET EQUILIBRIUM

Surplus
 The quantity supplied would exceed the quantity demanded
 At a price above the equilibrium level
Shortage
 The quantity demanded exceeds the quantity supplied.
 At a price below the equilibrium level

 In the event of a surplus and shortage, various competitive pressures cause the price to
change (decrease in the case of surplus, increase in the case of shortage)
 In the case of market shortage, as the price rises toward the equilibrium level, the market is
cleared because the quantity demanded decreases while the quantity supplied increases.
Equilibrium price
 The price that equates the quantity demanded with the quantity supplied (prices that clear
market surplus and shortage)
Equilibrium quantity
 The amount that people are willing to buy and sellers are willing to offer at the equilibrium
price level.
COMPARATIVE STATICS ANALYSIS
 The model of market demand, supply, equilibrium price and quantity developed.
 Particular method of analysis.
 Commonly used method in analysis.
 In effect, CSA is a form of sensitivity analysis, or what business people often refer to as what-
if analysis.
Statics - alludes to the theoretically stable point of equilibrium.
Comparative - refers to the comparison of the various points of equilibrium.
SHORT RUN MARKET CHANGES; THE RATIONING FUNCTION OF PRICE
 An increase in demand causes the equilibrium price and quantity to rise
 An decrease in demand causes the equilibrium price and quantity to fall
 An increase in supply causes the equilibrium price fall and quantity to rise
 An decrease in supply causes the equilibrium price rise and quantity to fall
RATIONING FUNCTION OF PRICE
 When markets price changes to eliminate the imbalance between quantities and demanded,
it is serving what economists call the “rationing function of price”.
 Often associated with shortage, but also included a surplus situation.

LONG-RUN MARKET ANALYSIS: THE “GUIDING” OR “ALLOCATING FUNCTION” OF PRICE

“GUIDING” OR “ALLOCATING FUNCTION” OF PRICE
 Movement of resources into or out of markets in response to a change in the equilibrium
price of a good or service.
SHORT RUN OR LONG RUN
 Refers to the amount of time it takes for sellers and buyers to react to changes in the market
equilibrium price.

SHORT RUN
 A period of time in which sellers already in the market respond to a change in equilibrium
price by adjusting the amount of certain resources, which economists call variable inputs.
Ex. labor hours and raw materials
 A period of time in which buyers already in the market respond to changes in equilibrium
price by adjusting the quantity demanded for a particular good or service.
LONG RUN
 Period of time in which new seller may enter a market or the original sellers may exit from a
market. This period is long enough for existing sellers to their fixed factors of production. Ex
PPE
 Period of time in which buyers may react to a change in equilibrium price by changing their
tastes and preferences or buying patterns.

SHORT RUN
 Increase in demand causes price to rise
 Decrease in demand causes price to fall
 Increase in supply causes price to fall
 Decrease in supply causes price to rise

LONG RUN
 Supply increases as new seller enter the market and original sellers increase production
capacity.
 Supply decreases as less profitable firms or those experiencing losses exit the market or
decrease production capacity.
 Demand increases as tastes and preferences of consumers eventually change in favor of the
product relative to substitutes
 Demand decreases as tastes and preferences of consumers eventually change away from
the product and toward the substitutes.