2. Supply, Demand and Equilibrium

1. There are many buyers and sellers in the market

2. No individual buyer and seller is big enough or has the power to be able to influence price

3. There is freedom of entry and exit to and from the market

4. Goods produced are homogenous (identical)

5. Buyers and sellers act independently and only consider their own position in making decisions

6. There are clearly defined property rights

demand is the quantity of a good sellers are willing and able to purchase at different prices.

it can be portrayed in demand schedules and in a demand curve.

Demand increases with decreasing prices.

Demand decrases with increasing prices.

The greater amount to be sold, the smaller must be the price in order that it may find purchaser.

—> the amount demanded increases with a fall in price and vice versa.

• strictly downward sloping

• As the price approaches infinity quantity approaches zero

• As the price approaches zero, quantity approaches infinity or the market saturation level

Moving along the curve:

Price changes for reasons unrelated to demand

1)Income Effect

2)Substitution Effect

Shifting the curve:

Quantity changes for reasons other than price (larger or smaller quantity is demanded at any price)

1. Changes in prices of other goods

2. Changes in the income levels

3. Tastes, fashions, trends

4. Changes in the size and structure of the population

5. Advertising effects

6. Changes in expectations about the future

—> is the quantity of the good that producers / sellers are willing and able to produce / sell at different prices

Law of supply: The quantity of supplied goods increases when the prices increase

• strictly upward sloping

• As price approaches infinity, quantity approaches infinity or the maximum output of the economy

• As price approaches zero, quantity approaches zero (typically already sooner)

-> Market equilibrium is a longterm state of the market. Short term deviations are possible, but it always turns back to the equilibrium point.

Shortage: Demand higher than supply

Surplus: Supply higher than demand

draw these

perfectly inelastic demand

inelastic demand

perfectly elastic demand

elastic demand

Perfectly inelastic demand: e=0

Perfectly elastic demand: e=∞

Inelastic demand: e<1

Elastic demand: e>1

—> is used when a price P0 is being changed to P1 and changed back again to P0.

Because a change in the price from P0 to P1 and a change from P1 to P0 could result in widely diverging elasticity values, frequently the midpoint

method of calculating elasticities is used:

Elasticity can be determined for a specific point using the derivative of the function:

See script

• Availability of Substitutes

• Necessity versus Luxury

• Definition of the Market

• Proportion of Income Devoted to the Product

• Time Horizon

Normal good: the quantity demanded decreases with falling income (c.p.)

Inferior good: the quantity demanded increases with falling income (c.p.)

Substitutes : Have positive cross price elasticities

Complements : have negative cross price elasticitites

Examples

Substitutes —> Margarine statt Butter

Complements —> contributes value to another linked good when demand increases —> CD´s and CD-Player, Cereal and Milk

Productive Capacity

• Size of the Firm or Industry

• Mobility of Production Factors

• Ease of Transporting

• Ease of Storing