Transcript Market Failure - uwcmaastricht-econ

Demand & Supply
(Tragakes, 2012, pp. 20-29)
C. Bordoy
UWC Maastricht
Competitive markets
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Market can be defined as any kind of
arrangement where buyers and sellers of
goods, services or resources are linked
together to carry out an exchange.
Goods & services are sold in product markets.
Resources are sold in resource markets.
In microeconomics, competition refers to the
situation where many buyers and sellers act
independently, so that no one has the ability to
influence the price at which a product is sold in
the market.
C. Bordoy
UWC Maastricht
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Market power: control over the price by a seller.
The greater the market power, the greater is the
control over price.
The greater the degree of competition between
sellers, the smaller their market power and the
weaker is their control over the price.
A competitive market is composed of large
numbers of sellers and buyers acting
independently, so that no one individual seller
has the ability to control the price of the
product. Instead, the price is determined by the
forces of demand and supply.
C. Bordoy
UWC Maastricht
Demand
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Concerned with the behaviour of buyers
(consumers) in product markets.
The demand of an individual consumer
indicates the various quantities of a good
or service the consumer is willing and able
to buy at different possible prices during a
particular time period, ceteris paribus.
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Willing= consumer wants to buy the good
Able= consumer can afford the good
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Demand schedule
Price of chocolate
bars
Quantity
demanded
(per week)
5
2
4
4
3
6
2
8
1
10
 Demand curve
Demand curve for an individual consumer
Price of chocolate bars
6
5
4
3
2
D=MB
1
0
0
2
4
6
8
Quantity of chocolate bars
10
12
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The Law of demand: there is a negative
causal relationship between the price of a
good and its quantity demanded over a
particular time period, ceteris paribus.
The reason for the negative slope of the
demand curve is the principle of
decreasing marginal utility: since
marginal benefit falls as quantity
consumed increases, the consumer will be
willing to buy each extra unit only if the
price falls.
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Different preferences → different MBs →
different demand curves for different
consumers.
Market demand is the sum of all
individual demands for a good. It is also
the sum of consumers’ marginal benefits.
Non-price determinants of demand
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The variables other than price that can influence
demand and are assumed to be constant by use
of the ceteris paribus assumption.
When any of these variables change the entire
demand curve shifts to the right or to the left.
Rightward shift (increase in demand): more is
demanded for a given price.
Leftward shift (decrease in demand): less is
demanded for a given price.
They include the following:
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Income for normal goods. A normal good is
a good such that the demand for it increases
when income increases (most goods are
normal). An increase in income will lead to a
rightward shift of the demand curve.
Income for inferior goods. A good is inferior
if the demand for it falls as income increases
(examples: secon-hand clothes, used cars).
As income increases, these goods are
substituted by more expensive alternatives
and their demand decreases, causing a shift
of their demand curve.
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Preferences & tastes. If preferences change in
favour of the product, its demand increases
and its demand curve shifts to the right.
Prices of substitute goods. Two goods are
substitutes if they satisfy a similar need. For
ex: Coke and Pepsi. A fall in the price of one
(Coke) results in a fall in the demand for the
other (Pepsi), causing a decrease in its
demand and a leftward shift of its demand
curve.
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Prices of complementary goods. Two goods
are complements if they are consumed
together. For ex: DVDs and DVD players. An
increase in the price of one will lead to a
decrease in the demand for the other.
Demographic (population) changes (changes
in the number of buyers).
Expectations about future prices. If the price
of a good is expected to increase in the
future, consumers may increase their demand
in the present.
A shift of a demand curve caused by
a change in a determinant of demand
A movement along the demand curve
P
P1
P
A
change in
quantity
demanded
decrease
in D
increase
in D
B
P2
D
Q1
Q2
D3
Q
C. Bordoy
UWC Maastricht
D1
D2
Q
Supply
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Concerned with the behaviour of sellers
(firms in product markets).
The supply of an individual firm indicates
the various quantities of a good a firm is
willing and able to produce and supply to
the market for saleat different possible
prices, during a particular time period,
ceteris paribus.
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Supply schedule
Price of chocolate
bars
Quantity
demanded
(per week)
5
600
4
500
3
400
2
300
1
200
Supply curve
Supply of chocolate bars
700
600
500
P ($)
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400
300
200
100
0
0
1
2
3
Q per w eek
4
5
6
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The Law of supply: there is a positive
causal relationship between the quantity
of a good supplied over a particular time
period and its price, ceteris paribus.
Why the supply curve slopes upward?
Higher prices mean higher profits and so
the firm faces an incentive to produce
more output.
Market supply is the sum of all individual
firms’ supplies for a good. It indicates the
total quantities of a good that firms are
willing and able to supply in the market at
different possible prices.
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The vertical supply curve. The quantity
supplied is fixed and is independent of
price. Two reasons:
1.
2.
There is no time to produce more of the
good. For instance, theatre tickets in a
theatre because there is a fixed number of
seats.
There is no possibility of ever producing
more of the good. For ex, original antiques,
stradivarius violins, original paintings,...
Non-price determinants of supply
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Factors other than the price that can
influence supply. Changes in these factors
cause shifts of the supply curve.
Rightward shift (increase in supply): more
is supplied for a given price.
Leftward shift (decrease in supply): less is
supplied for a given price.
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The number of firms.
Costs of factors of production (resource
prices). If a factor price rises, production costs
increase, production becomes less profitable and
the firm produces less.
Technology. A new improved technology
lowers costs of production, making production
more profitable.
Competitive supply of two or more products.
The firm can produce two goods and they
compete for the use of the same resources:
producing more of one means producing less of
the other.
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Joint supply (of two or more products). The
firm cannot produce more of one without
producing more of the other. Example: butter
and skimmed milk. An increase in the price of
one leads to an increase in its quantity supplied
and an increase in the supply of the other.
Firm expectations. If the price is expected to
rise, the firm may retain some of its current
supply in order to sell it at a higher price in the
future. This results in a fall in supply in the
present (leftward shift).
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Taxes (indirect taxes or taxes on profits). Taxes
are treated by firms as costs of production so ↑
tax → supply decreases.
Subsidies. A subsidy is a payment made to the
firm by the government. It has the opposite
effect of a tax. The introduction or increase of a
subsidy results in an increase in supply.
‘Shocks’ or sudden unpredictable events, such
as weather conditions (for agricultural products),
war, or natural/man-made catastrophes (oil spill
in 2010 caused a decrease in the supply of
locally produced seafood)