How Markets Work

1. Supply and Demand

Competitive Market: a market in which there are many buyers and many sellers so that each has a negligible impact on the market price

Perfectly Competitive Market:

1. The goods offered for sale are all exactly the same
2. the buyers and sellers are so numerous that no single buyer or seller has any influence over the market price

Price takers: in a perfectly competitive market, buyers and sellers must accept the price the market determines

Monopoly: only one seller, and this seller sets the price

Oligopoly: a few sellers

Monopolistic Competition: many sellers; slightly different products (compared with identical products in perfectly competition)

1.1 Demand

Quantity Demanded: the amount of a good that buyers are willing and able to purchase

Law of Demand: the claim that, other things being equal, the quantity demanded of a good falls when the price of the good rises

Demand Schedule and Demand Curve:

The market demand curve shows how the total quantity demanded of a good varies as the price of the good varies.

1.1.1 Shifts in Demand Curve

1. Income:
   • Normal Good: a good for which, other things being equal, an increase in income leads to an increase in demand
   • Inferior Good: a good for which, other things being equal, an increase in income leads to a decrease in demand
2. Number of buyers
3. Prices of Related Goods:
   • substitutes: two goods for which an increase in the price of one leads to an increase in the demand for the other
     • e.g. Coca-Cola and Pepsi
   • complements: two goods for which an increase in the price of one leads to a decrease in the demand for the other
     • e.g. computer and software
4. Tastes
5. Expectations

Application:

1.2 Supply

Quantity Supplied: the amount of a good that sellers are willing and able to sell

Law of Supply: the claim that, other things being equal, the quantity supplied of a good rises when the price of the good rises

Market supply is the sum of the supplies of all sellers.

1.2.1 Shifts in the Supply Curve

1. Input prices
2. Technology
3. Number of sellers
4. Expectations
   • If a firm expects the price of ice cream to rise in the future, it will put some of its current production into storage and supply less to the market today.

1.3 Supply and Demand Together

equilibrium a situation: in which the market price has reached the level at which quantity supplied equals quantity demanded

equilibrium price: the price that balances quantity supplied and quantity demanded

equilibrium quantity: the quantity supplied and the quantity demanded at the equilibrium price

Surplus: a situation in which quantity supplied is greater than quantity demanded

Shortage: a situation in which quantity demanded is greater than quantity supplied

1.3.1 Three Steps to Analyzing Changes in Equilibrium

1. Decide whether the event shifts the supply or demand curve (or perhaps both).
2. Decide in which direction the curve shifts.
3. Use the supply-and-demand diagram to see how the shift changes the equilibrium price and quantity.

Examples in real world:

• 如果石油价格上升是由于供给不足，则一定会引起GDP增长下降。
• 相反的，如果较高的石油价格反映的是强劲的需求，那么它就是健康的全球增长的结果（反向因果关系）。

2. Elasticity

颐和园和电影院的区别

需求收入弹性

2.1 The Elasticity of Demand

Elasticity: a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants

Price Elasticity of Demand measures how much the quantity demanded responds to a change in price. $$ \text{Price Elasticity of Demand} = { \text{percentage change in quantity demanded} \over \text{percentage change in price} } $$ Two computing methods:

• divided by starting point
• divided by midpoint, which is better

2.1.1 Factors affect elasticity

1. Necessities v.s. Luxuries

2. Necessities: inelastic demands

3. Luxuries: elastic demands

4. Narrowly defined markets tend to have more elastic demand than broadly defined markets

5. Goods tend to have more elastic demand over longer time horizons.
   • Consumers can have more ways to avoid the effect if rising price given more time.

2.1.2 Examples

2.1.3 Total Revenue

total revenue: the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold

Price decrease and quantity increase: $$ \begin{align}

\end{align} $$

2.2 The Elasticity of Supply

The price elasticity of supply measures how much the quantity supplied responds to changes in the price.

Because firms often have a maximum capacity for production, the elasticity of supply may be very high at low levels of quantity supplied and very low at high levels of quantity supplied.

2.3 Other Elasticities

2.3.1 Income Elasticity of Demand

Necessities: income inelastic, \(0 < e < 1\)

Luxuries: income elastic, \(e > 1\)

2.3.2 Cross-Price Elasticity of Demand

\[ e = {\text{Percentage of change in demand of A} \over \text{Percentage of change in price of B}} \]

Substitutes: \(e > 0\); more similar, greater \(e\)

Complements: \(e < 0\)

3. Supply, Demand, and Gov. Policies

3.1 Control on Prices

price ceiling

price floor

3.2 Taxes

Tax Incidence: the manner in which the burden of a tax is shared among participants in a market

Taxes levied on sellers and taxes levied on buyers are equivalent.

Distribution of taxes: who are more "elastic" or flexible have less tax burden; who are more dependent on a product or market have to shoulder more tax burden

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Last update: September 13, 2022

Authors: Co1lin