The Working of Competitive Markets

The Working of
Competitive Markets
Business in a Competitive Market
 Importance of a firm’s market environment
 A perfectly competitive market
 The price mechanism
 shortages: price rises
 surpluses: price falls
 Effects of changes in demand and supply
 a rise in demand
• price rises  quantity supplied rises
 a rise in supply
• price falls  quantity demanded rises
Business in a Competitive Market
 The interdependence of markets

 the interdependence of goods and factor markets
 effect of a rise in the demand for a good

• response in goods market
Demand
 Relationship between demand and price

 the ‘law of demand’ when price rises, quantity drops and vice versa.
Quantity that consumers are willing to buy at a SPECIFIC price during a
• the income effect SPECIFIED time period.
• the substitution effect
 The demand curve

 constructing the demand curve
• individual and market demand curves
• assumptions ê.g. coffee quantity of students depending on the price:
300/day for 2€
350/day for 1,80€
3 Conditions must be met:
200/day for 2,50€
want/need
can i afford it?
decide to do it!
The demand curve:
The demand for potatoes (monthly)
(1) (2) (3) (4)

Price Tracey's Darren's Total market
(pence per kg) demand demand demand
(kg) (kg) (tonnes: 000s)
A 20 28 16 700
B 40 15 11 500
C 60 5 9 350
D 80 1 7 200
E 100 0 6 100
Market demand for potatoes (monthly)
Point Price Market demand
100 (cents per kg) (tonnes 000s)
A 20 700
Price (cents per kg)
80
60
40
A
20
Demand
0
0 100 200 300 400 500 600 700 800
Quantity (tonnes: 000s)
A 20 700
B 40 500
80
60
B
40
A
20
Demand
0
0 100 200 300 400 500 600 700 800
A 20 700
B 40 500
80
C 60 350
C
60
B
40
A
20
Demand
0
0 100 200 300 400 500 600 700 800
A 20 700
D 40
B 500
80
C 60 350
C D 80 200
60
B
40
A
20
Demand
0
0 100 200 300 400 500 600 700 800
E Point Price Market demand
A 20 700
D 40
B 500
80
C 60 350
C D 80 200
60 E 100 100
B
40
A
20
Demand
0
0 100 200 300 400 500 600 700 800
Demand
 Relationship between demand and price

 the ‘law of demand’
• the income effect
• the substitution effect
 The demand curve
 constructing the demand curve
• individual and market demand curves
• assumptions
 use of demand curves
• curves based on real data
• sketches
Demand
 Other determinants of demand

 Tastes and preferences
 number and price of substitute goods
 number and price of complementary goods
 income
 Expected future prices

 Size of the market
Demand
 Movements along and shifts in the demand

curve
 change in price
 movement along D curve
 change in any other determinant of demand

 shift in D curve
• increase in demand  rightward shift
• decrease in demand  leftward shift

An increase in demand
P
Price
D0 D1
O Q0 Q1
Quantity
Supply
 Relationship between supply and price

 as price rises, firms supply more
• it is worth incurring the extra unit costs only if price is
higher.
• If price remains high, firms switch from less profitable
goods
 The supply curve
 constructing the supply curve
• individual and market supply curves
• assumptions
 generally upward sloping
The supply curve:
The supply of potatoes (monthly)
Price of Farmer X’s Total market

potatoes supply supply
(cents per kg) (tonnes) (tonnes: 000s)
a 20 50 100
b 40 70 200
c 60 100 350
d 80 120 530
e 100 130 700
Market supply of potatoes (monthly)
100
Supply
P Q
80
a 20 100
60
40
a
20
0
0 100 200 300 400 500 600 700 800
100
Supply
P Q
80
a 20 100
b 40 200
60
b
40
a
20
0
0 100 200 300 400 500 600 700 800
100
Supply
P Q
80
a 20 100
b 40 200
c c 60 350
60
b
40
a
20
0
0 100 200 300 400 500 600 700 800
100
Supply
d P Q
80
a 20 100
b 40 200
c c 60 350
60
d 80 530
b
40
a
20
0
0 100 200 300 400 500 600 700 800
100 e
Supply
d P Q
80
a 20 100
b 40 200
c c 60 350
60
d 80 530
e 100 700
b
40
a
20
0
0 100 200 300 400 500 600 700 800
Supply
 Other determinants of supply
 costs of production
 profitability of alternative products
 profitability of goods in joint supply
 nature and other random shocks
 Technology
 Expected future prices

 Taxes and subsidies
Supply
 Movements along and shifts in the supply

curve
 change in price
 movement along S curve
 change in any other determinant of supply

 shift in S curve
• increase in supply  rightward shift
• decrease in supply  leftward shift
Shifts in the supply curve
P
S0 S1
Increase
O Q
Shifts in the supply curve
P
S2 S0 S1
Decrease Increase
O Q
Price and Output Determination
 Equilibrium price and output

 response to shortages and surpluses
• shortage (D > S)
 price rises
• surplus (S > D)
 price falls
 significance of ‘equilibrium’
Equilibrium price and output:
The market demand and supply of potatoes (monthly)
Price of potatoes Total market demand Total market supply

(cents per kilo) (Tonnes: 000s) (Tonnes: 000s)
20 700 (A) 100 (a)
40 500 (B) 200 (b)
60 350 (C) 350 (c)
80 200 (D) 530 (d)
100 100 (E) 700 (e)

The determination of market equilibrium
(potatoes: monthly)
E e
100
Supply
D d
80
Cc
60
b B
40
a A
20
Demand
0
0 100 200 300 400 500 600 700 800
(potatoes: monthly)
E e
100
Supply
D d
80
Cc
60
b SHORTAGE B
40
(300 000)
a A
20
Demand
0
0 100 200 300 400 500 600 700 800
(potatoes: monthly)
E e
100
Supply
D SURPLUS d
80
(330 000)
Cc
60
b B
40
a A
20
Demand
0
0 100 200 300 400 500 600 700 800
(potatoes: monthly)
E e
100
Supply
D d
80
60
b B
40
a A
20
Demand
0
0 100 200 300 Qe 400 500 600 700 800
 Effects of shifts in the demand curve

 movement along S curve and new D curve
• rise in demand (rightward shift)  P rises
Effect of a shift in the demand curve
P
S
g
Pe1
D1
O Qe1 Q
P
S
g
Pe1
D1
O Qe1 Q
P
S
g
Pe1
D2
D1
O Qe1 Q
P
S
i
Pe2
g h
Pe1
D2
D1
O Qe1 Qe2 Q
 Effects of shifts in the demand curve

 movement along S curve and new D curve
• rise in demand (rightward shift)  P rises
• fall in demand (leftward shift)  P falls
 Effects of shifts in the supply curve

 movement along D curve and new S curve
• rise in supply (rightward shift)  P falls
• fall in supply (leftward shift)  P rises
Effect of a shift in the supply curve
P
S1
g
Pe1
D
O Qe1 Q
P
S1
g
Pe1
D
O Qe1 Q
P
S2
S1
g
Pe1
D
O Qe1 Q
P
S2
S1
k
Pe3
j g
Pe1
D
O Qe3 Qe1 Q
Determination of price and quantity
Effects from changes in demand and supply
Change in
Change in supply demand Effect on price Effect on quantity
1. Increase Decrease Decrease Uncertain
2. Decrease Increase Increase Uncertain
3. Increase Increase Uncertain Increase
4. Decrease Decrease Uncertain Decrease

The Working of Competitive Markets

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The Working of Competitive Markets

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The Working of

 The interdependence of markets

 effect of a rise in the demand for a good

 Relationship between demand and price

Quantity that consumers are willing to buy at a SPECIFIC price during a

• the income effect SPECIFIED time period.

• the substitution effect

 The demand curve

(1) (2) (3) (4)

 Relationship between demand and price

 Other determinants of demand

 Expected future prices

 Movements along and shifts in the demand

 change in any other determinant of demand

• decrease in demand  leftward shift

 Relationship between supply and price

Price of Farmer X’s Total market

 Expected future prices

 Movements along and shifts in the supply

 change in any other determinant of supply

 Equilibrium price and output

Price of potatoes Total market demand Total market supply

20 700 (A) 100 (a)

40 500 (B) 200 (b)

60 350 (C) 350 (c)

80 200 (D) 530 (d)

100 100 (E) 700 (e)

 Effects of shifts in the demand curve

 Effects of shifts in the demand curve

 Effects of shifts in the supply curve

Effects from changes in demand and supply

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