1

Buyers and Sellers Determine Prices

2

Goals of Buyers and Sellers

BUYERS

Make a transaction

Zero price

SELLERS

Infinite Price

Make a transaction

3

The Process of Price Determination

4

COMPETITION IS THE REGULATOR

It constrains buyers and sellers.

5

Competition is the Regulator

“If he charges too much for his wares, or if he refuses to pay as much as everybody else for his workers, he will find himself without buyers in the one case, and without workers in the other.”

6

Buyers want the lowest possible price, but....

For

Sale

DEMAND

Price

Quantity

7

they have to compete against all other buyers.

For

Sale

Price

Quantity

8

Sellers want to charge the highest price possible, but ......

For

Sale

Price

Quantity

Supply

9

they have to compete against all other sellers.

For

Sale

Price

Quantity

Supply

10

Competition determines the Equilibrium Price

For

Sale

SUPPLY

Demand

Price

Quantity

11

How are prices determined?

• Buyers competing against each other drive the price up

• Sellers competing against each other drive the price down

• Equilibrium Price is determined by the impersonal forces of supply and demand

12

About the buyers

13

Influences on the sellers

14

Reservation Prices

• Sellers – Supply price

– The lowest price that a seller is willing and able to accept for a particular quantity of a particular product

• Buyers– Demand price

– The highest price that a buyer is willing and able to pay for a particular quantity of a particular product

15

At the equilibrium price

• Buyers who are able and willing to pay the price get the goods and services they desire

• Sellers who are able to produce at that price sell all that they wish

• There are neither surpluses nor shortages

• Not all prospective buyers or sellers are satisfied

16

Relative Prices

$20

$10

$40

Income = $30,000

17

Relative Prices Have Not Changed

$20

$10

$40

Income = $30,000Income = $60,000

$20

$40

$80

18

Supply – a relationship

Price Quantity Supplied

$10 5

$9 4

$8 3

$7 2

$6 1

$5 0

$4 0

$3 0

$2 0

$1 0

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The Law of Supply

• Once all other factors have been considered, the quantity supplied of a product varies directly with the price of the product.

• If the price rises, the quantity supplied will rise; if the price falls, the quantity supplied will fall.

20

Demand – a relationship

Price Quantity Demanded

$10 0

$9 0

$8 1

$7 2

$6 3

$5 4

$4 5

$3 6

$2 7

$1 8

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The Law of Demand

• Once all other factors have been considered, the quantity demanded of a product varies inversely with the price of the product.

• If the price rises, the quantity demanded will fall; if the price falls, the quantity demanded will rise.

22

Price Elasticity of Demand

• Measure of the strength of buyers’ reactions to price changes

• If buyers don’t react very strongly, inelastic

• If buyers react strongly, elastic

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Determinants of Price Elasticity of Demand

• availability of substitutes

• percentage of income

• time

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Price Elasticity of Supply

• Strength of seller’s response to price change

• Determinants– time– use of easily transferable resources– divisibility of inputs.

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Equilibrium Price and Quantity Exchanged

Price Quantity Supplied

Quantity Demanded

$10 5 0

$9 4 0

$8 3 1

$7 2 2

$6 1 3

$5 0 4

$4 0 5

$3 0 6

$2 0 7

$1 0 8

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The Equilibrium Price

• Quantity supplied equals quantity demanded

• No shortages or surpluses

• The market clears

• Scarcity is not eliminated

• The measure of relative scarcity

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Relative Price: unit by which we measure relative scarcity scarcity

(Units on the Scarcometer)

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Order these products in terms of relative scarcity

yacht candy bardinner for one at MacDonalds a nice dinner for two in LA laptop computer Toyota mini truck ticket to a professional baseball game

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Main Points

• The Law of Demand states that a higher price will cause a decrease in the quantity demanded and a lower price will cause an increase in the quantity demanded.

• A demand schedule is a relationship between prices and quantities demanded.

30

Main Points

• The Law of Supply states that a higher price will cause an increase in the quantity supplied and a lower price will cause a decrease in the quantity supplied.

• A supply schedule is a relationship between prices and quantities supplied.

31

Main Points

• Price elasticity of demand is the strength of the buyers’ response to price changes.

• The determinants of price elasticity of demand are availability of substitutes, percentage of income, and time.

32

Main Points

• Price elasticity of supply is the measure of the strength of seller’s response to a price change

• The determinants of price elasticity of supply are time, use of easily transferable resources, and divisibility of inputs.

33

Main Points

• Buyers and sellers (demand and supply) determine equilibrium price and quantity exchanged.

• At the equilibrium price, the number of items that sellers are willing and able to offer for sale equals the number of items that buyers are willing and able to purchase.

• Relative scarcity is the relationship of supply and demand.

• Price is the measure of relative scarcity