Http:// Copyright 2006 – Biz/ed The Market System Demand, Supply and Price Determination

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Copyright 2006 – Biz/ed

The Market System

Demand, Supply and Price Determination



The Market System

• Market consists of:– Consumers - create a demand for a product

• Demand– the amount consumers desire to purchase

at various prices– Not what they will buy, but what they

would like to buy!

• Effective demand – must be willing AND able to pay



Individual and Market Demand

• Market demand – consists of the sum of all individual demand schedules in the market

• Represented by a demand curve• At higher prices, consumers generally

willing to purchase less than at lower prices

• Demand curve – negative slope, downward sloping from left to right



The Demand Curve

Price (£)

Quantity Demanded (000s)

Demand

£10

£5

100 150

The demand curve slopes downwards from left to right (a negative slope) indicating an inverse relationship between price and the quantity demanded. Demand will be higher at lower prices than at higher prices. As price falls, demand rises. As price rises, demand falls.



The Demand Curve 2

• The level of demand – – determines where on the graph it sits

• Low demand – – nearer the origin

• High demand – – further from the origin (assuming same

scale)• Dependent on a variety of factors• Demand curve moves in response

to changing factors



The Demand Curve 3• Factors influencing demand

D = f (Pn,Pn…Pn-1, Y, T, P, A, E)• Where:

• Pn = Price• Pn…Pn-1 = Prices of other goods – substitutes

and complements• Y = Incomes – the level and distribution

of income• T = Tastes and fashions• P = The level and structure of the population• A = Advertising• E = Expectations of consumers



The Demand Curve 4

Changes in any of the factors other than price causes the demand curve to shift either:

• Left (Less demanded at each price) or• Right (More demanded at each price)



The Demand Curve 5

Price (£)

Quantity Demanded (000s)

Demand

£10

100

D1

D2

10 200

Changes in any of the factors affecting demand other than price cause the entire demand curve to shift to the left (less demanded at each price) or to the right (more demanded at each price).



The Supply Curve

• Supply refers to the amount of a certain good producers are willing to supply when receiving a certain price

• The relationship between price and how much of a good or service is supplied to the market is known as the supply relationship



The Supply Curve

• Factors influencing supply:• S = f (Pn, Pn..Pn-1,H, N,F1..Fm,E,Sp)

• Where:• Pn = Price

• Pn..Pn-1 = Profitability of other goods in production and prices of goods in joint supply

• H = Technology• N = Natural shocks (Examples of supply shocks include unusually bad (good)

weather which reduces (increases) the supply of a commodity such as wheat)

• F1..Fm = Costs of production

• E = Expectations of producers• Sp = Social factors



The Supply Curve

• Changes in any of the factors OTHER than price cause a shift in the supply curve

• A shift in supply to the left – the amount producers offer for sale at every price will be less

• A shift in supply to the right – the amount producers wish to sell at every price increases

• HINT: Be careful to not confuse supply going ‘up’ and ‘down’ with the direction of the shift!



The Supply CurvePrice £

Quantity Bought and Sold (000s)

Supply

£3

200

£7

800

The supply curve slopes upwards from left to right indicating a positive relationship between supply and price. As price rises, it encourages producers to offer more for sale whereas a fall in price would lead to the quantity supplied to fall.



The Supply CurvePrice £


Supply

£4

400

S1

100

S2

900

Changes in any of the factors affecting supply other than price will cause the entire supply curve to shift. A shift to the left results in a lower supply at each price; a shift to the right indicates a greater supply at each price.



The MarketPrice (£)


S

D

£5

600

D1

300

Surplus

£3

450

A shift in the demand curve to the left will reduce the demand to 300 from 500 at a price of £5. Suppliers do not have the information or time to adjust supply immediately and still offer 600 for sale at £5. This results in a market surplus (S > D)

In an attempt to get rid of surplus stock, producers will accept lower prices. Lower prices in turn attract some consumers to buy. The process continues until the surplus disappears and equilibrium is once again reached.



The MarketPrice (£)


S

D

£5

600

S1

100

Shortage

£8

350

A shift in the supply curve to the left would lead to less products being available for sale at every price. Suppliers would only be able to offer 100 units for sale at a price of £5 but consumers still desire to purchase 600. This creates a market shortage. (S < D)

The shortage in the market would drive up prices as some consumers are prepared to pay more. The price will continue to rise until the shortage has been competed away and a new equilibrium position has been reached.

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Http:// Copyright 2006 – Biz/ed The Market System Demand, Supply and Price Determination