3. Market mechanism: demand, supply, prices

Plan:

1) Law, determinacy of demand

2) Law, determinacy of supply

3) Market equilibrium and price mechanism

4) Government interference into the price mechanism

Demand relates to human wants. It characterizes the behavior of consumers.

Supply relates to human resources. It characterizes the behavior of producers.

Demand

P	Qd
0	30
0.5	25
3.5	7
7	3
10	1
15	0

It has nothing to do with people’s needs.

Demand shows the various amounts of product which consumers are willing and able to purchase at each specific price in a series of prices during some period of time.

Quantity demanded – is an amount of product that consumers would buy if he could buy all he wanted at the current market price in a given time period.

Price is always per time period.

Demand characterizes the relationship between prices and quantity demanded.

Inverse relationship between P and Qd.

If price falls, people will demand more.

The law of demand describes the inverse relationship between price and quantity demanded: as price increases, people tend to buy less goods other things equal. And vice versa.

There are 2 effects that can give a formal support to the law of demand:

• Income effect of a price change. When price of a good falls down, the consumer is able to buy more goods, including the goods that become cheaper. And back wise. When the price falls down, this product becomes more attractive to a customer.

• And vice versa is the second effect. The substitution effect of a price decline means that this particular product becomes more attractive than other goods, so its consumption grows.

A demand schedule shows how much of a given product households would be willing to buy at different prices.

Sometimes the demand curve can shift to the left or to the right.

When demand grows, the demand curve shifts to the right. Consumers are willing to buy greater quantities of all price levels. When the curve shifts to the left, it means that the demand is decreased and consumers are willing to buy smaller quantities of goods at all the possible price levels.

Factors that change the demand and cause a shift on the demand curve are called the non-priced determinants of demand:

1) Income and wealth.

When income grows, demand grows also (curve shifts to the right).

All ordinary goods can be divided:

• Normal goods – are the goods, demand for which grows as income increases.

• Inferior goods – are the goods, demand for which grows as income falls down. And V.V.

2) Tastes and preferences.

When something is in fashion, demand grows

3) Expectations (ie of inflation=> D grows now)

4) The number of consumers

Also, Prices of other goods is a determinant

Substitute goods – the goods that can replace one another in assumption.

Ex: tea & coffee, Pepsi & Cola.

If price for coffee grows, demand for tea increases.

Complimentary goods – are the goods if you cannot consume them separately.

Example: Camera and film, Car and petrol – gas.

As price for cars decreases, price for gasoline also decreases.

Low of Supply

P	Qs
1	0
2	10000
3	20000
4	35000
5	50000

Supply shows the various amounts of a product which a producer is willing and able to produce and to supply to the market at each specific price in a series of prices in a given time period.

Relationship between price and quantity supplied. The supply slopes upward.

The positive relationship between the price and Qs.

Quantity supplied is the amount of a product which a producer is willing and able to produce and supply to the market at current price at a given time period.

Supply is a curve, QS is a point.

Supply curve shows how much a firm would produce if it could sell all it wanted at the given price.

Non-price determinants of supply are:

1 ) Cost of production

As it increases, supply goes down (or the supply curve shifts leftwards). As taxes become higher, supply lows. If a subsidy is paid, supply will raise and the curve will shift to the right.

2) Expectation makes the producers change their supply. If they expect the price to grow, they will wait to sell later.

3) Time.

Immediately a producer can’t change the price.

Also, Other goods prices is a determinant

Market Equilibrium

1) Qd>Qs at the current P, a situation is called excess demand

2) Qs>Qd at the current P, situation – excess supply

3)Qs=Qd at the current P - equilibrium

The price at which Qd equals to Qs is called the equilibrium price

As Qs>Qd (Qs is greater than Qd), producers start competing for the Ruble of consumers.

As price goes down, producers decrease Qs, while consumers increase Qd => the market will come to the market equilibrium. This is a self-regulating mechanism.

If Qs<Qd then there is a deficit.

Consumers compete for the goods produced.

Consumers start competition as price grows (auction).

This is also a self- regulating mechanism.

Government interference

G sometimes fixes the prices lower or higher than market equilibrium.

When price is set below E, it’s the ceiling price to support customers. So there appears to be a deficit.

Floor prices are made to support consumers. Result is overproduction, surplice.