Introduction to Markets

What is a Market?

A market is any arrangement that brings buyers and sellers together to exchange goods,
services, or resources. Markets don't have to be physical places - they can be online, over
the phone, or anywhere buyers and sellers can interact.

Examples of Markets:

●​ Local farmers market

●​ Stock market
●​ Labor market (where people sell their work)
●​ Housing market
●​ Online marketplace like Amazon or eBay
●​ Your college cafeteria

Competitive Markets

Most economic analysis focuses on competitive markets, which have these characteristics:

●​ Many buyers and sellers

●​ The good being sold is essentially identical across sellers
●​ Buyers and sellers are "price takers" (they accept the market price)
●​ Easy entry and exit from the market

Demand
What is Demand?

Demand refers to the quantity of a good that buyers are willing and able to purchase at
various prices during a specific time period.

Key Points About Demand:

●​ Demand is not just wanting something - you must be willing AND able to pay for it
●​ Demand always refers to a specific time period
●​ Demand shows the relationship between price and quantity demanded

The Law of Demand

The Law of Demand: As the price of a good increases, the quantity demanded decreases,
all else being equal. As the price decreases, the quantity demanded increases.
Why Does the Law of Demand Hold?

1.​ Substitution Effect: When a good becomes more expensive, people substitute
toward cheaper alternatives
2.​ Income Effect: When a good becomes more expensive, people's purchasing power
decreases, so they buy less
3.​ Diminishing Marginal Utility: Each additional unit of a good provides less additional
satisfaction

The Demand Curve

The demand curve is a graph that shows the relationship between price and quantity
demanded.

Characteristics of the Demand Curve:

●​ Price is on the vertical (y) axis

●​ Quantity is on the horizontal (x) axis
●​ Slopes downward from left to right (negative slope)
●​ Each point represents a price-quantity combination

Reading the Demand Curve:

●​ Moving along the curve shows how quantity demanded changes as price changes
●​ This is called a "change in quantity demanded"

Factors That Shift the Demand Curve

When factors other than price change, the entire demand curve shifts. This is called a
"change in demand."

Factors That Increase Demand (Shift Right):

1.​ Increase in Income (for normal goods)

○​ Normal good: A good for which demand increases when income increases
○​ Examples: restaurant meals, new cars, vacations
2.​ Decrease in Income (for inferior goods)
○​ Inferior good: A good for which demand increases when income decreases
○​ Examples: generic brands, public transportation, ramen noodles
3.​ Increase in Price of Substitutes
○​ Substitute goods: Goods that can replace each other
○​ Example: If Pepsi price increases, demand for Coca-Cola increases
4.​ Decrease in Price of Complements
○​ Complement goods: Goods that are used together
○​ Example: If computer prices decrease, demand for software increases
5.​ Change in Tastes and Preferences
○​ Example: Health concerns increase demand for organic foods
6.​ Favorable Expectations About Future
 ○​ Example: Expecting higher income next year increases demand for luxury
goods today
7.​ Increase in Number of Buyers
○​ Example: Population growth increases demand for housing

Factors That Decrease Demand (Shift Left): The opposite of all the factors above.

Supply
What is Supply?

Supply refers to the quantity of a good that sellers are willing and able to sell at various
prices during a specific time period.

The Law of Supply

The Law of Supply: As the price of a good increases, the quantity supplied increases, all
else being equal. As the price decreases, the quantity supplied decreases.

Why Does the Law of Supply Hold?

1.​ Higher Prices Mean Higher Profits: Sellers have more incentive to produce when
they can sell at higher prices
2.​ Increasing Marginal Cost: It usually becomes more expensive to produce each
additional unit
3.​ New Sellers Enter: Higher prices attract new producers to the market

The Supply Curve

The supply curve shows the relationship between price and quantity supplied.

Characteristics of the Supply Curve:

●​ Price is on the vertical (y) axis

●​ Quantity is on the horizontal (x) axis
●​ Slopes upward from left to right (positive slope)
●​ Each point represents a price-quantity combination

Factors That Shift the Supply Curve

When factors other than price change, the entire supply curve shifts. This is called a "change
in supply."

Factors That Increase Supply (Shift Right):

1.​ Decrease in Input Prices

 ○​ Input: Any resource used to produce a good (labor, materials, energy)
○​ Example: Lower steel prices increase supply of cars
2.​ Improvement in Technology
○​ Better technology reduces production costs
○​ Example: New farming techniques increase crop supply
3.​ Decrease in Prices of Other Goods the Firm Could Produce
○​ Example: If corn prices fall, farmers might shift to producing more soybeans
4.​ Favorable Expectations About Future
○​ Example: Expecting stable conditions increases willingness to invest in
production
5.​ Increase in Number of Sellers
○​ More firms entering the market increases total supply
6.​ Government Subsidies
○​ Subsidies reduce production costs
○​ Example: Solar panel subsidies increase supply of solar energy

Factors That Decrease Supply (Shift Left):

●​ Increase in input prices

●​ Worse technology (rare, but possible due to regulations)
●​ Increase in prices of other goods the firm could produce
●​ Unfavorable expectations about future
●​ Decrease in number of sellers
●​ Government taxes or regulations that increase costs

Market Equilibrium
What is Equilibrium?

Market Equilibrium occurs when the quantity demanded equals the quantity supplied at a
particular price. This price is called the equilibrium price, and the quantity is called the
equilibrium quantity.

At Equilibrium:

●​ No shortage (excess demand)

●​ No surplus (excess supply)
●​ No pressure for price to change
●​ Market "clears" - everyone who wants to buy at that price can find a seller, and
everyone who wants to sell at that price can find a buyer

Finding Equilibrium Graphically

Equilibrium occurs where the supply and demand curves intersect.

What Happens When Markets Are Not in Equilibrium?

Shortage (Excess Demand):

●​ Occurs when quantity demanded > quantity supplied

●​ Happens when price is below equilibrium
●​ Results in upward pressure on price
●​ Price rises until equilibrium is restored

Surplus (Excess Supply):

●​ Occurs when quantity supplied > quantity demanded

●​ Happens when price is above equilibrium
●​ Results in downward pressure on price
●​ Price falls until equilibrium is restored

Changes in Supply and Demand

Movement vs. Shifts

Movement Along a Curve:

●​ Caused by a change in the price of the good itself

●​ Results in a change in quantity demanded or quantity supplied
●​ No shift in the curve

Shift of the Entire Curve:

●​ Caused by a change in factors other than the good's price

●​ Results in a change in demand or supply
●​ The entire curve moves left or right

Analyzing Market Changes

Step-by-Step Process:

1.​ Start with supply and demand in equilibrium

2.​ Determine which curve(s) shift and in which direction
3.​ Find the new equilibrium
4.​ Compare the new equilibrium price and quantity to the original

Four Basic Cases:

Case 1: Increase in Demand (Demand Shifts Right)

●​ New equilibrium: Higher price, higher quantity

●​ Example: Income increases → demand for restaurant meals increases

Case 2: Decrease in Demand (Demand Shifts Left)

 ●​ New equilibrium: Lower price, lower quantity
●​ Example: Health concerns → demand for cigarettes decreases

Case 3: Increase in Supply (Supply Shifts Right)

●​ New equilibrium: Lower price, higher quantity

●​ Example: Better technology → supply of computers increases

Case 4: Decrease in Supply (Supply Shifts Left)

●​ New equilibrium: Higher price, lower quantity

●​ Example: Hurricane destroys crops → supply of oranges decreases

When Both Curves Shift

Sometimes both supply and demand change simultaneously. The final result depends on:

●​ Which curve shifts more

●​ The direction of each shift

Example Combinations:

●​ Both increase: Quantity definitely increases, price change depends on which shift is
larger
●​ Both decrease: Quantity definitely decreases, price change depends on which shift is
larger
●​ One increases, one decreases: Price change is predictable, quantity change
depends on which shift is larger

Real-World Applications
Gasoline Market Example

Factors that might increase gasoline demand:

●​ Summer driving season

●​ Economic growth (more people driving to work)
●​ Lower car prices (complement good)

Factors that might decrease gasoline supply:

●​ Hurricane affecting refineries

●​ Political instability in oil-producing countries
●​ Environmental regulations increasing production costs

Housing Market Example

Factors that might increase housing demand:

●​ Population growth
●​ Lower interest rates (makes mortgages cheaper)
●​ Economic optimism

Factors that might decrease housing supply:

●​ Zoning restrictions limiting new construction

●​ Higher construction material costs
●​ Shortage of skilled construction workers

College Textbook Market Example

Why are textbooks expensive?

●​ Limited competition (few publishers)

●​ Inelastic demand (students must buy required books)
●​ Frequent new editions reduce used book supply
●​ Professors (who choose books) don't pay the price

Key Terms to Remember

Market: Any arrangement that brings buyers and sellers together

Demand: The quantity buyers are willing and able to purchase at various prices

Supply: The quantity sellers are willing and able to sell at various prices

Law of Demand: Price and quantity demanded move in opposite directions

Law of Supply: Price and quantity supplied move in the same direction

Demand Curve: Graph showing the relationship between price and quantity demanded

Supply Curve: Graph showing the relationship between price and quantity supplied

Normal Good: Demand increases when income increases

Inferior Good: Demand decreases when income increases

Substitute Goods: Goods that can replace each other

Complement Goods: Goods that are used together

Change in Quantity Demanded: Movement along the demand curve due to price change

Change in Demand: Shift of the entire demand curve due to non-price factors
Change in Quantity Supplied: Movement along the supply curve due to price change

Change in Supply: Shift of the entire supply curve due to non-price factors

Equilibrium Price: The price at which quantity demanded equals quantity supplied

Equilibrium Quantity: The quantity bought and sold at equilibrium price

Shortage: Quantity demanded exceeds quantity supplied

Surplus: Quantity supplied exceeds quantity demanded

Practice Questions
Quick Review

1.​ What is the difference between "demand" and "quantity demanded"?

2.​ According to the law of demand, what happens to quantity demanded when price
increases? Why?
3.​ List three factors that would increase the demand for pizza.
4.​ List three factors that would increase the supply of corn.
5.​ If the demand for coffee increases while supply stays the same, what happens to:
○​ Equilibrium price?
○​ Equilibrium quantity?

Application Problems

1.​ Smartphone Market: Suppose new technology makes smartphones cheaper to

produce, while at the same time, incomes increase and smartphones are a normal
good. What happens to:
○​ Equilibrium quantity? (definitely increases/definitely decreases/uncertain)
○​ Equilibrium price? (definitely increases/definitely decreases/uncertain)
2.​ Concert Tickets: A popular band announces they're breaking up after one final tour.
At the same time, several venues become available, increasing the number of
concerts they can perform. Analyze the effects on ticket prices and quantities.
3.​ Gasoline Market: Political instability in the Middle East reduces oil supply, while a
recession reduces people's incomes (assume gasoline is a normal good). What
happens to gasoline prices and quantities?

Critical Thinking

1.​ Explain why the demand curve for insulin (needed by diabetics) might be very steep,
while the demand curve for luxury watches might be flatter.
2.​ During the COVID-19 pandemic, demand for hand sanitizer increased dramatically,
but supply couldn't increase quickly. What would you predict happened to prices?
What eventually happened to bring prices back down?
3.​ Some cities have rent control laws that set maximum prices landlords can charge.
Using supply and demand analysis, predict what effects this might have on:
○​ The quantity of rental housing available
○​ The quality of rental housing
○​ Wait times for apartments