Market - a kind of arrangement where buyers and sellers of goods, services, or resources are linked

together to carry out an exchange.

Competition: occurs when there are many buyers and sellers acting independently, so that no one has
the ability to influence the price at which the product is sold in the market. By contrast, market power,
also known as monopoly power, refers to the control that a firm has over the price of the product it sells
in the market. The greater the market power, the greater is the control over price. It follows that the
greater the degree of competition in an industry, the less the market power of firms, and the weaker in
each firm's control over the price that prevails in the market.

DEMAND
● Demand is concerned with the behaviour of buyers. Consumers (households) are buyers of
goods and services in product markets, whereas firms are buyers of factors of production in
resource markets

● Individual Demand
○ Consumers buy goods and services in product markets. As buyers, they are demanders
of those items they wish to buy.
○ Definition of demand - the various quantities of a good (or service) the consumer is
willing and able to buy at different possible prices during a particular time period (ceteris
paribus)
- Consumer’s demand for a good can be presented as a demand schedule (which
is a table listing quantity demanded at various prices)

- Willing = consumer wants to buy the good

- Able = consumer can afford to buy it

Law of demand - according to the law of demand, there is a inverse relationship between the quantity of
good demanded over the particular time period and its price, ceteris paribus: as the price of the good
increases, the quantity of the good demand falls; as the price falls, the quantity demanded increases, all
other things equal
- The demand curve illustrates a very important relationship: as the price of a good falls, the
quantity of the good demanded increases
- Inverse / indirect relationship (law of demand)
 Law of diminishing marginal utility
As the quantity of a good increase, the marginal (or additional) benefit it provides to the consumer
decreases. This principle is known as the law of diminishing marginal utility.
As consumption of the good increases, marginal utility, or the satisfaction the consumer receives,
decreases with each additional unit consumed.
E.g. imagine you are thirsty and would like a soft drink. You buy one soft drink which provides you with a
certain amount of benefit. You are still thirsty, so you buy a second. Whereas you will enjoy your second
soft drink, you will most likely enjoy it less than you had enjoyed the first; in other words, the second
soft drink provides you with less benefit than the first. If you buy a third, you will get even less benefit
than from the second, and so on with each additional soft drink. The extra benefit that you get from
each additional unit of something you buy is called the marginal benefit.

The explanation for the shape of the demand curve can be found in the principle of decreasing marginal
benefit: since marginal benefit falls as quantity consumed increases, the consumer’s willingness to pay
also falls as the quantity increases.

Market demand: is the sum of all individual demands for a good. The market demand curve illustrates
the law of demand, shown by an inverse relationship between price and quantity demanded. The market
demand curve can also be considered as the sum of consumers’ marginal benefits.

law ofdemand:inverse relationship substitutioneffectonestate

->
income effect
d & real income ↑ demand
price
Determinants of Demand
● Are the variables other than price that can influence demand
● They are the variables that were assumed to be constant and unchanging when the relationship
between price and quantity demanded was being examined (ceteris paribus)
● Changes in the determinants of demand cause shifts in the demand curve (entire demand curve
moves to the right or to the left)
○ Rightward shift of the demand curve indicates that more is demanded for a given price;
leftward shift of the demand curve indicates that less is demanded for a given price
○ Rightward shift = increase in demand; leftward shift = decrease in demand
1) The number of buyers - if there are a increase in the number of buyers (demanders), demand
increases and therefore the market demand curve shifts to the right; if the number of buyers
decreases, demand decreases and the curve shifts to the left
2) Taste - if the taste changes in favour of a product (good becomes more popular), demand
increases and the demand curve shifts to the right; if tastes change against the product (it
becomes less popular) demand decreases and the demand curve shifts to the left
3) Income in the case of normal goods - when demand for a good increases in response to an
increase in consumer income, the good is a normal good (good is normal if the demand for it
varies directly with income), most goods are normal goods, therefore an increase in income will
give rise to a rightward shift in the demand curve when the good is normal, and a decrease in
income will give rise to a leftward shift
4) Income in the case of inferior goods - while most goods are normal, there are some goods the
demand for which falls as consumer income increases (inferior good - a good is inferior if the
demand for it varies inversely with income). E.g. used clothes, used car, bus tickets. As income
increases, consumers switch to more expensive alternatives (new clothes, new car, car or
aeroplanes rather than travelling by bus), and so the demand for inferior goods falls.
5) Prices of substitute goods - Two goods are substitutes if they satisfy a similar need. An example
of substitute goods is CocaCola and PepsiCola. A fall in the price of product A results in a fall in
the demand for product B. The reason is that as the price of product A, some consumers will
switch from product B to product A, and thus product B’s demand falls. On the other hand, if
there is an increase in price for product A, there will result in an increase in the demand for
product B as some consumers switch away from product A towards product B. Therefore, for any
two substitute goods X and Y, a decrease in the price of X will produce a leftward shift in the
demand for Y, while an increase in the price of X will produce a rightward shift in the demand for
Y. The price of X and demand for Y change in the same direction.
6) Prices of complementary goods - two goods are complements if they tend to be used together.
E.g. CDs and CD players. In this case, a fall in the price of one (CD players) will give a rise to an
increase in demand for the other (CDs). This is because the fall in the price of CD players lead to
a bigger quantity of CD players being purchased, and therefore the demand for CDs will increase.
Therefore, for any complementary goods X and Y, a fall in the price of X will lead to a rightward
shift in the demand for Y, and an increase in the price of X will lead to a leftward shift in the
demand for Y. The price of X and the demand for Y change in opposite directions. [goods that are
not related to each other are called independent goods]
 7) Expectation of future income - if consumers expect that their future income will increase, their
demand for a good in the present will be likely to increase; if they expect their income to fall in
the future, their demand for a good in the present will be likely to fall
8) Expectations of future price changes - if consumers expect that the price of a good will increase
in the future, they will probably demand more of it in the present in order to take advantage of
the lower present price, and so the demand will shift to the right; if they expect that the price
will fall in the future, they will demand less of it in the present, as they will postpone their
purchases for the future, and so demand in the present shifts to the left.

Change in quantity demanded vs Change in demand

❏ Whenever the price of a good changes, ceteris paribus, it gives rise to a movement along the
④

demand curve (increase in quantity demanded or decrease in quantity demanded)

❏ By contrast, any change in one or more determinants of demand gives rise to a shift in the whole
demand curve, this is called change in demand (shift rightwards or leftwards)

Supply
Individual Supply
- firms produce goods and services, and they supply them to the product markets for sale. As
sellers, therefore, they are suppliers of goods and services
Definition of supply - the various quantities of a good (or service) the firm is willing and able to produce
and supply to the market for sale at different possible prices, during a particular time period, ceteris
paribus

Law of supply - as price increases, quantity supplied also increases (positive/direct relationship)
- According to the law of supply, there is a direct relationship between the quantity of a good
supplied over a particular time period and its price, ceteris paribus: as the price of the good
increases, the quantity of the good supplied also increases; as the price falls the quantity
supplied also falls
WHY?
Higher prices generally mean that the firm’s profit increases, and so the firm faces an incentive to
produce more output. Lower prices mean lower profitability, and so the incentive facing the firm is to
produce less. Therefore, there is a direct relationship between price and quantity supplied; the higher
the price, the greater the quantity supplied by the firm.

Market supply - is the sum of all individual firms’ supplies for a good. The market supply curve illustrates
the law of supply, shown by a direct relationship between price and quantity supplied.

Vertical supply curve

➢ Under certain special circumstances, the supply curve, rather than slope upward, is vertical at
some particular fixed quantity
➢ A vertical supply curve tells us that even as price increases, the quantity supplied cannot
increase; it remains constant
➢ Quantity supplied is independent of price because:
○ There is a fixed quantity of a good supplied because there is no time to produce more of
it (e.g. there is a fixed quantity of theatre tickets in a given theatre, because there is a
fixed number of seats, no matter how high the price, it is not possible to increase the
number of seats in a short period of time
○ There is a fixed quantity of the good because there is no possibility of ever producing
more of it. This is the case with original antiques (stradivarius violins) and the original
paintings and sculptures of famous artists. It may be possible to make productions, but it
is not possible to make more originals. The supply curve is therefore vertical at the fixed
quantity of the good that exists

Determinants of supply (market supply)

➔ Rightward shift = supply increases (increase in supply)
➔ Leftward shift = supply decreases (decrease in supply)
◆ The number of firms - an increase in the number of firms producing the good in question
increases supply and gives rise to a rightward shift in the supply curve; a decrease in the
number of firms decreases supply and produces a leftward shift.
◆ Resource prices and cost of production - the firm buys various resources (FoP) that it
uses to produce its product. If the price of one or more resources rises, production
becomes less profitable and the firm produces less; the supply curve shifts to the left. If
one or more resource prices fall, production becomes more profitable and the firm will
produce more; the supply curve will shift to the right. Resource prices are important in
determining the firm’s cost of production. In general, when costs of production increase,
production becomes less profitable, and so supply falls (the supply curve shifts to the
left) and when costs decrease, supply increases (the supply curve shifts to the right)
◆ Technology - a new improved technology lowers cost of production, thus making
production more profitable. Supply increases and the supply curve shifts to the right. In
 the event that a firm employs a less productive technology, cost of production increases
and the supply curve shifts leftwards
◆ Price of other goods the firm can produce - suppose a farmer grows wheat. If the price
of another product, say corn, increases, the farmer may switch to corn production,
which isM no more profitable; this results in a fall in wheat supply: the supply curve shifts
to the left. If the price of corn falls, corn producers may switch to growing wheat, as this
is now more profitable; the supply of wheat increases and the supply curve shifts to the
right. Therefore the supply curve of a good can shift in response to changes in the price
of other goods that the firm can produce.
◆ Producer (firm) expectation - if firms expert the price of their product to rise, they may
withhold some of their current supply from the market (not offer it for sale), with the
expectation that they will be able to sell it at a higher price in the future; in this case
there will result a fall in supply in the present, and hence a leftward shift in the supply
curve. If the expectation is that the price of their product will fall, they will increase their
supply in order to take advantage of the current higher price, and hence there will be a
rightward shift in the supply curve
◆ Taxes - firms treat taxes as if they were costs of production. Therefore, the imposition of
a new tax or the increase of an existing tax represents an increase in production cost, so
supply will fall and the supply curve will shift to the left. The elimination of a tax or a
decrease in the existing tax represents a fall in production cost; supply increases and the
supply curve shifts to the right
◆ Subsidies - a subsidy is a payment made to the firm by the government, and so has the
opposite effect of a tax (subsidies may be given in order to increase the incomes of
producers or to encourage an increase in the production of the good produced.) The
introduction of a subsidy or an increase in an existing subsidy is equivalent to a fall in
production costs, and will give rise to a rightward shift in the supply curve, while the
elimination of a subsidy or a decrease in a subsidy will give rise to a leftward shift in the
supply curve
◆ Supply shocks - supply shocks are sudden events that have an impact on supply, such as
unusual weather, war, or cuts in major inputs supplies (e.g. imports of oil). An adverse
supply shock, such as unusually bad weather that affects agricultural output, or a cut in
oil supplies will result in a decrease in supply and leftward shift in the supply curve. A
beneficial supply shock (such as unusually good weather) results in an increase in supply
and a rightward shift in the supply curve.
Law of diminishing marginal returns
All firms use inputs (factor of production) to produce output.

Short run - a time period where at least one input is fixed and cannot be changed by the firm.
—> Fixed as in unchanging quantity and quality.

Long run - a time period where all inputs can be changed.

Relationship between input and output in the short run

Total product - total quantity of output produced by a firm

Marginal product - additional output produced by one additional unit of variable input.
—> E.g. labour; it tells us by how much output increases as labour increases by one worker.

Diminishing marginal returns

In the table above, the marginal product when one worker increases at first increases, it reaches
a maximum with the third worker, and then begins to fall.

Law of diminishing marginal return thus shows how there is first an increase in marginal product,
then a decrease.

Marginal product first increases; when there is 0 workers, there is no output. When 1 worker is
hired, there will be some output and so total product incrreases to 20 kilos.
However, one worker doing all the work results in a low output. So, when 1 more worker is hired,
the 2 workers share the work, and the total product increases to 50 kilos.
The marginal product due to the second worker is 30, and is greater than the marginal product
of the first worker (20).
—> This also happens with the third worker, with 40 marignal product.

At 3 workers, marginal product is at its maximum, so when the fourth worker is added, marginal
product begins to fall. (continues to fall).
This is because of overcrowding; each additional worker has less and less work to do, and so
produces less and les output.

At one point, the farm will be so crowded that the addition of 1 worker will not increase output.
Law of diminishing marginal return - as more and more units of variable input (labour) is added
to a fixed input (land), the marginal product of the variable input at first increases, but then it
begins to decrease.

Marginal cost
Total cost - all cost of production a firm has,

Marginal cost - the additional cost of producing one more unit of output.

As the number of total product increases, total cost increases. As expected since an increase
in output involves more cost.

Marginal cost shows the additional cost to produce one more unit of output.

How the marginal cost relates to diminishing marginal return

Marginal cost first decreases then increases.
Diminishing marginal return first increases then decreases.

The firm‘s supply curve is a

portion of its marginal cost
curve.
—> Shows the combination
of quantity and price where
the extra cost of producing
an additional unit of output is
equal to the price of that unit.

M
When marginal product increases, marginal cost decrease
When marginal product is maximum, marginal cost is minimum.
When marginal product falls, marginal cost increases.

At lower levels of output, the margianl product of labour increases. So each worker prdocues
more and more output. Since workers add to costs, and each worker produces more output,
the cost of producing each additional unit of output (marginal cost) falls.

On the other hand, when marginal product of labour decreases, the cost of each additional unit
of output (marginal cost) increases.

Thus, when the additional output of labour is at maximum, the extra labour cost of producing
an additional unit of output (marginal cost) is lowest.
 Change in quantity supplied vs Change in supply
● Change in quantity supplied shows a movement on the supply curve, it can occur only as a result
of changes in price
● Change in supply represents the shift of the whole supply curve, this happens when there is a
change in one or more determinants of supply 4

Market Equilibrium - demand and supply here i

★ If quantity demanded of a good is smaller than quantity supplied, the difference between the
two is called a surplus; if quantity demanded of a good is larger than quantity supplied, the
difference is a shortage (market disequilibrium)
★ The existence of a shortage or surplus in a free market will cause the price to change so that the
quantity demanded will be made equal to quantity supplied. In the event of a shortage, the price
will rise; in the event of a surplus, the price will fall

Market Equilibrium
- Equilibrium is defined as a state of balance between different forces, such that there is no
tendency to change
- When quantity demanded is equal to quantity supplied, there is market equilibrium; the forces
of supply and demand are balance, and there is no tendency for the price to change
- Market equilibrium is determined at the point where the demand curve intersects the supply
curve
- The price prevails in market equilibrium as the equilibrium price, and the quantity is the
equilibrium quantity
- At the equilibrium price, the quantity that consumers are willing and able to buy is exactly equal
to the quantity that firms are willing and able to sell
- The buyers and sellers are satisfied, and there is no pressure on the price to change
P
- This price is known as market-clearing price, or simply market price.
P..-
Change in demand
❏ Demand curve that shifts to the right= new higher equilibrium price and greater equilibrium .....?!
quantity Q Q2 Q
❏ Demand curve that shifts to the left= fall in both the equilibrium price and the equilibrium

Bitt
quantity
Change in supply
❏ Supply curve that shifts to the right= lower equilibrium price, but higher equilibrium quantity
❏ Supply curve that shifts to the left= new equilibrium will be at a higher price and lower quantity a,,Q
noopportunitytFree good and Economic good
free
- Is a good for which the quantity supplied is greater than the quantity demanded when the price
is zero
- Supply is so large relative to demand that there is excess quantity supplied even at a zero price
economi
- Is a good for which quantity supplied is smaller than quantity demanded when the price is zero
Price mechanism P.
The market’s ability to allocate resources can be found in the signalling and incentives function of prices
r=
ii
-
=

in resource allocation. if demand curve shifts right

A new, higher price of the signal's info to producers that
there is Q,02
a

Signals - prices communicate information to decision-makers. a shortage.

Incentives - prices motivate decision-makers to respond to the information. Anew, higher price incentivises producers increase quantity.
to

In summary, changes in price cause signals and incentives. Which causes a change in demand or supply
and the quantity of it.

Rationing - method on portioning goods and services among consumers .

Price rationing - whether a consumer will get the goods or not is determined by its price. All those who
are willing and able to buy the goods will get it. Price is the factor that determines whether a consumer
will get a good or not.

P consumer
Allocation efficiency is achieved at the point of competitive market equilibrium, where Marginal Benefit surplus M
N
(MB) = Marginal Cost (MC), and where the sum of consumer and producer surplus is maximised.
.....
Allocative efficiency refers to producing a quantity of goods and services socially optimum. producer
surplus
MB
The intersection of the MB and MC curve because it means the extra benefit to society of getting one
Q
more unit of a good is equal to the extra cost to society of producing one more unit of a good.
At the intersection of the MB and MC curve, there is a social surplus (consumer and producer surplus is
maximum).

Marginal benefit curve

Marginal benefit is the extra benefit you receive from consuming each additional unit of good.
Since marginal benefit decreases as the quantity of a good consumed increases, consumers will only be
willing to buy an extra unit of good if price falls. Thus the demand curve can be represented by the
marginal benefit curve.

Marginal cost curve

Marginal cost is the extra cost of producing one more unit of output.
Marginal cost increases as the quantity of a good produced increases, producers will only be willing to
produce and sell an extra unit of good if the price increases. Thus the supply curve can also be called the
marginal cost curve.

highestprice willing pay price actually paid

to -

Consumer surplus
➢ Defined as the highest price consumers are willing to pay for a good, minus the price actually
paid
➢ Willingness to pay is the price that a consumer is willing to pay in order to get a unit of the good
➢ In a competitive market, the price actually paid is determined at the market equilibrium by
supply and demand
➢ Consumer surplus is the shaded area between the demand curve and the equilibrium price
P

Q
 ➢ It represents the difference between total benefits consumer receive and the price paid to
receive them
➢ Consumer surplus indicates that whereas many consumer were willing to pay a higher price to
get the good, they actually received it for less
Producer surplus
➢ Defined as the price received by firms for selling their good, minus the lowest price that they are
willing to accept in order to produce the good
➢ The lowest price they are willing to accept represents the firms; cost of producing an extra unit
of the good (marginal cost), and is shown by the supply curve (the logic behind this is: the lowest
price that the firm is willing to accept must be just enough to cover its cost of producing each
extra unit; this cost is known as marginal cost)
➢ Producer surplus is shown diagrammatically as the area above the firms’ supply curve and below
the price received by firms (equilibrium price)

Rational economic decision making

Economic theories are based on rational economic decision making, which is assuming
individuals act in their best self interest. Trying to maximise their satisfaction when making an
economic decision.
Producers try to maximise their profit.
Rational consumer choice
Consumer make choices on what gives them the most satisfaction
The 3 assumptions of rational consumer choice: ⑤
↑better
1) Consumer rationality - consumers can rank the goods according to their preferences. I
Preferences among alternative choices are consistent. The consumer always prefers
more of the good than less. If ACB and BLC, then As a
2) Perfect information - the consumer has all the information on alternatives. Has perfect information
on
·

3) Utility maximisation - consumers always try to maximise their satisfaction. good A&B.
them the most
buying combinations goods thatgive
of
satisfection
Limitations of rational behavior (why sometimes consumers don't make the best choices)
Biases - systematic errors which sways the consumer from normal thinking.
- Biases that affect consumer choices:
● Rule of thumb - simplifying complicated decisions.
● Anchoring - use of irrelevant information to make decisions.
● Framing - how choices are presented to decision makers.
● Availability - information most recently available. People usually rely on the most recent
information.

Bounded rationality limited due to insufficientinformation

The idea that consumers are only rational within limits. Humans can’t process all information
therefore decision-makers seek a satisfactory choice rather than the best choice.

Bounded self-control
only
- Refers to the idea that people, in reality, exercise self control within limits. This means
they do not have self control that would be required of them to make rational decisions.
e.g. eat too much, spend too much.
Bounded selfishness
- The idea that people are selfish only within limits.

Imperfect information
- When consumers don’t have all the information before making a decision, resulting in
their decision or choice not being the best.

Behavioral economics (how individuals make decisions)

Nudge theory
- A method designed to influence consumers choice in a predictable way, without offering
financial incentives or imposing laws, and without limiting choice.
● In the UK, late taxpayers decreased by 15% when told most people in that area
has paid their taxes. Late taxpayers felt like exceptions and norms.
● Putting healthy food in more visible parts of the store has increased the purchse
of healthy foods.
Choice architecture
- The design of particular ways or environments in whcih people makes choices. How
options are presented to the decision maker.
Default choice - a choice that is made by default. Making choices without thinning
M about
it.
Restricted choice - a choice made because of limitations of environment or authority.
Mandated choice - a choice between alternatives that is made mandatory by the
government or authority.

Advantages of behavioural economics (nudges and choice architecture)

● Simple and low cost way to influence people's behaviour.
● Has been shown successful
● Offers freedom of choice without forcing consumers.
● There is a flexible trial and method error for discovering the correct nudges or choice
architecture.

Disadvantages of behavioural economics (nudges and choice architecture)

● May not be valid in different groups of people. Age, income, cultures.
● Indirect taxes, subsidies may be more effective.
● May not be the reflection of consumers' true preferences.
● Disguises of freedom of choice as consumers are manipulated subconsciously.

Rational producer behaviour: profit maximisation

- Standard economic theories of the firms assume rational producer behaviour. Meaning
firms want maximised profit which involves determining the amount of output.

Alternative business objectives (why firms may not want profit maximization)
Ethical and environmental concerns
- Firms used to think acting ethically and environmentally will decrease total revenue
because of the increase in cost of production. However, consumers may avoid buying a
firm’s goods because they are not acting ethically which will result in a decrease in total
revenue.
Ways firms can be ethical and environmental:
● Avoid polluting activities
● Engage in environmental sound practices
● Supporting human rights
● Art and athletic sponsorships
● Donations to charity

Market share
- Refers to the percentage of total sales in a market that is earned by a single firm.
- Firms may lower prices and reduce total revenue in order to own a larger market share.

Quality
the and
increas
Growth maximisation
- Another possible reason firms don’t want to maximise profit is because they want to
maximise growth.
- Maximising growth means the growth of the firm. How much power the firm has in a
market. And sometimes reducing total revenue is needed in order to increase the power
the firm has on the market.

Revenue maximisation
- Firms may want to maximise sales (revenue) rather than maximising profit for the
following reasons:
- Target sales can be used to motivate employees.
- Created a sense of success
- Rewards for managers and employees are often linked to sales.

Satisficing
- Modern firms have numerous objectives which may overlap. Therefore they aim to
achieve satisfactory results for all those objectives instead of maximising one.