Supply, Demand and Competition

Basic facts Consumers have a great influence on the price of goods and services. Consumers have a great influence on the price of goods and services. Market: Represents the freely chosen action between buyers and sellers. Market: Represents the freely chosen action between buyers and sellers. Voluntary exchange: Buyers and sellers work out a deal that suits both sides. Voluntary exchange: Buyers and sellers work out a deal that suits both sides.

Law of Demand Explains the amount people are willing to buy as prices change. Explains the amount people are willing to buy as prices change. Demand can only occur if a buyer is willing and able to buy. Demand can only occur if a buyer is willing and able to buy. Three factors that affect what and how much people buy are diminishing marginal utility, real income, and substitution. Three factors that affect what and how much people buy are diminishing marginal utility, real income, and substitution. Price goes up Demand goes down Demand goes up Price goes down

Diminishing Marginal Utility (DMU) Utility: Power of a good or service to satisfy. Utility: Power of a good or service to satisfy. Total satisfaction rises with additional units purchased, but additional satisfaction diminishes. Total satisfaction rises with additional units purchased, but additional satisfaction diminishes. People will buy until price exceeds satisfaction. People will buy until price exceeds satisfaction. Price decreases, people will buy more. Price decreases, people will buy more.

Real Income Effect Income limits the amount of money people can spend. Income limits the amount of money people can spend. People cannot keep buying the same amount if price increases and income stays the same. (Real income effect). People cannot keep buying the same amount if price increases and income stays the same. (Real income effect). People are forced to trade-off if price increases. People are forced to trade-off if price increases. If price decreases and you buy the same amount, your real income has increased. If price decreases and you buy the same amount, your real income has increased.

Substitution If two items satisfy the same want or need, people can substitute. If two items satisfy the same want or need, people can substitute. If price rises on one, people will buy the other. If price rises on one, people will buy the other. Big MacWhopper

Price Elasticity How consumers react when prices change. How consumers react when prices change. –Elastic: Many competing brands. Many competing brands. Price increases, people choose a substitute. Price increases, people choose a substitute. –Inelastic: Not much competition. Not much competition. Price increases, demand does not change. Price increases, demand does not change. Elasticity is determined by: Elasticity is determined by: –Existence of substitutes. –Percentage of income spent on a good or service. –Time allowed to adjust to a change.

Determinants of Demand Characteristics that will affect the amount people will buy. Includes changes in population, income, and preferences. Characteristics that will affect the amount people will buy. Includes changes in population, income, and preferences. –Substitutes: If price for one item increases, demand for a substitute will increase. If price for one item increases, demand for a substitute will increase. If price of a substitute increases, demand for original will increase. If price of a substitute increases, demand for original will increase. –Complimentary goods: Items used together. If price of one decreases, people will buy more. They also buy more of its compliment. If price of one decreases, people will buy more. They also buy more of its compliment. If price of one increases, people buy less. They also buy less of its compliment. If price of one increases, people buy less. They also buy less of its compliment.

Law of Supply The amount producers are willing to provide at various prices. The amount producers are willing to provide at various prices. –As price increases, supply increases. –As price decreases, supply decreases. Law of diminishing returns: Adding units of a factor of production will increase output for a time. Eventually output will decrease. Law of diminishing returns: Adding units of a factor of production will increase output for a time. Eventually output will decrease.

Supply and Demand If price falls, demand will increase and supply will decrease. If price falls, demand will increase and supply will decrease. If price rises, demand will decrease and supply will increase. If price rises, demand will decrease and supply will increase. Equilibrium price: Point where supply and demand meet. Equilibrium price: Point where supply and demand meet. Shortage and surplus: Shortage and surplus: –When demand is greater than supply, a shortage occurs. –When supply is greater than demand, a surplus occurs. –Prices will rise in a shortage and fall in a surplus.

Competition Competition will exist if different businesses produce similar products. Competition will exist if different businesses produce similar products. Perfect Competition Perfect Competition 1. Large Market 2. Similar Product 3. Easy entry and exit 4. Information obtainable 5. No control over price –Market Price is equilibrium price.

Imperfect Competition One group can have an impact on price. One group can have an impact on price. –Monopoly –Oligopoly –Monopolistic Competition Barriers to entry: Barriers to entry: –Government regulations: Some goods and services are protected from duplication by the government. –Cost of getting started: Large amount of capital is needed to begin. –Ownership of raw materials: Companies control materials and do not sell to competitors.

Monopoly One group controls the market. One group controls the market. 1. Single seller 2. No substitutes 3. No entry 4. Complete control over price Suppliers can raise prces without losing business. Suppliers can raise prces without losing business.

Types of Monopoly 1. Natural: Control of resources. 2. Geographic: Control of location 3. Technological: Patent on technology 4. Government: Created by the government. Illegal to enter. 5. Cartel: International form of monopoly (OPEC).

Oligopoly A few businesses in competition. A few businesses in competition. 1.Domination of a few sellers 2.Barriers to entry 3.Identical or slightly different products 4.Some control of price Price wars are common place. Price wars are common place.

Monopolistic Competition 1.Numerous sellers 2.Easy entry 3.Different products 4.Competition 5.Some control of price Substitution and advertising are factors. Substitution and advertising are factors.

Mergers One company joins with another. One company joins with another. –Horizontal: Companies in the same business. –Vertical: Company joins with one it buys from. –Conglomerate: Buying of un-related businesses.

Government policies Late 1800’s the railroad industry was the biggest in the United States. Late 1800’s the railroad industry was the biggest in the United States. Theodore Roosevelt set out to stop monopolies with his “trust-busting” policy, which would break up large businesses. Theodore Roosevelt set out to stop monopolies with his “trust-busting” policy, which would break up large businesses. All mergers must be approved by the Government. All mergers must be approved by the Government.