2.1 Intro to Competitive Markets
Market: any kind of arrangement where buyers and sellers of goods, resources or services are linked
together to carry out an exchange
● Competition occurs when there is a large number of buyers and sellers acting independently. No
individual seller has complete power to control the price of a good or service.
● Competition is the opposite of monopoly power, which is when a dominant firm has control
over the price of the goods it sells.
2.2 Demand
● 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
● Market demand: the sum of all individual demands for a good
● Law of demand: There is a negative relationship between the price of a good and its quantity
demanded over a particular time period, CP. As the price of a good increases, quantity
demanded decreases, CP.
● Ceteris Paribus: all other things being equal
NON-PRICE DETERMINANTS OF DEMAND
● Income
○ Normal Goods: Income ↑, D ↑
○ Inferior Goods: Income ↓, D ↓
● Preferences and Tastes: Taste ↑, D ↑
● Prices of Substitute Goods (Cola and Pepsi): Pcola ↓, Dcola ↑, Dpepsi ↓
● Prices of Complementary Goods (Tennis Rackets and Tennis Balls): Prackets ↑, Drackets ↓,
Dballs ↓
● Number of consumers: # of buyers ↑, D ↑
MOVEMENTS ALONG DEMAND CURVE vs SHIFT
● Change in price → change in Qd → movement along the demand curve
● Change in non-price determinants → change in demand → shift of demand curve
, 2.3 Supply
Supply: the various quantities of a good or service a firm is willing and able to produce and supply at
different possible prices during a particular time period, CP
Law of Supply: there is a positive causal relationship between the quantity of a good supplied and its
price over a particular time period, CP
Market supply: the sum of all individual firms’ supplies for a good
NON-PRICE DETERMINANTS OF SUPPLY
● Costs of Factors of Production: FOP $ ↑, COP ↑, S ↓
● Technology: Technology ↑, COP ↓, S ↑
● Prices of Competitive Supply (corn and wheat): Pcorn ↑, Scorn ↑, Swheat ↓
● Prices of Joint Supply (butter and skimmed milk): Pbutter ↑, Sbutter ↑, Sskimmed milk ↑
● Producer Expectations: Expect P ↑ in the future, withhold supply to profit in the future, S ↓
● Taxes: Tax ↑, COP ↑, S ↓
● Subsidies: Subsidy ↑, COP ↓, S ↑
● The Number of Firms: # of Firms ↑, S ↑
● Supply Shocks: Bad weather conditions ↑, S ↓
MOVEMENTS ALONG SUPPLY CURVE vs SHIFT
● Change in price → change in Qs → movement along the supply curve
● Change in non-price determinants → change in supply → shift of supply curve
, 2.4 Competitive market equilibrium: Demand and Supply
MARKET EQUILIBRIUM
● Shortage: Excess Demand (Demand > Supply)
○ Price will rise so Qd=Qs
● Surplus: Excess Supply (Supply > Demand)
○ Price will fall so Qd=Qs
● Competitive Market Equilibrium: the forces of supply and
demand are in balance, there is no tendency for prices to
change, Qs = Qd
2.5 The role of price mechanism and market efficiency
PRICE MECHANISM & ALLOCATIVE EFFICIENCY
● Scarcity forces societies to make choices about how to allocate their resources, which involve an
opportunity cost because of foregone alternatives that could have been chosen instead.
→ demand for computers increase due to increase in
consumer income
→ D curve shifts to the right from D1 to D2
→ at initial P1, Qd > Qs, shortage due to excess demand
→ price increases from P1 to P2 to rid the shortage
→ due to the higher price, Qd decreases from Q2 to Q3
→ old equilibrium at P1Q1; New at P2Q3
→ supply of computers increases as COP decreases
→ S curve shifts to the right from S1 to S2
→ At P1, Qs > Qd, surplus due to excess supply
→ price decreases from P1 to P2 to rid the surplus
→ as P decreases, supply decreases from Q2 to Q3
→ old equilibrium at P1Q1; New at P2Q3
, EFFICIENCY
● Allocative Efficiency: the allocation of scarce resource such that the optimal combination of
goods are produced to satisfy consumer demands, minimizing resource waste
● Productive Efficiency: producing goods using the fewest possible resources (lowest cost)
● Resource Allocation: the allocation of scarce resource for specific uses among many possible
alternatives
MARGINAL BENEFIT & MARGINAL COST
● Marginal benefit curve = demand curve
○ MB = The extra benefit that consumers receive from each additional unit of goods
bought
○ As MB decreases as the quantity of good consumed increases, consumers are only
willing to purchase an additional unit of goods if price decreases
● Marginal Cost = Supply Curve
○ MC = The extra benefit firms receive from each additional unit of goods produced
○ As MC increases as the quantity of good produced increases, firms are only willing to
supply an additional unit of good if price increases
● Allocative efficiency: MB = MC at competitive market equilibrium, the society is making the best
possible use of its scarce resources.
CONSUMER & PRODUCER SURPLUS
● Consumer Surplus: The highest price consumers
are willing to pay for a good minus the price paid.
● Producer Surplus: The price received by firms for
selling their good minus the lowest price they are
willing to accept to produce the good
● Social Surplus: the sum of consumer + producer
surplus; it is maximum when MB = MC at the point
of competitive market equilibrium
● Social Welfare: is max when social surplus is max
Market: any kind of arrangement where buyers and sellers of goods, resources or services are linked
together to carry out an exchange
● Competition occurs when there is a large number of buyers and sellers acting independently. No
individual seller has complete power to control the price of a good or service.
● Competition is the opposite of monopoly power, which is when a dominant firm has control
over the price of the goods it sells.
2.2 Demand
● 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
● Market demand: the sum of all individual demands for a good
● Law of demand: There is a negative relationship between the price of a good and its quantity
demanded over a particular time period, CP. As the price of a good increases, quantity
demanded decreases, CP.
● Ceteris Paribus: all other things being equal
NON-PRICE DETERMINANTS OF DEMAND
● Income
○ Normal Goods: Income ↑, D ↑
○ Inferior Goods: Income ↓, D ↓
● Preferences and Tastes: Taste ↑, D ↑
● Prices of Substitute Goods (Cola and Pepsi): Pcola ↓, Dcola ↑, Dpepsi ↓
● Prices of Complementary Goods (Tennis Rackets and Tennis Balls): Prackets ↑, Drackets ↓,
Dballs ↓
● Number of consumers: # of buyers ↑, D ↑
MOVEMENTS ALONG DEMAND CURVE vs SHIFT
● Change in price → change in Qd → movement along the demand curve
● Change in non-price determinants → change in demand → shift of demand curve
, 2.3 Supply
Supply: the various quantities of a good or service a firm is willing and able to produce and supply at
different possible prices during a particular time period, CP
Law of Supply: there is a positive causal relationship between the quantity of a good supplied and its
price over a particular time period, CP
Market supply: the sum of all individual firms’ supplies for a good
NON-PRICE DETERMINANTS OF SUPPLY
● Costs of Factors of Production: FOP $ ↑, COP ↑, S ↓
● Technology: Technology ↑, COP ↓, S ↑
● Prices of Competitive Supply (corn and wheat): Pcorn ↑, Scorn ↑, Swheat ↓
● Prices of Joint Supply (butter and skimmed milk): Pbutter ↑, Sbutter ↑, Sskimmed milk ↑
● Producer Expectations: Expect P ↑ in the future, withhold supply to profit in the future, S ↓
● Taxes: Tax ↑, COP ↑, S ↓
● Subsidies: Subsidy ↑, COP ↓, S ↑
● The Number of Firms: # of Firms ↑, S ↑
● Supply Shocks: Bad weather conditions ↑, S ↓
MOVEMENTS ALONG SUPPLY CURVE vs SHIFT
● Change in price → change in Qs → movement along the supply curve
● Change in non-price determinants → change in supply → shift of supply curve
, 2.4 Competitive market equilibrium: Demand and Supply
MARKET EQUILIBRIUM
● Shortage: Excess Demand (Demand > Supply)
○ Price will rise so Qd=Qs
● Surplus: Excess Supply (Supply > Demand)
○ Price will fall so Qd=Qs
● Competitive Market Equilibrium: the forces of supply and
demand are in balance, there is no tendency for prices to
change, Qs = Qd
2.5 The role of price mechanism and market efficiency
PRICE MECHANISM & ALLOCATIVE EFFICIENCY
● Scarcity forces societies to make choices about how to allocate their resources, which involve an
opportunity cost because of foregone alternatives that could have been chosen instead.
→ demand for computers increase due to increase in
consumer income
→ D curve shifts to the right from D1 to D2
→ at initial P1, Qd > Qs, shortage due to excess demand
→ price increases from P1 to P2 to rid the shortage
→ due to the higher price, Qd decreases from Q2 to Q3
→ old equilibrium at P1Q1; New at P2Q3
→ supply of computers increases as COP decreases
→ S curve shifts to the right from S1 to S2
→ At P1, Qs > Qd, surplus due to excess supply
→ price decreases from P1 to P2 to rid the surplus
→ as P decreases, supply decreases from Q2 to Q3
→ old equilibrium at P1Q1; New at P2Q3
, EFFICIENCY
● Allocative Efficiency: the allocation of scarce resource such that the optimal combination of
goods are produced to satisfy consumer demands, minimizing resource waste
● Productive Efficiency: producing goods using the fewest possible resources (lowest cost)
● Resource Allocation: the allocation of scarce resource for specific uses among many possible
alternatives
MARGINAL BENEFIT & MARGINAL COST
● Marginal benefit curve = demand curve
○ MB = The extra benefit that consumers receive from each additional unit of goods
bought
○ As MB decreases as the quantity of good consumed increases, consumers are only
willing to purchase an additional unit of goods if price decreases
● Marginal Cost = Supply Curve
○ MC = The extra benefit firms receive from each additional unit of goods produced
○ As MC increases as the quantity of good produced increases, firms are only willing to
supply an additional unit of good if price increases
● Allocative efficiency: MB = MC at competitive market equilibrium, the society is making the best
possible use of its scarce resources.
CONSUMER & PRODUCER SURPLUS
● Consumer Surplus: The highest price consumers
are willing to pay for a good minus the price paid.
● Producer Surplus: The price received by firms for
selling their good minus the lowest price they are
willing to accept to produce the good
● Social Surplus: the sum of consumer + producer
surplus; it is maximum when MB = MC at the point
of competitive market equilibrium
● Social Welfare: is max when social surplus is max
