Theory of Markets

• Market

  An arrangement whereby buyers and sellers, motivated by self-interest, interact to exchange goods and services
• The market is driven by

  Forces of demand and supply
• Equilibrium in the market

  Determination of equilibrium price (Pe) and quantity (Qe)
• The market is in equilibrium where the market demand and supply curves intersect at point E
• Change in Demand for Normal goods

  When income increases, demand increases and vice versa
• Change in Price of Substitutes

  Two goods are considered substitutes if a change in the price for one of the good causes the demand for the other good to change in the same direction
• Change in Demand for Inferior goods

  When income increases, demand decreases and vice versa
• Factors affecting Demand of a Product


  • Change in Consumer’s income
  • Change in Price of related goods
• Change in Demand


  Change in consumption of goods or services due to factors not related to price of good or service
• Change in Quantity Demanded


  Change in the consumption of a good or service is affected by changes in the price of the good
• Demand


  The amount of goods and services consumers are willing and able to buy in a given period of time at a given price, ceteris paribus
• Goods in Derived Demand


  Goods are in derived demand when a good is demanded not for its own sake but for its contribution to the manufacture of another product
• Non-Price factors of Demand

  • E—changes in Expectations of future prices
  • G—changes in Government policies
  • Y—changes in income
  • P—changes in Population/ changes in Price of related goods
  • T—changes in Tastes and preferences
  • O—changes in Other factors like availability of credit facilities
• Individual Demand vs Market Demand

  Individual demand refers to demand for a good or service of one consumer. Market demand is the sum demand of all consumers in a market
• Change in the Price of Compliments


  Two goods are considered complements if a change in the price for one of the good causes the demand for the other goods to shift in the opposite direction
• As the Demand of cars increases, the demand for Steel increases so as to produce more cars
• As the Demand of cars increases

  The demand for Steel increases so as to produce more cars
• Supply of a good

  The amount of a good a producer is willing and able to sell in a given period of time, at a given price, ceteris paribus (other things remaining constant)
• Theory of Supply


  • The amount of a good supplied in a market depends on the choices made by the producers
  • The objective of every rational producer is to earn the highest profits possible where profits = revenue – cost
• Types of supply

  • Individual Supply
  • Market Supply
• Law of supply


  In a given time period, the quantity of a supplied of good is directly related to its price, ceteris paribus
• Change in Quantity Supplied


  • Changes in amount of goods and services produced due to a change in price of goods or services
  • Shown by movement along the supply curve
• Change in Supply


  • Change in amount of goods and services produced due to factors not related to the price of the goods
  • Shown by shift in the supply curve
• Factors affecting the Supply of a Product

  • W—changes in Weather
  • E—changes in Expectations of future prices
  • T—changes in Technology
  • P—changes in Production of related goods
  • I—changes in price of related goods
  • G—changes in Gov policies
  • S—changes in number of Supplies
• Change in price of factor inputs

  • Refers to the cost of factor production (e.g. wages, rent)
  • If increase in cost of factors of production, cost of production would increase, producers may cut down on supply of goods, although the price of these goods have not changed
• Change in production of GOODS in Competitive Supply

  When a product is in competitive supply, increased production of one will mean diverting some resources away from producing the other
• Change in the production of goods in Joint Supply

  • Goods are in joint supply when the production of more of one good leads to the production of another good
  • For example, producing beef also results in the production of leather
• Changes in Technology

  • Technological changes can take place over time as a result of innovation and enterprise
  • Improved production methods make factors of production more productive, increasing the production of goods and shifting the supply curve to the right
• Change in Govt policies

  • Imposition of indirect taxes increases the cost of producing a good, leading to a decrease in supply
  • Subsidies lower the cost of production, increasing supply
  • Government policies can impact the supply curve
• Changes in the number of supplies

  • Rise in profits attracts firms from other industries to enter, increasing supply
  • Increase in the number of suppliers increases supply, shifting the supply curve to the right
  • Suppliers leaving the industry decrease market supply, shifting the supply curve to the left
• Expectation of future price changes

  • Sellers adjust current supply based on expectations of future price changes
  • Expectations of higher prices reduce supply now, and expectations of lower prices increase supply
• Changes in Weather conditions

  • Favorable weather conditions increase supply in agricultural and fishery industries
  • Poor weather conditions decrease supply of agricultural products
• Exceptional Supply Curves


  • Curves that do not follow the law of supply
• Vertical supply curve

  • A perfectly price inelastic supply curve where the same quantity of the good is offered for sale regardless of price
• Factors affecting fixed short-term supply for agricultural products

  • Long gaps between sowing and harvesting
  • Very short time frame
• Horizontal supply curve

  • A perfectly price elastic supply curve where firms are able and willing to supply an infinitely large quantity at the given price
• Market Equilibrium


  • State where there is no tendency to change, determined where demand and supply curves intersect at point E
• Quantity that consumers want to buy

  Equals Quantity that producers offer for sale
• Market equilibrium

  Leads to equilibrium price and quantity where quantity demanded equals quantity supplied, resulting in no shortage or surplus
• Allocative efficiency


  • Optimal amount of each good and service being produced and consumed