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06 Elements of Market

Elements of Market

  1. Demand
  2. Supply
  3. Equilibrium

Demand

indicates optimal quantity of commodities which consumers are willing and able to buy at a particular price, in a particular period

if prices change, demand also changes

Law of Demand

Assuming every factor (like preferences, current state affairs) remains constant, \(\text{demand} \propto \frac{1}{\text{price}}\) this goes other way round too

Individual Demand Curve

can vary from one individual to another even for the same commodity, due to Factors of Trade

graph is a straight line with a negative slope

  • x = Demand
  • y = price

Be careful of the slope, cuz the slope formula is for the inversed graph of the demand Curve Slope \(= \frac 1 {\alpha_2}\)

\[ \text{Demand as a function of price}\\ \begin{aligned} D &= f(P) \\ &= \alpha_1 - \alpha_2 P \\ \alpha_2 &= -\frac{\partial D}{\partial P} \end{aligned} \]
Term Meaning
\(x\) Demand
\(P\) Price
\(\alpha_2\) Sensitivity of demand wrt price
The no of units of demand decreases by when the price increases by 1 unit
- Necessities have low sensitivity
- Luxury goods have high sensitivity
\(\alpha_1\) Demand even when commodity is free
Captures impact of all other factors that affect the demand (Income of consumers, advertising, etc)

Graph Characteristics

Horizontal Graph Vertical Graph
Slope of graph \(\to 0\) \(\to \infty\)
\(\alpha_2\) \(\to \infty\) \(\to 0\)
sensitivity High Low
even a small change in price will cause variation in demand even large changes in price cause negligible change in demand
Example when there are too many sellers and buyers; and only one seller changes the price medicines, food

Market Demand

total demand for a commodity in a market at a particular price

summation of individual demands for commodity at particular prices

Giffen Goods

Law of demand not applicable for them

eg: BW TVs, Nokia Phone

\(\text{demand} \propto \text{price}\)

Factors of Demand

Out of the following factors, economic policies mainly target the expectations factor

\[ x_1 = \alpha - \alpha_1 p \pm \alpha_2 M \pm \alpha_3 W \pm \alpha_4 M^e \pm \alpha_5 p^e + \alpha_6 A \]

Income and Wealth

More income and wealth means more spending and hence, higher demand

  • Income is flow of money currently
  • Wealth is what we have accumulated over time
Relationship
Type		 Elastic
Demand?		 Shift in
individual demand curve		 Consumption at
same price		 Example
+ve ✅ Rightward Greater Luxury Items
Neutral ❌ None Same Staple foods
-ve ✅ Leftward Lower Inferior and Giffen goods

Types of Goods based on Income Elasticity

Type Income Elasticity
Superior +ve Smartphones, LED TVs, Cars
Necessities 0 Staple foods
Inferior -ve B/W TV, tungsten bulbs, public transport

Price of Other goods

Cross Price is measured by \(\alpha_3\)

when price of complimentary good increases, the demand of main commodity decreases when price of substitute good increases, the demand of main commodity increases

hence, if

  • \(\alpha_3 > 0\) substitute
  • \(\alpha_3 < 0\) complimentary

Types of Goods based on Income Elasticity

Example
Complimentary goods Goods that are consumed together Car & Petrol
Substitute Goods Goods that are alternatives of each other Pepsi & Coke

Tastes/Preferences

idk how to write this

Customer Expectations

Expectation Meaning Explanation
Expected Price What I predict to be the price of the commodity in the future If expected price > current price, then demand increases, which ends up increasing the price; whether or not it would’ve happened naturally, nobody will know 😆; here, our expectations clearly affects the actual outcome
If expected price < current price, then demand decreases
Expected What I predict to be my income in the future

Market Size

No of buyers in the market

\[ \text{Demand} \propto \text{Market Size} \]

Advertising Expenditure

Does not affect the product, but changes the perception of the product in consumers’ heads

\[ \text{Demand} \propto \text{Advertising Expenditure} \]

Season/Time of the Year

  • demand for cotton is greater in summer
  • demand for wool is greater in winter

Supply

is the optimal quantity which sellers are willing and able to sell at a given price, in a particular period

Law of Supply

Assuming that factors are same, supply \(\propto\) selling price of commodity

Contemporary Relation

\(S = \beta_1 + \beta_2 P_{t}\)

  • land
  • eggs
  • milk

Lagged Relation

\(S = \beta_1 + \beta_2 P_{t-1}\)

For commodities with large gestation period, such as agricultural

Terms

  • \(\beta_1 =\) minimum selling price for which suppliers are willing to produce commodity
  • \(\beta_2 =\) sensitivity of supply wrt price

Graph

  • y = P
  • x = S
Shift Supply for the same price
Outward Greater
Inward Lower

All points on the supply curve show the optimal supplies Any point inside/outside the supply curve will not provide maximum profit

Individual Supply

Every firm has different supply curve due to difference in cost structures

\[ \text{Cost} \propto \frac{1}{\text{Scale}} \quad (\because \text{Benefits of Scale}) \]

Market Supply

Total supply for a commodity in a market at a particular price

Summation of supplies of commodity by different firms at particular prices

Factors of Supply

\[ S = \beta_1 + \beta_2 P + \beta_3 F + \beta_4 T + \beta_5 E \]

Cost of Production

input prices, technology

if cost inc, supply dec

Expectations

  • if expected price/returns > current price, then supply increases
  • else supply decreases

\(S \propto \frac{1}{p_r}\)

if price of raw materials, transport and complimentary goods like oil increase, then supply decreases

Number of Sellers

\(S \propto n\)

greater the no of sellers, greater the market supply

Producer Sentiments

mindset of producers

  • if it is positive, then supply increases
  • else supply decreases

Market Equilibrium

market situation when price has reached the level where quantity supplied = quantity demand

no tendency for change in price/decisions, as both producers and consumers are satisfied

in the long run, excess demand and supply tends to 0

Auctions take place until equilibrium is reached

Evaluating Equilibrium Price/Quantity

  1. Get \(P\) by equating demand and supply functions and solving them
  2. Get \(Q\) by substituting \(P\) in either function (both gives the same answer)

we can also draw a graph and obtain the point of interception of the supply and demand curves

Equilibrium

Dis-equilibrium

Whenever there is a disequilibrium, the market automatically adjusts the price

Surplus Shortage
Characteristic Excess Supply/
Low Demand		 Excess Demand/
Low Supply
Buyers not willing to buy Sellers not willing to sell
Price Actual > Equilibrium Actual < equilibrium
Automatic
Correction		 Actual price will reduce to equilibrium price automatically, as there is low demand actual price will increase to equilibrium price automatically, as there is low supply

Automatic market correction mechanism always occurs, given that

  1. Prices are flexible
  2. Market free from government intervention
  3. Both buyers and sellers are equally-informed about the market (internet has helped with making information symmetric); otherwise there will be one or more of the following
  4. sellers will manipulate buyers
  5. all the sellers will be selling bad products, as it more profitable to do so
  6. company recruiters will only get bad candidates as the salary they provide will be amazing for bad candidates, but too low for good candidates so only the bad candidates will end up accepting the job
  7. buyers will be hesitant to pay higher price, even when the seller is justified to ask that much

Govt

Whenever there is govt intervention in market dis-equilibrium, there will be always be a tendency for the existence of a parallel black market. Black market (not the illegal market one) is a market that sells commodity at price cheaper than govt-issued price.

Events

  1. Determine if the event changes the demand/supply
  2. Determine the shift in the curves
  3. Find how the equilibrium price and quantity are affected

Change in Equilibrium

Equilibrium Geogebra

Direction of Shift in Demand & Supply Curve Cause Meaning
Right/Left Change in constant Change in factors other than price
Angular upward/downward Change in coefficient of price Change in price

Imagine an auction

Supply const Supply inc Supply dec
demand const P same
Q same		 P ⬇
Q ⬆		 P ⬆
Q ⬇
demand inc P ⬆
Q ⬆		 P ambiguous
Q ⬆		 P ⬆
Q ambiguous
demand dec P ⬇
Q ⬇		 P ⬇
Q ambiguous		 P ambiguous
Q ⬇

Ambiguous –> it depends on the relative change bw the supply and demand

Misc

Black Money

The money isn’t necessarily illegal, the problem is that the transaction is unofficial, to avoid paying taxes for the transaction.

Demonetization

They assumed that all black wealth is in the form of cash, but if you look at data - 0.0002% of total wealth is in the form of cash - only ~1% of black wealth is in cash

Demerits were the cost of - Printing the notes - Time of people in queues wasted and hence they did not perform productively - Informal sector shops lost everything, due to the above

It mainly did one thing: introduction of a new commodity: old currency

Fake Currency

Fake currency is only an issue if it facilitates illegal activities. However, as long as fake currency is used for legal activities, then there is no problem from the perspective of economics. However, if the proportion of fake money is too large, then there is risk of inflation

Monopoly

image-20240213224223004

Monopoly supplier produces at the quantity where Marginal Revenue & Marginal Cost intersect

Last Updated: 2024-05-12 ; Contributors: AhmedThahir

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