Demand, supply and equilibrium analysis part 1(ECO101/ECO401 class notes)
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Course
ECO 101 (ECO401)
Institution
Virtual University Of Pakistan
The chapter on Demand, Supply, and Equilibrium Analysis delves into the fundamental principles that govern market dynamics. It explores the intricate interplay between consumer demand and producer supply, dissecting the forces that shape economic transactions.
The notes cover some basic definition...
Goods/product/commodity markets:
Markets serve as platforms for the exchange of final goods or services. Product markets
facilitate the exchange of consumer goods acquired by the household sector, capital investment
goods procured by the business sector, and items acquired by the government and foreign
sectors. It's essential to note that a product market excludes the trading of raw materials, scarce
resources, factors of production, or any form of intermediate goods. The annual value of goods
transacted in product markets is quantified by gross domestic product (GDP). On the demand
side of product markets, one finds consumption expenditures, investment expenditures,
government purchases, and net exports. Conversely, the supply side is represented by the
production activities of the business sector.
Factors markets:
Markets are instrumental in facilitating the exchange of factor of production services, which
include labor, capital, land, and entrepreneurship. Factor markets, also referred to as resource
markets, specialize in the exchange of services provided by factors, rather than the factors
themselves. To clarify, factor markets deal with the services of factors; for instance, the labor
services of workers are traded through factor markets, not the workers themselves. It is
important to highlight that buying and selling actual workers constitutes illegal practices, such
as slavery, and would be associated with product markets, not factor markets. In a more
practical sense, capital and land, considered as resources, are legally traded through product
markets, while the services derived from these resources are transacted through factor
markets. The annual value of services exchanged through factor markets is quantified as
national income.
Assumption is a belief or feeling that something is true or that something will happen, although
there is no proof. Economists make frequent use of assumptions in putting forward their
theories.
Perfect competition refers to a situation in which no firm or consumer is big enough to affect
the market price.
DEMAND ANALYSIS
Shortage:
A shortage occurs when demand exceeds supply, leading to producers
being unable to meet market demand for the product. Shortages cause
prices to rise, prompting producers to increase production and consumers to
decrease demand.
Surplus:
A surplus arises when there is an excess supply, meaning that market
demand falls short of the quantity supplied; i.e., producers are unable to sell
, all the produced goods in the market. Surpluses cause prices to fall,
prompting producers to reduce supply and consumers to increase demand.
Price Mechanism:
The price mechanism serves as a signaling and rationing device that guides
consumers and producers to adjust their demand and supply, respectively,
in response to a shortage or surplus. Shortages cause prices to rise,
motivating producers to boost production and consumers to lower demand.
Surpluses cause prices to fall, encouraging producers to reduce supply
while prompting consumers to increase demand. In either case, the price
mechanism attempts to clear the shortage or surplus in the market.
Normal goods:
These are goods whose quantity demanded goes up as consumer income increases.
Inferior goods are goods whose quantity demanded goes down as consumer income
increases.
Giffen goods:
These are the subcategory of inferior goods. It is a rare type of good seldom seen in the real
world, in which a change in price causes quantity demanded to change in the same direction (in
violation of the law of demand). In other words, an increase in the price of Giffen good results in
an increase in the quantity demanded. The existence of a Giffen good requires the existence of
special circumstances. First, the good must be an inferior good. Second, the income effect is
greater than the substitution effect. A Giffen good is most likely to result when the good is a
significant share of the consumer's budget. Margarine is a Giffen good as compared to butter.
Substitution Effect:
One of the two reasons for the law of demand and the negative slope of the
market demand curve is the substitution effect. This effect occurs because a
change in the price of a good makes it relatively higher or lower than the
prices of other goods that might act as substitutes. A higher price means
that a good is more expensive relative to other goods, while a lower price
means it's less expensive.
In simpler terms, if the price of a good increases, people tend to reduce its
consumption and substitute it with another good whose price has not
increased. This phenomenon is known as the substitution effect.
Income Effect:
Also one of the two reasons for the law of demand and the negative slope
of the market demand curve, the income effect results from a change in
price that gives buyers more real income or the purchasing power of the
income, even though money or nominal income remains the same. This
leads to changes in the quantity demanded of goods.
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