A summary of Chapter 8 of CORE-Econ's book: The Economy 2.0:Microeconomics. The summary includes: notes on all content covered in the chapter; graphs, tables and diagrams (alongside explanations for clarity); and a bullet point summary of the chapter.
CORE-Econ - The Economy 2.0: Microeconomics - Chapter 10 Summary
CORE-Econ - The Economy 2.0: Microeconomics - Chapter 9 Summary
CORE-Econ - The Economy 2.0: Microeconomics - Chapter 7 Summary
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Unit 8: Supply and Demand: Markets with Many Buyers
and Sellers
Markets characterized by many buyers and sellers, differ significantly from markets with differentiated goods, where
each seller has a unique product. In highly competitive markets with many sellers offering the same product,
competition is more intense, leading to different dynamics.
Willingness to pay (WTP) is crucial for buyers, particularly in online auctions like eBay, where a buyer can set a
maximum bid equal to their WTP. eBay automates the bidding process up to this maximum, ensuring that the buyer
only wins the auction if the highest bid is at or below their WTP.
Figure 8.1: The market demand curve for books.
The market for second-hand textbooks is an example of a market
with many buyers and sellers. Demand comes from students with
varying WTP, depending on factors like how much they value the
book and their financial resources. The demand curve is
constructed by ordering potential buyers from the highest to the
lowest WTP. This curve typically slopes downward, indicating that
as the price decreases, more students are willing to buy the book.
On the supply side, willingness to accept (WTA) measures how
much sellers value a good by the minimum price sellers—students
who have completed the course—are willing to accept. The
supply curve is created by ordering sellers by their WTA, typically
sloping upward, as higher prices encourage more students to sell
their books.
Figure 8.2 illustrates the relationship between price and the
Figure 8.2: The supply curve for books. quantity of books supplied. Sellers have different reservation
prices—the minimum price they are willing to accept. For example, the first seller will only sell if the price exceeds
$2.25, while the 20th seller will sell at $7, and the 40th seller requires $12. As the price increases, more sellers are
willing to sell their books. At a price of $10, 32 books would be supplied. This upward-sloping supply curve reflects
that higher prices incentivize more sellers to participate in the market.
Market clearing (the price at which the amount of the good
demanded is equal to the amount supplied) occurs where the
supply and demand curves intersect, determining the market-
clearing price. For instance, if the price is set at $8, 24 books
will be sold, as 24 buyers are willing to pay $8 or more, and 24
sellers are willing to accept $8 or less. This price point ensures
that there are no excess goods left unsold, and no unmet
demand.
Figure 8.3: The market for second-hand books will clear if
the price is $8.
Market Balance ensures there is:
, • Efficient Allocation: Market clearing ensures resources are used effectively, matching supply with consumer
demand.
• Price Stability: It stabilizes prices, allowing better planning for both consumers and producers.
• Welfare Maximization: Both consumer and producer surplus are maximized at the market-clearing price.
• Market Signals: It indicates whether new firms should enter or exit the market.
Prices in competitive markets tend to gravitate towards a point where supply equals demand. If sellers set prices
around $10, few would attract buyers and some might think they could do better by lowering their prices.
Conversely, if books were priced at $5, high demand would encourage sellers to raise prices to maximise profits.
Even though some books might sell at different prices, market forces generally push prices towards this equilibrium,
ensuring most transactions occur at or near the market-clearing price.
Market Equilibrium and Competitive Equilibrium
Marshall defined the market-clearing price, also known as the equilibrium price, as the price where supply equals
demand, leading to a stable market with no tendency for price changes. For second-hand books, the equilibrium
price is $8, where the quantity supplied and demanded is balanced. When prices deviate from this point, market
forces push them back towards equilibrium.
Figure 8.4: Equilibrium in the market for
second-hand books. In competitive markets with many buyers and sellers, everyone
The market-clearing price of $8 (P* = 8) results in equilibrium,
where the quantity supplied (Q* = 24) equals the quantity
demanded. If the price rises above $8, excess supply occurs,
leading sellers to lower prices. If the price falls below $8, excess
demand arises, causing buyers to bid higher and sellers to raise
prices. Only at $8 does the market stabilize, with no incentive
for buyers or sellers to change the price.
acts as a price-taker, leading to a Nash equilibrium
where no buyer or seller can benefit from attempting to trade at any other price than the prevailing market price.
Experiments by Vernon Smith confirmed that markets with well-informed participants tend to converge toward
competitive equilibrium. A market is in competitive equilibrium if the quantity supplied is equal to the quantity
demanded at the prevailing price, and all buyers and sellers are price-takers, so no-one can benefit from attempting
to trade at a different price.
In his experiments, participants were given information about prices and
allowed to trade multiple times, which mimicked real-world market
behaviour. Initially, prices and the number of trades did not match the
theoretical equilibrium, similar to how, in the real world, prices above or
below the equilibrium price lead to excess supply or demand. However, as
the experiment progressed and participants gained more information,
prices began to converge toward the equilibrium point. By the fifth round,
trades occurred near the predicted equilibrium price, demonstrating that
with enough information and repeated interactions, markets tend to reach
an equilibrium where supply equals demand.
Figure 8.6: Vernon Smith’s experimental results.
Competitive Market Behaviour and Equilibrium
in the Bread Industry
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