Microeconomics – BS1551 – Supply & Demand (Markets)
Introduction
Economists view markets objectively, knowing that they have their benefits but also have
their drawbacks.
- Definition of a market: A market consists of the buyers and sellers of a good or
service.
Markets are confined to a specific;
- Location: for example, you can’t look at sellers of apples in Britain and buyers of
apples in Australia, as these two would never meet to trade.
- Good or service – for example, there is no point in comparing the owners of
swimming pools in Cardiff with the sellers of apples in Cardiff.
- Time – You must compare the buyers and sellers at the same time. For example, no
point in comparing buyers and sellers in 2020 and buyers and sellers in 2002.
Economists have recognised over the years that even subtle product differences matter a
great deal to consumers, and the trend in analysis has been toward ever-narrower
definitions of goods and markets. Two otherwise identical products are often classified as
separate if they differ only with respect to the times or places, they are available. An
umbrella on a sunny day, for example, is in this sense a very different product from an
umbrella during a downpour.
In markets, goods are exchanged at a given real price, P. This price is most frequently
money; however, this could also be other goods. The price, P, is relative to the price of other
goods and includes the opportunity cost.
The real price of a product is its price relative to the prices of other goods and services.
How much should I consume?
Buyers and consumers have a continuous choice that they must make.
Consumers need to decide how much they want to buy. How do they do this?
- It is a continuous choice.
- MB(q) is the marginal benefit of consuming one more unit, having consumed q-1
units already.
- What is the marginal cost? The marginal cost is the price, P, that you have to pay for
a good. This includes the opportunity cost, as you can’t now spend the money that
you have spent on that good, on something else.
- What is the marginal benefit? The marginal benefit is the benefit that you receive
from that good.
- Consume one more unit of the good if MB(q) > P.
,Example: Storage Hunters – what is going on?
Before starting the auction, each individual had a look in the locker to see how much the
locker was worth to them. Each individual has a different value on the lock, which means
they each had a different marginal benefit on the locker.
All auctioneers face the same price. However, as the price increases, more people find that
MBlocker < P. This means that the number of people demanding the locker fell and fewer
people continued to bid.
This can be shown graphically:
The following can be drawn from the graph:
- The bidding started at point 7 (when 7 people were interested in buying the locker
for £100). This means that 7 people were willing to buy the locker for a £100,
however, the person selling the locker only had one locker which meant the price
increased.
- The price then reached £500, and now only 3 people were still in the auction. This
means that the people who dropped out of the bidding valued the locker at
somewhere between £100 and £500 and now that the locker reached £500, the
marginal cost had exceeded their believed marginal benefit (they believed at £500,
they would not receive any gain).
- By the time the bidding reached £650, there was only one person left in the auction.
This meant that only one person valued the locker at that price and thought they
would receive some form of net gain from it.
- Plotting all these points, a downward sloping line can be seen, this is known as a
demand curve. This shows that as the price goes up, the quantity demanded of a
good goes down.
The law of demand
The law of demand states that as the price of a good rises, the quantity that consumers
demand of it decreases.
- Definition: the demand for a product changes inversely to its price, all else being
equal.
, There are two mechanisms at play in this law, as the price rises:
1. Fewer consumers demand the good.
2. Each consumer demands a smaller quantity of the good.
For both of these reasons, the amount desired of a good decreases as the price goes up.
Horizontal interpretation
We constructed the demand curve by asking how many consumers wished to consume at
different prices. More generally we could ask how many units each consumer wishes to
consume.
Asking how many units each consumer wishes to consume is known as the horizontal
interpretation. This means that if you tell me the price of the good and I know what the
demand curve looks like, I can read across and be able to tell you how many goods you
would be able to sell at that price.
The horizontal interpretation is important for working out market demand from the
individual demand.
The horizontal interpretation tends to be downward sloping: meaning that the quantity
demanded rises as the price of the product falls.
Vertical interpretation
Instead of starting on the price axis, you can start on the quantity axis and ask how much a
consumer is willing to pay.
If a consumer is buying more than one unit, they will keep buying it so long as the MB(q)>P.
This means that the highest price that they are willing to pay for the unit q, must be the
marginal benefit because this is the tipping point where above this level you are no longer
receiving marginal gains, and below this point you are still receiving net gain and you will
want to keep purchasing the unit.
This means that the highest price they are willing to pay is MB(q) and this is the price on the
demand curve.
Vertical interpretation shown graphically
