Markets exist anywhere, in real or virtual
space, that buyers and sellers can transact business (MKM C4/68). Put another way,
Markets are where Demand meets Supply setting a price/quantity that
clears the market; ‘X’ marks the spot where the willingness to buy
exactly matches the willingness to sell
(MKM Fig 4.8). Markets can be:
- commodity-based, geographic or virtual;
- in or out of equilibrium (MKM
Fig 4.9 a &
- sensitive or insensitive to changes in
price, income, taste or technology;
- influenced by someone - consumer,
producer or government - who alters the price/quantity outcome by
exercising market power.
1. Market Demand Curve
Curve for each individual consumer shows demand at
each price. At any given price we can,
horizontally in Cartesian space, sum up
how much all consumers are willing to buy at each price. Hence, the
Curve is the horizontal summation of the individual demand curves
of each consumer.
The Market Demand Curve is thus an
aggregation of individual consumer demand curves. As will be seen,
and importantly, what can be aggregated can sometimes be disaggregated.
All things being equal, the higher
the price of a good or services, the smaller the quantity demanded.
This is the Law of Demand. Among other things the law reflects the
substitution and income effect of a price increase on the quantity of a
good demanded by consumers.
Substitution Effect: when the price of a good increases it does so
relative to all other goods. Although each good is unique it has
substitutes - other goods that will serve almost as well. As the
opportunity cost of a good rises, people will tend to buy less of it and
more of its substitutes.
ii - Income Effect: when the
price of a good rises, all things being equal, it rises relative to
income. Faced with a higher price and an unchanged income, the
quantity of at least some goods and services must decrease.
The demand curve can, however, shift, if other prices or
other factors change (P&B
7th Ed Fig. 3.8; MKM
Fig. 4.10). A shift in the demand curve can result due to changes in:
i - Price of Other Goods or
ii - Income;
iii - Expected Future Prices;
iv - Population; and,
v - Preferences.
2. Market Supply Curve
Curve for individual firms shows supply
at each price. At any given price we can sum up, horizontally in
Cartesian space, the
amount all firms are willing to supply at each price. Hence, the Industry
Curve is equal to the horizontal summation of the individual supply curves
of each producer.
The Market Supply Curve is thus an
aggregation of individual firm supply curves. As will be seen, and
importantly, what can be aggregated can sometimes be disaggregated. All
things being equal, the higher the price of a good or services, the
greater the quantity supplied. This is the Law of Supply.
Assuming other factors do not change,
there will be movement along the supply curve as the price of the good or
service changes. The supply curve can, however, shift, if other
factors change (P&B
7th Ed Fig. 3.9;
& b). A shift in the supply curve can result due to changes in:
i - Price of Factors of Production;
ii - Expected Future Prices;
iii - Number of Suppliers; and,
iv - Technology.
3. Consumer &
The market demand
curve (MKM C7/Fig. 7.7, AB) demonstrates that consumers are willing to
pay a higher price for a smaller quantity due to the Law of Diminishing
Marginal Utility. The market supply curve (CD) demonstrates
that producers are willing to sell a larger quantity at a higher price
due to the Law of Eventually Diminishing Marginal Product.
The intersection of the two curves at E sets the market clearing
equilibrium price and quantity.
It is achieved through a process called
a concept introduced by French economist Léon
It is a trial-and-error process by which equilibrium prices and
stability are reached in competitive markets.
consumers this means that there is a difference between what they were
willing to pay for every unit before equilibrium. This difference
is measured from equilibrium price UP to the market demand curve (AB).
It is called consumer surplus. It shows the difference between how
much consumers were willing to pay and how much they actually paid.
For producers this
means that there is a difference between what they were willing to
accept in payment for every unit before equilibrium. This
difference is measured from equilibrium price DOWN to the market supply
curve (CD). It is called producer surplus. It shows the
difference between how much producers were willing to accept and how
much they actually received.
As will be seen,
under Perfect Competition consumers and producers keep their respective
surplus. Under Imperfect Competition, however, market power is
used to appropriate part of the consumer surplus into economic, excess
or monopoly profits. It is the consumer's willingness to pay a
higher price for a smaller quantity that allows Imperfect Competitors to
4. Market Forces:
In a Market,
price regulates the quantity of goods and services demanded and
supplied. If price is too high, consumers demand less than producers
are willing to supply. A surplus exists. To rid themselves
of this surplus producers lower their price. If price is too low,
consumers demand more than producers are willing to supply. A
shortage exists. To get more of the good consumers bid up the
price (MKM Fig 4.9 a &
The tendency of producers to lower price faced with
a surplus and consumers to bid up price faced with a shortage is called
Market Forces. These tend to keep the market price/quantity where ‘X’
marks the spot.
Such forces should
not be confused with Market Power exercised by buyers or sellers in