Market Mechanics: Interactions of Buyers and Sellers

Demand

The desire to own something combined with the ability to pay for it.

Law of Demand

There is an inverse relationship between price and quantity demanded.

Substitution Effect

If the price of Good A rises, consumers buy less of Good A and more of a relatively cheaper substitute.

Income Effect

If the price of a good falls, the consumer's purchasing power increases, allowing them to buy more.

Law of Diminishing Marginal Utility

As more units of a good are consumed, the additional satisfaction from each unit declines.

Change in Quantity Demanded

Caused only by a change in the current price of the good; shown as a movement along the demand curve.

Change in Demand

Caused by a non-price determinant that shifts the entire demand curve left or right.

Determinants of Demand

Factors that cause shifts in the demand curve, including market size, expectations, related goods prices, income, tastes, and preferences.

Market Size

An increase in the number of consumers leads to a rightward shift in the demand curve.

Expectations (demand)

If consumers expect future prices to rise, they will buy now, shifting demand right.

Related Goods Prices

The impact of price changes in substitutes or complements on demand for a good.

Normal Goods

Goods for which demand increases as consumer income increases.

Inferior Goods

Goods for which demand decreases as consumer income increases.

Law of Supply

There is a direct relationship between price and quantity supplied.

Determinants of Supply

Factors that cause shifts in the supply curve, including technology, related goods, inputs, competition, and expectations.

Technology

Improvements in technology can make production more efficient and shift the supply curve to the right.

Competition (supply)

An increase in the number of sellers in a market shifts the supply curve to the right.

Market Equilibrium

A situation where the quantity of a good demanded by consumers equals the quantity supplied by producers.

Surplus

Occurs when the market price is set above equilibrium, leading to excess supply.

Shortage

Occurs when the market price is set below equilibrium, leading to excess demand.

Single Shifts

When either demand or supply shifts, resulting in predictable changes in price and quantity.

Double Shifts

When both demand and supply shift simultaneously; one variable's change is known, while the other is indeterminate.

Future Price Expectations

How beliefs about future prices can affect current demand and supply.

Change in Demand vs Change in Quantity Demanded

Change in demand shifts the curve; change in quantity demanded shows movement along the curve.

Common Pitfall: Supply Shifts

Thinking an increase in supply means the supply curve moves up; it actually shifts right.

Indeterminate Effect

In a double shift situation, one variable's change in price or quantity is not clear without numerical data.