Today's content

• Supply and demand: a model of competitive market

• Demand curve

• Supply curve

• The perfect equilibrium

Some problems

Market

• Chip makers and chip users create the market for chip.

• Market is a "place" where buyers and sellers meet to exchange goods and services for payment.

• When there are 'many' buyers and 'many' sellers, we often say the maket is competitive.

• How many is 'many'? 100? 1.000?

Competitive market

• The important feature of competitive market is power.

• In the competitive market, buyer and seller cannot control price.

  • Seller trying to sell above market price won't get any buyer, vice versa.

• Competitive market is also known as perfect market or perfect competition.

Competitive market

• As previously discussed, we analyze with model.

• While no market is exactly perfect, we always start with competitive market.

  • Like all model, we start with something simple.

  • as we move forward, we will see the implication of relaxing the perfect market assumption.

Demand

• Demand is the consumer side of the market, measured by quantity.

• It is generally accepted that people buy less goods if it is expensive, ceteris paribus ¹.

• People say this is the law of demand.

• economists usually measure this using the demand schedule & demand curve.

Demand schedule

• A demand schedule is a table showing how much people will want to buy a certain product given prices.

• If everyone in a country face the same price, we can measure demand by adding up all demand for a given price.

• Making a demand schedule is not easy, in part because ceteris paribus isn't realistic.

  • prices change, but so other things.

Demand schedule

A hypothetical demand schedule for rice in Indonesia

Demand curve

• We can illustrate the demand schedule in a graph.

• A High school reminder of a Cartesian diagram:

  • Two planes, $x$ (horizontal) and $y$ (vertical).
  • $y=f\left(x\right)$

• We plot price on the y-axis, and quantity on the x-axis.

  • however, perfect market implies $Q^D=f\left(P\right)$

Demand curve

High school reminder

• Change in price leads to change in quantity along the lines.

• We say quantity is a function of price

$$Q^D=f\left(P\right)$$

• Price is exogenous, quantity is endogenous.
  • quantity does not affect price.
  • That's why perfect market is convinient.

Demand curve

• There are plenty of things affect demand:

  • increased income, change of taste, influencers, etc.

• Additionally, prices change too:

  • Technology, disaster, tax, etc.

• As long as the change doesn't cause by buyers & sellers.

• When this happen, we shift the curve.

Key take away

• We use graph to show relationship between price and quantity.

• In perfect competitive market, buyers and sellers can't affect price. Hence price is exogenous and quantity is endogenous.

• Change in price $\Rightarrow$ movement along the curve.

• Change in everything else $\Rightarrow$ shift the curve.

Back to demand

• Shift the curve is what generally means by economist when we say increase in demand or decrease in demand.

  • i.e., at the same price point, demand change.

• What shift the demand curve?

  • Changes in the prices of related goods.
  • Changes in income.
  • Changes in taste.
  • Changes in expectations.
  • Changes in the number of consumers.

Changes in the prices of related goods or services

• Most normal goods have a substitutes.

• A Substitute is another good which serve the same purpose.

  • you will not likely to buy it if you have your main good.

• Bread, noodle, and pasta can be considered a substitute for rice. What else?

• When $P_{noodle}$ goes down, you might want to switch to noodle, hence reducing demand for rice even when $P_{rice}$ doesn't change.

Changes in the prices of related goods or services

• The opposite of substitute is complements ${}^2$

• Demand is reduced if its complement is also reduced in demand.

• Demand for combustion engine car reduced when gasoline (bensin) prices go up.

  • similarly, people tend to buy electric car if charging it is relatively cheaper.

[2]: not compliment. different word

Changes in income

• In most goods, people buy more when their income increases.

  • that's why businesses pay attention to a country's economic growth.

• Most goods are normal goods, not inferior goods.

• inferior goods behave the other way around: buy less when income goes up.

  • you buy less of instant noodle when you're richer.

Changes in tastes.

• Changes in taste is straightforward.

  • nobody listens to K-Pop back in the 90s.

• We don't know how, but people's taste is changing.

  • Marketers and advertisers would like to disagree.

• If you can detect changes in tastes, or even better, influence other people's taste, you have an advantage in business!

Changes in expectations.

• People reacts on signal and what they expect for the future.

• Some people hold back purchasing some goods because they know those goods will have a discount in the near future.

• People buy more stocks when vaccine introduced cuz they expect the economy to grow in the near future.

• Knowledge is an advantage

  • that's why insider trading is illegal.

Changes in the number of buyer

• Similar with income, more buyer means more demand given the same price.

• This is why warteg often gets higher demand when there is a new construction site nearby.

• As the number of middle-class increases, demand for things that they usually buy also increase.

Supply

• Is the other side of the market.

• Like demand but the opposite:

  • Supply goes up when prices goes up.
  • When surgical facemask's price went up, even Polytron supplies facemasks.

• We also express supply with supply schedule and supply curve.

Demand schedule

A hypothetical demand schedule for rice in Indonesia

Supply Curve

• When price changes, quantity supplied go up.

• like demand, if sellers can't affect the market price, they follow the market price.

$$Q^S=f\left(P\right)$$

• the difference is, prices positively correlated with $Q^S$, $i.e.,$ $\frac{d{Q}^S}{dP}>0$, $i.e.,$ upward sloping.

• Hence, $P$ is exogen, $Q^s$ is endogen.

Supply curve

• Plenty of things that are not prices also affects the supply curve.

• Affecting farmers' decision to supply includes:

  • change in import price.
  • change in minimum wage in manufacturing.
  • Draught or flood.
  • Adoption in tech, etc.
  • we'll learn more about production cost later.

• When these changes, we shift the curve.

What shifts the supply curve?

• Like demand, there are several generelised factors affecting the supply curve.

• They are:

  • Changes in input prices
  • Changes in the prices of related goods or services
  • Changes in technology
  • Changes in expectations
  • Changes in the number of producers

Changes in input prices

• To produce, you need inputs

  • labour, seeds, fertilizers, price of land.

• $P_{input}\uparrow \Rightarrow$ Increase in production cost.

  • needs higher price to supply same amount of goods.

• In a sense, a producer in a market may be a consumer in another market.

  • A Factory outlet is a producer in the shirt market, but a consumer in the fabric market.

Changes in the prices of related goods or services

• Especially important for producers which sell many types of products with a very similar inputs.

• Toyota produces a lot of Avanza in Indonesia.

  • taxes for sedan and utility vehicles is higher in Indonesia.
  • You won't see Avanza in Australia. Instead, there's a lot of Camries and Hiluxes.

Changes in expectation

• Suppliers also tend to react to expectation.

• When a producer think there will be increase in price of its good in the future, it will hold to sell it.

• In fact, hoarding is a part of a producer's strategy.

• There's a trade-off between selling it now vs storing it and sell it later.

Changes in the number of sellers

• Similar with income, more seller means more supply given the same price.

• The rise of Gojek and the likes leads to higher supply of transportation service.

• Similarly when China started to rise up in manufacturing: more supply for cheap labour for electronic industry.

Market equilibrium

• Now that we learn that buyer and seller react to price on a curve, it is time to unite them!

• The perfect market is when quantity supplied matches quantity demanded.

$$Q^D=Q^S$$

• The price that causes this is called equilibrium price or market clearing price.

• The easiest way is to graph the two Q together.

Market equilibrium

Market equilibrium

• Price equilibrium may take some time to adjust.

• Some Markets are constantly moving (stock price is a good example)

• Shocks to demand and/or supply will move market equilibrium to a new position.

• New market equilibrium basically means a new equilibrium price and equilibrium quantity is formed.

Equilibrium after shock

• A positive demand shock leads to a higher equilibrium quantity and price.

• A positive supply shock leads to a higher equilibrium quantity but a lower price.

• A negative demand shock leads to a lower equilibrium quantity and price, and lower equilibrium quantity with a higher price.

Double positive shocks

• As you can see, if the positive shock is big enough, it can offset the rise in price with even higher increase in demand.

• You might note as well that the slope of the curve matters.

  • steeper curve change quantity even more.

• We will learn more later on elasticity.

Perfect market

• So we learned a bit on how perfect market operates:

  • Supply and demand will eventually settle on a market clearing price.
  • Market clearing price adjust quickly.
  • No single buyer or seller can affect it.

• Movement along the curve occurs when price change

• while exogenous shock (non-price change) shifts the curve.

Next week

• What happens when market prices doesn't adjust as quickly?

• What happens when the government intervene in a perfect market?

• We will learn tomorrow in:

Meddling with the market