Basic Elements of Supply

Chapter 3
Basic Elements of Supply and Demand

Volatile markets
Like the weather, markets are always changing, dynamic, unpredictable. As with the weather, careful study of markets also shows certain forces and patterns underneath the daily random movements.
The essential tool for understanding the movement of prices and outputs in individual markets is called the analysis of supply and demand.

Gasoline Prices Move with Demand and Supply Changes
T-15
Figure 3-1

Source: U.S. Department of Energy and Labor

Figure 3-1 The volatile price of gasoline
 Gasoline prices have fluctuated wildly over the last three decades.
 Supply reductions in the 1970s produced two dramatic “oil shocks”, which provoked social unrest and calls for increased regulation
 Reductions in demand from new energy-saving technologies led to the long decline in price after
1980
 War against Iraq led to price spikes in 1990 and
2003
 The tools of demand and supply are crucial for understanding these trends.

What lay behind these dramatic shifts?
Economics has a very powerful tool for explaining these and many other changes in the economic environment. It is called the theory of supply and demand. This theory shows:
--consumer preferences determine consumer demand for commodities
--business costs are the foundation of the supply of commodities

Markets and competition
A market is a group of buyers and sellers of a particular good or service
The terms demand and supply refer to the behavior of people as they interact with one another in markets.
Buyers determine demand, while sellers determine supply

Competitive markets
A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price.

Competition: perfect or otherwise
 Perfect competition
-- products are the same
-- numerous buyers and sellers so that each has no influence over price
-- buyers