Tutorial 2: Markets and the Role of Supply and Demand

Learning Objectives:
(1) Identify what markets are and discuss the importance of prices

(2) Construct the supply and demand model and analyse how prices in a competitive market are
determined.

(3) Use the supply and demand model to analyse real time series data.

Agenda
Part 1 – 10 minutes

Working in your groups, identify a market of your choice. Who are the participants in the market?
What goods and services are being transacted? How are prices determined? Does government impact
upon this market?

Subjective answer it’s up to you to do this.

Part 2 – 30 minutes

As a class, answer the following questions using one of the markets identified in Part 1:

i) Derive the market demand curve.

The market demand curve is the summation of individual demand curves. It is downward sloping and
shows a negative relationship between price and the quantity demanded. The basic idea is very
simple if prices rise, consumers demand less of a good or service.

ii) What factor moves you along the demand curve? What factors shift the demand curve?

Changes in prices move you up and down the curve. This could be caused by a supply curve shifting.

Any other potential factor can shift the curve. For simplicity, it is always useful to isolate a demand
shifter. In other words, we consider a factor that shifts demand whilst holding all other factors
constant. This is the ceteris-paribus (https://www.economicshelp.org/blog/glossary/ceteris-paribus/)
assumption. Typically we usually isolate the effects of income i.e. normal and inferior goods and the
price of other goods i.e. complements and substitutes.
iii) Derive the market supply curve.

The basic idea, is that if markets are competitive (i.e. lots of firms in the market) then higher prices
incentivise producers to produce more goods.

iv) What factor moves you along the supply curve? What factors shift the supply curve?

Movements along the supply curve are caused by changes in prices. This could be caused by the
demand curve shifting.

Shifts in the curve are usually due to changes in productivity i.e. if the costs of production fall. For
example improved technology shifts the curve to the right. Or, a reduction in labour costs/capital
costs allows producers to produce more. Government regulation could also have an impact.

v) Show the market equilibrium.

Equilibrium occurs where supply is equal to demand. At this position prices are said to “clear” the
market.
vi) Analyse situations where there is disequilibrium i.e. Excess Demand & Excess Supply

Here we have an excess demand e.g. the demand for Peter Kaye tickets after he has sold out. On the
secondary market the price of Peter Kaye tickets will sky-rocket eliminating the shortage.

Here we have an excess supply e.g. the Christmas sales at House of Fraser. There are lots of clothes
piled up and if the retail outlet wishes to sell them all then it has to drop the price.

Part 3 – 20 minutes

On the following page there is a time series graph of crude oil prices from 1861 onwards. Usefully
the figure also identifies some of the main historical events during this long time period.

I often ask a question in the exam that uses a figure like this but set in a different context. For
example, I could give you a time-series of house prices, agricultural goods, and commodities such as
iron, steel, silver or even gold as we saw in the lecture. The question would look something like this
and would envisage you applying the supply and demand model to analyse prices over time.

Question: “Using the supply and demand model, analyse the price of oil from 1861 onwards. What
factors might you consider in order to predict the future oil price?”

To help you, as you are 1st year students, I also give a few hints:
“In your answer, comment on the factors that impact upon the supply and demand for oil. In addition,
make sure you include annotated diagrams, comment on the elasticity of supply and demand for oil and
utilise any other information you might know about this market”.

If you want, you can practice writing a question like this and bring it to my office hours and I’ll give
you almost instant feedback!

For this tutorial therefore, how would you go about answering a question like this? Can you apply the model to
the time series? What about the identification issue? Discuss as a class how you would tackle this question.

You have to have a go at writing an answer for this. If you want I can grade it for you in office hours.