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The Basics of Supply and Demand 285

Finally, monopolistic competition (not shown in the table) shares several

of the characteristics of perfect competition: many small firms competing in the

market and an absence of entry barriers. In this sense, it would occupy the

same cell as perfect competition. However, whereas perfect competition is char-

acterized by firms producing identical standardized products, monopolistic

competition is marked by product differentiation. In short, the two dimensions

of competition shown in Table 7.1, though useful, do not do the full job in dis-

tinguishing different market structures.

THE BASICS OF SUPPLY AND DEMAND

A thorough knowledge of the workings of supply and demand, and how they

affect price and output in competitive markets, is essential for sound manage-

rial decision making. For example, if a product or service is sold in a perfectly

competitive industry, top management is naturally concerned with a predic-

tion of future prices in the market. Should the firm expand capacity with the

expectation of price increases? Conversely, if price declines are expected, down-

sizing might be the proper response.

In a perfectly competitive market, price is determined by the market

demand and supply curves. We will consider each of these entities in turn.

The demand curvefor a good or service shows the total quantities that

consumers are willing and able to purchase at various prices, other factors held

constant.^2 Figure 7.1 depicts a hypothetical demand curve D for shoes in a

local market. As expected, the curve slopes downward to the right. Any change

in price represents a movement along the demand curve.

The supply curvefor a good or service shows the total quantities that pro-

ducers are willing and able to supply at various prices, other factors held con-

stant. In Figure 7.1, the supply curve for shoes (denoted by S) is upward

sloping. As the price of shoes increases, firms are willing to produce greater

quantities because of the greater profit available at the higher price. Any

change in price represents a movement along the supply curve.

The equilibrium pricein the market is determined at point E where mar-

ket supply equals market demand. Figure 7.1 shows the equilibrium price to

be $25 per pair of shoes, the price at which the demand and supply curves

intersect. At the $25 price, the quantity of output demanded by consumers

exactly matches the amount of output willingly offered by producers. The

corresponding equilibrium quantity is 8,000 pairs. To see what lies behind

the notion of demand-supply equilibrium, consider the situation at differ-

ent prices. Suppose the market price were temporarily greater than $25

(^2) In Chapters 2 and 3, we already have presented an extensive analysis of the demand curve facing
an individual firm. In the present discussion, we focus on total demand in the market as a whole.
Except for this difference, all of the earlier analyses apply.
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