Notes on Principles of Macroeconomics
Vijaya Raj Sharma, Ph.D.
DEMAND, SUPPLY, AND MARKET OUTCOME
Market is a place (it could be a real place like malls, flee markets, or department stores,
or a virtual place, like different websites devoted to buying and selling in the internet)
that brings buyers and sellers of a good together. The two groups then can negotiate on
the price and quantity of transaction.
Whether a transaction actually takes place depends
on buyers' willingness to pay for the good (called
), suppliers' opportunity cost of
producing the good (called
), and the cost of negotiation and arranging for the trade
). Let me briefly introduce transaction cost; then we will discuss
about demand and supply.
Transaction costs are the costs of arranging contracts or transaction agreements between
demanders and suppliers, and it also includes shipping and handling costs. Middlemen
and retailers bring goods near to buyers, so that they do not have to travel to producers of
goods, and thus reduce transaction cost. If there were no grocery stores, imagine how
difficult it would be for each buyer to identify farmers willing to sell grocery. Transaction
costs use up real resources which may have alternative uses.
A well functioning market provides necessary information to both buyers and sellers to
facilitate transactions. When complete information is not available, transaction cost goes
up. Consider sales of used books. When students sell their used books to book stores,
they get paid only about 25 percent of the original price of the book. On the other hand,
when students buy used books from book stores, they are charged about 75 percent of the
original price. The difficulty of identifying those students who are willing to sell used
books and those students who are willing to buy used books and then the difficulty to
bring the potential buyer and seller together raises transaction costs of buying/selling
used books. Book stores take advantage of this difficulty or high transaction cost while
pricing used books they sell and used books they buy.
Use of money for transaction lowers transaction cost. In olden days when there was no
money and goods were bartered, a double coincidence of wants only would allow a
transaction to happen. Imagine a condition when the only way I could buy corn for my
home was to barter it with a lecture in economics (because that is what I do for living).
The transaction could take place only when my want of corn could be matched with a
corn seller’s want of lecture in economics. Because of high transaction cost, the volume
of trade in those days was small. By lowering transaction cost, volume of trade can be
increased. That is what money does. Use of money as a medium of exchange abolishes
the need of double coincidence of wants. I collect money in exchange of lecture in
economics, whosoever buys the lecture, and then use this money to buy corn, whosoever
sells the corn.