2.8 When to Use the Supply-and-Demand Model

As we’ve seen, the supply-and-demand model can help us understand and predict real-world events in many markets. Through Chapter 10, we discuss perfectly competitive markets, in which the supply-and-demand model is a powerful tool for predicting what will happen to market equilibrium if underlying conditions—tastes, incomes, and prices of inputs—change. A perfectly competitive market (Chapter 8) is one in which all firms and consumers are price takers: No market participant can affect the market price.

Perfectly competitive markets have five characteristics that result in price-taking behavior:

  1. The market has many small buyers and sellers.

  2. All firms produce identical products.

  3. All market participants ...

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