Topic 3: Demand, Supply, & Pricing

Topic 3: Demand, Supply, & Pricing

Warm-Up:1)What is your most important

consideration when you consider buying something?

2)What are five things that you couldn’t live without? Would you still buy these items if they doubles or tripled in price?

Buyers demand goods, sellers supply those goods, and the interactions between the two groups lead to an agreement on the price and

the quantity traded.

Rules To RememberDWAP: desire, willingness, ability to

purchaseDemand dipsLaw of Demand inverse Price(P) &

Quantity(Q)Demand = Quantity Demanded (D =

Qd)Price only changes quantity demanded5 shift factors of the demand curve that

are not related to price

Law of DemandThe law of demand holds that

other things equal, as the price of a good or service rises, its quantity demanded falls.◦ Inverse relationship: as the price of a good

or service falls, its quantity demanded increases.

Demand is important because it shows how people are willing to allocate resources

ExamplePizza:

If a slice of pizza costs $1, would you buy it?

How many slices would you buy?

If a slice of pizza cost $3, would you buy it?

How many slices would you now buy?

This shows us the law of demand…as price increases you will buy less

Demand Schedule: A demand schedule is a table that lists the quantity of a

good that an individual in a market will buy at each different price.

A market demand schedule is a table that lists the quantity of a good all consumers in a market will buy at each different price.

Demand CurveShows how much consumers will

demand at given prices in graph form

Change in quantity demanded (Qd) refers to movement along the curve; a

change in quantity based on price

Consider This:What might happen to sales of a particular type of car if its producer announced that its new engine emitted no pollution, was more powerful than previous engines, had better gas mileage than ALL other vehicles, and would cost the same?

Shifts in Demand

A willingness to buy different amounts at the same prices

Shift in the Quantity Demanded A willingness to buy different amounts at the same prices

The following five things cause a shift in the demand curve (SPITE):◦Substitution: complimentary goods used to

replace or with a good or service◦Population: population increases, demand

tends to increase◦Income: more $, more willing to pay more or

buy more quantity◦Tastes & Preferences: trends, values/ beliefs◦Expectations: what they expect

How the Demand Curve Changes

When we have an INCREASE in demand the curve will shift to the RIGHT because at the SAME price we are demanding more

When we have a DECREASE in demand the curve will shift to the left because at the SAME price we are demanded less

Demand Elasticity

•Give 3 examples of goods that can affect demand for another good because of price change.

Warm-Up:

Demand ElasticitySmall change in price = great (large) change in quantity demanded

The extent in which changes in price cause changes in the quantity demanded

It is the way consumers respond to price changes

Elasticity of a good varies at every price level

Consider This:

What is essential to me? What goods must I have even if the price rises greatly?

Elastic DemandConsumers care about changes in

the price of products with elastic demand

Example:◦ The current price of a donut is $.75. Dunkin

Donuts hold a promotion for their coffee, and in the meantime lower the price of a donut to $.50.

◦ What is the effect on quantity demanded?◦ How is this related to elasticity?

Determinants of Demand Elasticity

Urgency of need (Necessity v. Luxury)◦if it is not a necessity it is elastic◦if it is a need, it is inelastic

Relative Importance◦Ex. Clothing: if you currently spend

½ of your budget on clothing, an increase in the cost of clothing will cause a large reduction in the quantity you purchase.- Elastic

◦Ex. Shoelaces: if the price doubled, would you cut back? Probably not because you may not even notice the difference b/c it is only a small part of your budget-Inelastic

Determinants of Demand Elasticity (Continued)

Substitution availability◦If substitutions are available- elastic

Ex. Butter/ margarineChange over time

◦Can’t react quickly to price increase so it takes time to find substitutes; so demand is inelastic for a short time until they find substitutes

Income portion to buy◦If goods/services are expensive-

elastic

Inelastic DemandA small change in price causes a very little change in quantity demanded

A demand for a good you keep buying despite a price increase◦Examples:

Gas Milk at the grocery store costs $3.79 per

gallon. Price Chopper has a weekly sale and lowers the price to $3.39 per gallon. What is the effect on quantity demanded? How is this related to inelasticity?

Supply

Warm-Up:

Rules of Supply (Producer)

S = Supply (Think about what’s already on the store shelves available for purchase and not what the manufacturing potential is).

Supply to the sky (Curve)Law of Supply- direct relationship (P

Q )Price = change in Quantity Supplied8 factors that shift supply

Law of Supplyholds that other things equal, as

the price of a good rises, its quantity supplied will rise, and vice versa.P Q OR P Q

Direct Relationship

•Producers produce more output when prices rise so they can cover higher marginal costs of production

What is a Supply Schedule?

Shows the relationship between price & quantity supplied

What is a Supply Curve?

A graphical representation of the supply scheduleHorizontal axis measures the quantity of good

suppliedProducer's supply curve shows the quantity of an

item that producers will supply for given prices.

Equilibrium occurs at a price of $3 and a quantity of 30 units.

EquilibriumIn economics, an equilibrium is a situation in which:

• there is no inherent tendency to change, • quantity demanded equals quantity supplied

Shifts in Supply A change in any variable other than price that influences quantity supplied produces a shift in the supply curve or a change in supply (GETSTIPS).Government RegulationExpectationsTechnologySubsidiesTaxesInput (Cost Of)ProductivitySellers (number of)

Elasticity of Supply◦Measure of the way suppliers respond to a change in price

◦If supply is ELASTIC it means that changes in price will have a large impact on Quantity supplied

◦If supply is INELASTIC, it means price does little to change Quantity Supplied

What Affects Elasticity of Supply?

TimeIn the long run, firms are more flexible, so supply can become more elastic.

• In the short run, a firm cannot easily change its output level, so supply is inelastic.

Supply Elasticity vs. Demand Elasticity

If quantities are being purchased, the concept is demand elasticity

If quantities are being sold, concept is supply inelasticity

Government Influences on Supply

SubsidiesA subsidy is a government payment that supports a business or market. Subsidies cause the supply of a good to increase.

TaxesThe government can reduce the supply of some goods by placing an excise tax on them. An excise tax is a tax on the production or sale of a good.

RegulationRegulation occurs when the government steps into a market to affect the price, quantity, or quality of a good. Regulation usually raises costs.

Costs

Fixed Costs Variable Costs

Total Cost

Costs that don’t change with output

Costs that change withOutput

Ex. Wage workers, Raw materials,

electricity

Sum of fixed & Variable costs

DefinitionsMarginal Costs:Costs incurred by making one more unit

Marginal Product:Extra output made by adding one more unit of input

Theory of Production:Deals w/ relationship between Factors of Production

and output; it looks at how output changes when input changes

Law of Variable Proportions: output will change as one input is changed

Stages of ProductionStage #1 Increasing

ReturnsEach input contributes more to total output(ex. Labor)

Stage # 2 Diminishing Returns

Output increases with each input, but at a slower rate

Stage # 3 Negative Returns

Each added input makes total output decrease

Pricing & Decision Making

Pricing As Signals: The role of prices is to act as signals for buyers and sellers in the market.

Measure of ValueSignal

Flexible

Cost

Choice of g/s

Efficient

• Standard form of measure for g/s

• for excess or shortage: suppliers inc/dec production for profit; consumers inc/dec spending• can decrease price to get rid of a surplus•Can increase price to alleviate shortage problem

• no administrative cost b/c supply and demand determine price

• variety of prices for each g/s

• FOPS adjust based on demand• Easily understood (universal language)

Allocation without Prices:Rationing:

◦Government decides everyone’s fair share Ex. WWII/ OPEC 1973 Oil Embargo

Problems with Rationing◦Fairness: small shares for everyone◦Diminished incentives: no motivation to work

◦Can lead to BLACK MARKET

How Prices are Determined?

The Economic Model◦Analyzes behaviors ◦Predicts outcomes

When Quantity Demanded = Quantity Supplied, we have a market equilibrium

Surplus

When Qs>QdEffects:

◦cause Price to decrease

◦ Qd to increase

◦Qs to decrease

Shortage

Shortage◦ Qs < Qd

EFFECTS of a Shortage (how to return to Eq):

1. Increase price2. Quantity

Supplied increase

What happens when prices are fixed?

Price Ceilings◦Maximum legal price charged b/c the gov’t thinks price is too high

◦Effect: SHORTAGE◦Example: rent control

Price Floors◦Minimum legal price charged b/c the gov’t thinks it is too low

◦Effect: SURPLUS◦Example: minimum wage

$2.00

$1.00

$.50

Price Ceiling

$2.00

$1.00

$.50Price Floor