Chapter 3 Supply and Demand Additional – Circular Flow Model.

Chapter 3 Supply and Demand

Additional – Circular Flow Model

What Determines a Person’s Income in the Market?

This means… what is the value of the human being?Determined by:

a) value of their product…. Rock singer, athlete, Shaq, Oprah, department store clerk, insurance salesman, teacherb) supply and demand…. If lot of people doing same things you are… not likely to be paid much.(underwater welders)……. As demand for product decreases, reduces number of available jobs… gas station jobs!c) if demand for product lacking- rewards minimal and number of competing workers is few, demand high, wages high. 20 years ago… heart surgeons

Who Determines the value of a product?

The value of the product is the worth that society puts on it….

What worth does society put on sports?

What worth does society put on music industry?

What worth does society put on sport cars, SUVs, large houses, motorcycles, eating out, designer clothes, entertainment. Etc, etc. etc. Education?

WORKING MODEL OF THE ECOMONYWORKING MODEL OF THE ECOMONY

Product Market

Receive Goods & Services

Payments for Goods & Services

BUSINESS HOME

Land,Labour, Capital, Entrepreneurs

Rent, Wages, Interest, Profit

Leakage

Injection

Savings Taxes

Investment

Banks

Leakage S + T = I + G InjectionS+T > I+G = RecessionI+G > S+T = Inflation

Factor Market

International Participants

International Participants

Government

Circular Flow Explanation

Flow of resources in the market shows how the market works…

In market system, voluntary exchanges continually take place in circular flow model

System works that what is an expense to one is ultimately an income to the other

Two Leakages Explained

Savings and Taxes Savings does not help unless it is

invested back into the flow (economy). Financial intermediaries: why are they

called this? (because they take savings of one group and

make it available to another to borrow or invest) Financial Intermediaries are: banks, savings & loan,

credit unions, stock market, insurance companies.

If savings is greater than investment..business expenses mount.*****

Taxes are also a leakage.

Government injects tax dollars back into the economy (flow) by spending the money that taxes take out.

What expenditures does government make into the flow?

****Money spent on redistribution of income or transfer payments is not “productive into the flow.” Why?**This is where a lot of the controversy occurs about stimulus package.

S + T greater than I + G = recession

G + I greater than S + T = inflation

Supply-siders favor strong IDemand-siders (Keynesian

economy) favor strong G *** this is where we are now for most of populous thinking

What if???

Banks will not loan money?People lose their jobs?Companies are not hiring?People are under-employed?Consumption decreases significantly?

Characteristics of Recession/InflationRecession:

Businesses not selling what it producesInventories accumulateBusinesses then cut down on employment

(hence unemployment/layoffs)Inflation:_____________________________Government and investors spending moreInventories begin to be depletedPrices increaseProduction increasesMore workers are hired

What is a Market?Any Place Where Goods and Services are

Voluntarily Exchanged (brings together buyers and sellers)Price is a primary influence in determining

allocation of resources in our free enterprise economy.

Difference between Price, Value, UtilityPrice= value of product in terms of

moneyValue= has to do with relative scarcity

= exchange valueUtility = satisfaction that good or

service can provide

Law of Supply

As the price of the product increases, the quantity that the supplier tends to supply also increases.

****Ceteris Paribus Ceteris Paribus Assumption[KAY-ter-us PEAR-uh-bus]

Nothing changes except the factor or factors being studied.

Other things “constant” “equal”

Economics as a Science (cont'd)

Ceteris Paribus Assumption[KAY-ter-us PEAR-uh-bus]

Nothing changes except the factor or factors being studied.

“Other things constant”

“Other things equal”

Law of supply

= positive relationship between the quantity of a good supplied and price.

PRICE IS THE INDEPENDENT VARIABLE

Determinants of Supply

1. Technique of production (technology)(ovens, organic farming)

2. Resource Prices (Factor Costs)– cost of inputs

3. Taxes and Subsidies4. Prices of Other Goods – (decline in wheat

will cause farmer to shift to corn)5. Expectations- (farmers expect price to

rise.. Hold back production)6. Number of sellers in market – more

sellers, greater supply….

Important Concepts

Change in Supply (shifting of curve)OrChange in Quantity Supplied (movement

along curve)

Ability to Respond to Price varies

Often the ability of an individual firm to respond to an increase in price is limited or constrained by its existing scale of operations, or capacity, or ability to obtain resources….. IN SHORT RUNIN SHORT RUN

Examples:IN LONG RUNIN LONG RUN… can adjust. The greater the

amount of time producers have to adjust, the greater their output response.

Law of Demand

AS THE PRICE OF A GOOD DECREASES THE QUANTITY DEMANDED TENDS TO INCREASE….

***Ceteris ParibusPrice once again is the independent

variable!

Wishing for a new boat does not constitute demand… one must be WILLING AND ABLE to purchase a boat.

Generally speaking…. The higher the price obstacle, the less of a product a consumers will buy.

Bargain days are based on law of demand.Two prices- Absolute and Relative.

Absolute = price in $ termsRelative = price in terms of another good.Price of a car relative to an airplane.

The greater the want satisfaction…. The greater the utility…

Marginal Utility… How much more utility do you get adding or subtracting units (more doughnuts… more cars… more steak in one day)

DIMINISHING MARGINAL UTILITY.As the number of units of a

product a consumer has increases, the satisfying power for each extra unit decreases.

Utility

Purpose of Utility analysis is to study how people behave not how they think.

Theory of consumer choice is based on the idea that each consumer spends his/her income in a way that yields the greatest satisfaction.

Determinants of Demand

1.Preferences2.Prices of Related Goods 3.Number of Buyers4.Expectations of future price5.Income

Determinants of Demand

1. Tastes and preferencesTaste changes throughout our lifetime.

# 2 Determinant: Prices of Related Goods

Your preference is Coke… price skyrockets….

Affected in the market by substitute goods and complimentary goods.*Substitute goods… anything that can be substituted for the product or service desired…

(Coke/Pepsi, Millers/Coors, potato chips/popcorn). If price of Coke rises… and consumer doesn’t feel

strongly about brand preference… will buy Pepsi until Coke price declines)

When two products are substitutes, the price of one good and the demand for the other are DIRECTLY RELATED.

*Complementary Goods… Goods that “go along with other goods consumer’s buy”peanut butter/jelly, beer/pretzels, milk/cookies, golf balls/golf tees,

When two goods are complements, an increase in the price of one good adversely affects the demand for the other and creates an inverse relationship.

Independent Goods… No connection between price and demand (cars/bread)

Determinants Continued

3. Number of buyersThe number of buyers will increase demand for the product which (if supply is fixed) will drive up the price.)

Determinant #4

Income- RATHER OBVIOUS HERE.Show shifts…

Superior or Normal goods= commodities whose demand varies DIRECTLY with money income.

INFERIOR OR “POOR MAN’S” GOODS.

Goods whose demand varies inversely with a change in money income.

5. Expectations…

If you are in medical school or law school, the expectation of you getting a larger income when you get out of school will affect your demand for goods… Inheriting money, winning the lottery!

IMPORTANT CONCEPTS OF DEMAND

Change in Demand ORChange in Quantity Demanded

Terms to RememberProfit:

TR-TCTotal Revenue

P x QMarginal Utility

To maximize utility, consumers should choose that good which delivers the most marginal utility per dollar. Optimal utility is then achieved.

Optimal consumption= mix of output that maximizes total utility for the limited amount of income you have to spend.

Equilibrium

Equilibrium = market clearing price… supply and demand are “in balance.”

Does not occur often if ever with the constantly changing “invisible hand” and the consumer fickleness.

In our U.S. economy we have consumer sovereignty… which tends to shift both curves or move along the curve almost continuously.

Ceilings and Floors

Price Ceiling- a legally established maximum price

that sellers may charge (rent control)

Direct effect of a price ceiling is a shortage

Secondary effect- reduction in the quality of the good, inefficient use, lower future supply, black markets,

Price Floors Price floor is a legally established

minimum price that buyers must pay. (minimum wage)

Direct effect= reduces employment of low-skilled labor

Indirect effects – reduction in nonwage component of compensation (perks), lesson-the-job training.

Recap Ceilings and Floors

Q

S

D

P

Q

S

D

P

Black Markets

Markets that operate outside the legal system

Have a higher incidence of defective products, higher profit rates, greater violence (cigarettes, drugs {both prescription and illegal}, Levis during cold war)

Equilibrium Tutorial

Equilibrium

Supply and Demand for Cowboy Tickets

http://www.tickco.com/schedule/dallas-cowboys/

http://www.tickco.com/schedule/new-england-patriots

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Kiley is my best friend… SheSupplies a lot of love!