Chapters 4, 5 & 6. Demand – the desire to own something and the ability to pay for it. Law of Demand – consumers will buy more of a good when its.

UNIT 2Chapters 4, 5 & 6

Demand – the desire to own something and the ability to pay for it.

Law of Demand – consumers will buy more of a good when its price is lower and less when its price is higher

Substitution Effect – when consumers react to an increase in a good’s price by consuming less of that good and more of a substitute good

Income Effect – the change in consumption that results when a price increase causes real income to decline

Chapter 4 - Demand

Demand Schedule – a table that lists the quantity of a good a person will buy at various prices in a market

Market Demand Schedule – a table that lists the quantity of a good all consumers in a market will buy at various prices

Demand

The Demand Graph:◦ Demand Curve – a graphic representation of a

demand schedule

Demand

What two qualities make up demand?

Under the substitution effect, what will happen when the price of a good drops?

Suppose you are a small business owner. How would a market demand schedule or a market demand curve be useful to you?

Chapter 4.1 Questions

A demand curve is accurate only as long as there are no changes other than price that could affect the consumer’s decision

When other factors are allowed to change the demand curve, the curve will shift.

What causes a shift?◦ Income

Normal Goods – a good a consumer demands more of when income increases

Inferior Goods – goods that you would buy in smaller quantities, or not at all, if your income were to rise and you could afford something better

Changes in Demand

What causes a shift cont’d?◦ Consumer Expectations –

Consumers’ expectations for the future◦ Population –

When population increases certain goods & services will see increasing demand

◦ Demographics – the statistical characteristics of populations and population segments Shifts in age, race, gender, income level and so on in a

given market will change demand for goods & services◦ Consumer Tastes & Advertising

Advertising and publicity play an important role in setting many trends

Change in Demand

Changes in Demand

Prices of Related Goods:◦ Prices for some goods shift if demand for another

good changes◦ Complements – two goods that are bought and

used together◦ Substitutes – goods that are used in place of one

another

Changes in Demand

Name at least three goods that could be bought as complements to hamburgers?

List at least three goods that could be considered substitutes for movie tickets.

Does a change in the price of a good cause the demand curve to shift? Why or why not?

What kinds of changes cause shifts in the demand curve?


Elasticity of Demand – a measure of how consumers respond to price changes

Inelastic – demand that is not very sensitive to price changes

Elastic – demand that is very sensitive to a change in price

Elasticity of Demand

Calculating Elasticity:Elasticity of Demand

Price Range:◦ Elasticity of demand for a good varies at every price

level◦ Demand for a good can be highly elastic at one price and

inelastic at a different price Values of Elasticity

◦ In mathematical terms, if the elasticity of demand is less than 1 then the good is inelastic

◦ If elasticity of demand is greater than 1then the good is elastic

◦ Unitary Elastic – when elasticity of demand is exactly 1 When percent change in quantity demanded is exactly equal

to the percent change in the price


Factors Affecting Elasticity:◦ Availability of Substitutes

If there are few substitutes, then even if price rises you still probably buy a good

If there are many substitutes, then the demand for the good is probably elastic

◦ Relative Importance How much do you spend on the good If it is a big budgetary item and it increases in price significantly, can you

afford it???◦ Necessities Versus Luxuries

Consumers will typically purchase a necessity regardless of a price increase (inelastic)

Luxury goods can be cut out (elastic)◦ Change Over Time

When prices change it takes time for consumers to react, so demand may be inelastic in short-term

Once substitutes are found demand becomes elastic.


Elasticity and Revenue:◦ Computing a Firm’s Total Revenue:

Total revenue – amount of money a company receives by selling goods or services

= quantity sold x price per item◦ Total Revenue and Elastic Demand

Raises in price will result in lower total revenue


Elasticity and Revenue cont’d:◦ Total Revenue and Inelastic Demand

Price and total revenue move in the same direction Increase in price would increase Total Revenue

Elasticity and Pricing Policies◦ Companies need to know elasticity of a good to

set the price of a good


Name three factors that determine a good’s elasticity.

Suppose demand for a product is elastic at a given price. What will happen to the company’s total revenue if it raises the price of that product? Why?

How does the percentage of your budget you spend on a good affect its elasticity? Why is this the case?


Supply – the amount of goods/services available

Law of Supply – producers offer more of a good as its price increases and less as its price falls

Quantity Supplied – the amount that a supplier is willing and able to supply at a specific price

Chapter 5 - Supply

Law of Supply◦ Higher Production

If prices rise a firms total profits will increase Rise in prices will encourage a firm to increase

production◦ Market Entry

If an industry is profitable, people will want to enter the industry to make money

Supply

The Supply Schedule◦ Supply schedule – a chart that lists how much of

a good a supplier will offer at various prices◦ Market Supply Schedule – a chart that lists how

much of a good all suppliers will offer at various prices

Supply

The Supply Schedule cont’d◦ Supply Curve – a graph of the quantity supplied

of a good at various prices◦ Market Supply Curve – a graph of the quantity

supplied of a good by all suppliers at various prices

Supply

Supply and Elasticity◦ Elasticity of Supply – a measure of the way

quantity supplied reacts to a change in price◦ Elasticity of Supply & Time

Major determining factor for elasticity of supply is time

Short run – some firms cannot change supply very fast so it is Inelastic

Long run – supply becomes more elastic as suppliers have time to react to price changes

Supply

What is the difference between supply and quantity supplied?

State whether you think the supply of the following services is elastic or inelastic, and explain why:◦ A lawn-care service◦ Making movies◦ Professional baseball


Labor and Output◦ Marginal Product of Labor – the change in

output from hiring one additional unit of labor

Costs of Production

Labor and Output cont’d◦ Increasing Marginal Returns – a level of

production in which the marginal product of labor increases as the number of workers increases

◦ Diminishing Marginal Returns – a level of production at which the marginal product of labor decreases as the number of workers increases

Cost of Production

Production Costs◦ Costs are split into two categories◦ Fixed Cost – a cost that does not change, no

matter how much of a good is produced ex. Rent, property taxes, salaries of management,

depreciation on machinery/equipment◦ Variable Cost – a cost that rises or falls

depending on the quantity produced ex. Utility bills, materials for producing goods,

shipping◦ Total Cost – sum of fixed costs plus variable

costs

Cost of Production

Production Costs cont’d◦ Marginal Cost – the cost of producing one more

unit of a good

Cost of Production

Setting Output◦ Basic goal is to maximize profits at all times

Profit = total revenue – total cost◦ Best Level of output happens when:

Marginal Revenue = Marginal Cost◦ Marginal Revenue – the additional income from

selling one more unit of a good; sometimes equal to price

◦ Another look at Figure 5.5◦ Average Cost = total cost / quantity produced

Cost of Production

Setting Output◦ When a firm changes the price of a good the

marginal revenue changes.◦ The firm can then produce more:

Costs of Production

What are examples of fixed costs and variable costs for a farm?

Why would a company produce more units of a good if its marginal cost is less than its marginal revenue?

Why would a company not simply produce more and more units?


Input Costs◦ Any change in cost of an input to produce a good will

affect supply◦ If inputs become more expensive supply will decrease◦ If inputs become less expensive supply will increase◦ Effects of Rising Costs:

If an input price increases then Marginal Costs increases. Thus, a firm must produce less otherwise it will lose money

This shifts the supply curve left◦ Technology:

Can lower production costs which would decrease marginal costs and increase production

This shifts the supply curve to the right

Changes in Supply

Changes in Supply

Government’s Influence on Supply◦ Government can raise or lower cost of producing

goods◦ Subsidies – a government payment that supports

a business or market These lower the cost of production and allow higher

production Governments subsidize to protect young industries,

maintain lifestyle, and maintain a sense of national pride

Changes in Supply

Government’s Influence on Supply◦ Taxes

Excise tax – a tax on the production or sale of a good This increases marginal cost and decreases production

Can be used to discourage use of a product i.e. cigarettes, alcohol, high pollutant gas, etc.

These are built directly into the price of the item so consumers don’t realize they pay them

◦ Regulation – government intervention in a market that affects the production of a good This typically raises production costs

Changes in Supply

Other Influences on Supply◦ Changes in the Global Economy

Rising wages Import restrictions Supply increases

◦ Future Expectations of Prices If prices are expected to rise in the future, suppliers will

store goods until later causing a shortage in the short-term If prices are expected to fall, suppliers will flood the

market with goods now◦ Number of Suppliers

More suppliers = higher supply Less suppliers = lower supply

Changes in Supply

Where do Firms Produce?◦ What are the costs of transportation:

To bring inputs to the facility To ship final products to consumers

◦ Locate near specialized workforce◦ Locate in areas with tax breaks◦ Locate in areas with low energy costs

Changes in Supply

Analyze and explain the impact on the supply curve for the American-made computers from each of the following events:◦ The government places an excise tax on laptops◦ An engineer invents a way to produce desktop cases

more cheaply◦ European countries end an import quota on American-

made computers

If regulation increases price and decreases supply, why does the government issue regulations?


Combining Supply and Demand◦ Reaching Equilibrium

Chapter 6 - Prices

◦ Equilibrium – the point at which the quantity demanded equals the quantity supplied Benefits include buyers being able to find what they

want and firms having enough buyers for their goods

Combining Supply and Demand

Disequilibrium – occurs when the quantity supplied is not equal to quantity demanded

Shortage – when the quantity demanded in the market is more than the quantity supplied◦ Caused by price being below the equilibrium price

Surplus – when quantity supplied exceeds quantity demanded◦ Caused by price being above the equilibrium price

Another look at Figure 6.1



Price Ceiling – a maximum price that can be legally charged for a good or service◦ Government set the price ceiling below

equilibrium price◦ Set on some goods that are considered essential

Example is “Rent Control” in NYC Allows “more” people to afford housing


Price Floor – a minimum price, set by the government, that must be paid for a good or service◦ set to ensure sellers get rewarded for their efforts◦ Example is Minimum Wage


91’ - $4.2596’ - $4.7597’ - $5.1507’ - $5.8508’ - $6.5509’ - $7.25

Under what conditions is a market at equilibrium?

When supply exceeds demand, what happens to prices? How will the market return to equilibrium?

What action will a producer usually take when the price charged is higher than the equilibrium price? Why might the producer choose to keep the price as it is?


Changes in supply and demand upset market equilibrium and cause prices to change

Moving Toward Equilibrium◦ Over time price and supply will gradually move

toward equilibrium levels◦ Two ways to push a market in equilibrium into

disequilibrium Shift demand curve Shift supply curve

Changes in Market Equilibrium

Increase in Supply◦ This changes equilibrium price which will change

quantity sold◦ Ex. Digital Cameras



Decrease in Supply◦ Results in a rise in price and falling demand

Increase in Demand◦ Fad – a product that enjoys enormous popularity

for a fairly short time◦ Causes a shortage which will result in increased

price and increased supply◦ Search Costs – the financial and opportunity

costs that consumers pay in searching for a product or service


Decrease in Demand◦ Surplus of products results in lowering prices and

decreasing supply


Why is equilibrium described as a “moving target”?

What does a rapid increase in demand for a good mean for a consumer?

What are some signs of a shortage in a market? What signs indicate that a market has a surplus?


Prices in a Free Market◦ A tool for distributing goods and resources in the economy◦ Nearly always the most efficient way to allocate, or

distribute, resources Advantages of prices

◦ Provide a common language for buyers and sellers◦ Price as an Incentive

Higher prices will cause current firms to produce more and new firms to enter the market

◦ Price as Signals High price signals a good is in demand to suppliers Low price signals a good is oversupplied to suppliers Low price signals consumer to purchase more of a product High price signals consumer to be careful and think twice

The Role of Prices

◦ Flexibility Price can change as needed Supply Shock – a sudden shortage of a good, such

as gasoline or wheat How do you decide who gets what’s left??? Rationing – a system of allocating goods and services

using criteria other than price Raising price is quickest way to resolve a shortage

◦ Price System is “Free” Costs nothing to administer a free flowing price Pricing distributes goods through millions of

decisions made on a daily basis by consumers and suppliers

The Role of Prices

Choice and efficiency◦ Consumers have a variety of goods and services to

choose from◦ Price allows consumers to narrow choices◦ Rationing and Shortages such as those done in USSR

are expensive and inconvenient and leaves consumers unhappy This can lead to Black Markets Black Market – when people conduct business without

regard for government controls on price or quantity◦ Prices allow efficient resource allocation and ensure

resources will be used for their most valuable purposes

The Role of Prices

Prices and the Profit Incentive

The Role of Prices

The “Wealth of Nations”◦ Written by Adam Smith in 1776◦ Business prosper by finding out what people want

and then providing it. Market Problems

◦ Imperfect Competition – monopolies, oligopolies◦ Negative Externalities – pollution◦ Imperfect Information – need to make informed

decisions to do what is best

The Role of Prices

How does supply shock affect equilibrium price?

What does a higher price for a good tell a producer?

What is the quickest way to solve a shortage?

What is the quickest way to eliminate a surplus?


Chapters 4, 5 & 6. Demand – the desire to own something and the ability to pay for it. Law of Demand – consumers will buy more of a good when its.

Documents

elasticity of demand

demand schedule slide

price slide

price level demand

demand graph

demand demographics

goods price

market demand curve