How does supply and demand impact prices? Supply & Demand 1.3.

How does supply and demand impact prices?

Supply & Demand 1.3

Essential Questions• 1. What are the different types of costs a business must cope with?

• 2. What are is marginal and total revenue?

• 3. How does a cost benefit analysis help a business make production decisions (law of diminishing returns?

• 4. What is meant by supply and demand?

• 5. How to create a supply and demand schedule?

• 6. How to create a “demand”/ “supply (the curve)?

• 7. What is the equilibrium price and quantity?

• 8. How to find the “market clearing price” or “equilibrium price and quantity?”

• 9. What is meant by supply/ demand elasticity?

• 10. What occurrences will move supply curves and demand curves (e.g. An improvement in technology will cause an industry’s supply curve to slide to the right. Advertisement for a product will cause the demand curve to slide to the right, supplements, compliments)?

Getting the Idea• Costs are the price of inputs that go into production.

o Fixed Cost

o Variable Cost

o Total Cost

o Marginal Cost

• Competition forces producers to offer the lowest prices while still making a profit.

o To accomplish this they most lower costs in order to lower price without sacrificing profit

• Possible Revenues are used to estimate profits and different prices

o Marginal Revenue

o Total Revenue

• Cost Benefit Analysis is used to determine when to stop production

o Law of Diminishing returns states that eventually amount of revenue decreases after certain production numbers

Getting the Idea• Costs are the price of inputs that go into production.

o Fixed Cost

o Variable Cost

o Total Cost

o Marginal Cost

• Competition forces producers to offer the lowest prices while still making a profit.

o To accomplish this they most lower costs in order to lower price without sacrificing profit

• Possible Revenues are used to estimate profits and different prices

• The fundamental ideas behind economics are:o The law of demando The law of supply

• Before a producer can determine a possible price and supply quantity they must determine:

• Costs

• Possible Revenue

• Cost Benefit Analysis

• The law of demand:o States that when the price of a product goes up consumer demand for the

product falls

• The law of supply:

• States that when the price of the product goes up, the quantity of the product goes up

Getting the Idea

Getting the Idea

• The two are combined in the law of supply & demando States that the price for a product

will keep changing until supply & demand are equal

• Equilibrium Priceo The price where supply & demand

are equalo Also called the market price

because it is the price determined by the market

Getting the Idea

Types of Business Costs• Fixed costs: business costs that do not

depend on the level of productiono Example: Rent

• Variable costs: depend on a firm’s level of productiono Example: Overtime pay

• Total costs: combination of fixed & variable costs into the overall cost of operating at a particular rate of production

Types of Business Costs• Marginal Costs

o Measure the balance of costs & benefits from the decision to produce an additional unit of good or service

• Marginal Cost of the Additional Unito Cost of the additional factors of production needed

to produce the unito Example: Auto Manufacturer wants to make an

additional truck Marginal cost refers to: materials, labor, building costs

that went in to making it Company stops increasing production when marginal

costs lower profits

Revenue • Price: the producer must determine the willingness

of consumers, or the demand, the total and marginal costs of the product, and the desired profit in determining the price.

• Once a projected price is determine the producer can estimate revenue in order to determine the profit.

• Total Revenue is the amount of money a business takes in from selling a good or service; price*amount sold=total revenue

• Marginal revenue is the additional revenue from selling one more unit

• Profit is then determine by subtracting total revenue from total costs

Creating a Cost Benefit Analysis• Before creating a cost benefit analysis, you must find all of

your costs.

• Lets suppose we are making shirts

• We are making them in units of 10

• Our fixed costs are 5 dollars

• Variable cost increases by five for every 10 units produced.

• Total cost is variable times fixed

• Marginal is TC2-TC1

• We need to find average marginal cost in order to plot it.

• To do that we use the following formula

• MC2-MC1/U2-U1=AMC

• Plug it in

• 600-500/50-40=100/10=10

• 500-400/40-30=100/10=10

• So the average marginal cost is 10

• Your AMC should appear as a straight line

Units Fixed Cost

Variable Cost

Total Cost

Margin-al Cost

10 5 20 205 300

20 5 25 505 400

30 5 30 905 500

40 5 35 1405 600

50 5 40 2005 -----

Creating a Cost Benefit Analysis: Marginal Revenue

• To create a cost benefit analysis, you must now find marginal revenue

• Again you need to make a table

• Lets suppose we price are shirts at 35 dollars (yea they’re designer shirts)

• Due to law of demand the higher the price the lower the demand, so as demand goes up price goes down

• We need to find the Marginal Revenue:

o TR=Total Revenue

o U=Units demanded

o Formula

TR2-TR1/U2-U1=MR

• Plug it in

750-800/50-40=-50/10=-5

800-750/40-30=50/10=5

750-600/30-20=150/10=15

600-350/20-10=250/10

When you plot it, it will start high and go down

UnitsDemanded

Price Total Reven-ue

Change in Rene-nue

Marginal Revenue

10 35 350 250 25

20 30 600 150 15

30 25 750 50 5

40 20 800 -50 -5

50 15 750 ____

Cost Benefit Analysis: the chart

• Plot both on a line graph.o Bring line graph into class

• What does it tell you?

Supply

• A chart that shows the quantity of a product at a particular price is a supply schedule

• When each of these points is graphed and then connected by a curve, the diagram show the supply curve for the producto The curve is just a picture of the

information in the schedule (the prices of different quantities of supply)

Supply Schedule

• Many changes in the economy can change the equilibrium price & influence supply

• Any product can have a compliment:o A product that goes with another producto Example: sugar in iced tea, jelly & peanut

butter

• When the price of a complimentary good goes up demand for the compliment goes downo Example: if sugar is more expensive people

will buy less tea

Complimentary Goods

• By demanding less iced tea, people may demand more of some other drink such as lemonade

• The other drink is a substitute product for iced tea

• If the price of the substitute product goes down and the price of ice tea does not change, then demand for the substitute will go up and demand for iced tea will go down

Substitute Goods

• Supply-side economics is a recent, controversial economic school of thought

• It says that government should cut taxes on business to increase productivity

• Critics:o Claim that needed government services

would be cut under this approach

• Defenders:o Claim that increased productivity

increases jobs

Supply-side Economics

• According to its defenders, supply-side economics has a trickle-down effect

• Big business would get tax cuts & government programs might be cut, but the increased money for business investment will get to the people through jobs

Trickle-down Effect

Demand

• A chart that shows the quantity of a product demanded at a particular price is a demand schedule

• When each of these points is graphed at then connected by a curve the diagram shows the demand curve for the producto The curve is just a picture of the

information in the scheduleo The quantity demanded at different

prices of a product

Demand Schedule

• Many changes in households have influences on demand

• The household’s demand is limited by its personal income

• Before buying other goods & services, personal income must first pay for necessities of life

Personal Income

• The amount of income left after paying for necessities

• Disposable income is the amount of money available for savings, entertainment, and more expensive products

• Example: bread is a necessity but cinnamon raisin bread is more expensive bread that requires disposable income because it is more than just bread and costs more

Disposable Income

Influences on Prices

• Market activities can change prices

• The market activities that change prices are changes in consumer demand

• Consumer demand changes because the things consumers want change

• This change is a change in consumer tasteso Example: low-carb foods were expensive when they first

came to market. Now, many low-carb products are sold at low prices because consumer tastes for low-carb products have decreased

Consumer Tastes

• The decrease in demand for l0w-carb foods has created a surplus (excess supply) because consumers did not want to buy all of the products available at the price the producers wanted for them

• When gasoline prices went up, people wanted cars that got higher gas mileageo The demand for high-mileage cars was greater than the supplyo The resulting shortage of high-mileage cars caused the prices of

high-mileage cars to go upo These changes all affect the demand or supply schedule

Surplus

• Government actions can change prices and wages with wage and price controls

• Example: government sets minimum wages that firms pay to workers for labor & interest rates that firms pay to households for capitalo The minimum wage is the lowest wage that can be paid according

to lawo Wages can be and often are highero When the minimum wage goes up households have more money

to spend on products however firms must charge higher prices for their goods so that they can pay their workers higher wages.

Wage & Price Controls

• Inflation: Occurs when prices go up (become inflated) but no real change in supply or demand has happenedo Is bad because wages do not rise with

prices

• Deflation: Occurs when prices fall without a change in supply or demando Is bad because profits to businesses go

down so much they may lay off workerso They also lack capital to invest for

economic growth

Inflation & Deflation