Prices Theory of Production What are the Factors of Production? Theory deals with the Factors of Production and the output of goods and services. Law.

Prices

Theory of Production

• What are the Factors of Production?• Theory deals with the Factors of Production and the

output of goods and services.• Law of Variable proportions: in the short run, output

will change as one input(Factors or Production) is varied, while the others are held constant– EX: you know that a little bit of salt will make the food

taste better. A bit more may make it tastier still, but too much can ruin the taste. As the amount fo the input(salt) varies, so does the output(quality of the meal).

The Production Functions• Illustrated with a schedule and graph: Only workers

was changed, no other input. 3stages of production– Increasing returns– Diminishing returns– Negative returnsFigure 5.5a

Figure 5.5b

Measures of Cost• Fixed Cost: Give some examples • Variable Cost: Give some examples• Fixed cost + Variable cost = Total Cost• Marginal Cost: Extra cost when producing more

then 1 itemFigure 5.6

S

Qo

$5

$4

$3

$2

$1

10 20 30 40 50 60 70 80

$54321

60503520 5

P QS

Price of Corn

Quantity of Corn

CORN

Combiningwith

Demand

Balancing a Market

• What is Equilibrium?

• Chart and graph

Figure 6.1a

Figure 6.1b

MARKET DEMAND & SUPPLY

7

S

Qo

$5

4

$3

2

1

2 4 6 8 10 12 14 16

PQD

$5$4$3$2$1

2,0004,0007,000

11,00016,000

$5$4$3$2$1

12,00010,0007,0004,0001,000

D

P QS

Price of Corn

Quantity of Corn

CORN

MARKET

CORN

MARKET

Market Clearing Equilibrium

Balancing a Market• What is Disequilibrium?

-Excess Demand(Shortage) -Excess Supply (Surplus)Figure 6.2aFigure 6.2b

Government Intervention

• Price Ceiling– Rent control

• Price Floors– Minimum

wage

Figure 6.5a

Figure 6.5b

Equilibrium Changes

• Figure 6.4

[D – “TIMER”; QD – price change of product (inverse)]

___1. Which of the following will cause an "Increase in Demand" for computers? a. decrease in price of computers b. decrease in income c. increase in income d. increase in price of computers

___2. Which of the following will cause an "Increase in QD" for computers? a. decrease in price of computers b. decrease in income c. increase in income d. increase in price of computers

___3. Which of the following will cause a "Decrease in Demand" for plasma TVs? a. increase in price of plasma TVs b. decrease in price of plasma TVs c. decrease in # of consum ers(marketsize)

___4. Which of the following will cause a "Decrease in QD" for plasma TVs? a. increase in price of plasma TVs b. decrease in price of plasma TVs c. decrease in # of consumers (market size)

[S – “RATNEST”; QS – price change of product (direct)] ___5. Which of the following will cause an "Increase in Supply" for DVDs?

a. decrease in price of DVDs c. decrease in resource cost b. increase in price of DVDs d. expectations of price increase

___6. Which of the following will cause an "Increase in QS" for DVDs? a. decrease in price of DVDs c. decrease in resource price

b. increase in pric e of DVDs d. expectations of price increase

___7. Which of the following will cause a "Decrease in Supply" for DVDs? a. increase in price of DVDs c. subsidies to suppliers of DVDs

b. decrease in price of DVDs d. expectations of price increase

___8. Which of the following will cause a "Decrease in QS" for digital cameras? a. increase in price of cameras c. subsidies to suppliers of cameras b. decrease in price of cameras d. expectations of digital camera price increase

C

A

C

A

C

B

D

B

c. decrease in # of consumers

Making Predictions• Suppose that your state wanted to make health care more affordable for

everyone. To do this, state legislators put a series of price controls–price ceilings–in place that cut the cost of medical services in half. What would happen to the demand for medical services at the new, lower price? What would happen to the supply of medical services that doctors would be willing to provide at the new, lower price? Where do you think new doctors would prefer to set up practice? Explain the reasons for your answers.

• Because demand for medical services tends to be inelastic, the quantity demanded will increase only moderately. Because prices for services would be set below market level, there would be less incentive for doctors to offer services. Quantity supplied would probably decrease. New doctors might want to set up practice in states where there were no price ceilings.

D0 Prices Work in a Free Market?Advantages of Prices

FreeFlexibleWide choice of Goods

Competition

Efficient Resource AllocationWhich one is better at this? Free or

Command Markets. Which one works better?

America during the Depression

Russia under Communism

• Chapter Worksheet: Supply and Demand