T HE U NITED S TATES M ARKET S YSTEM Consumers and the Law of Demand; Firms and the Law of Supply, Market Equilibrium, and Market Structure.

THE UNITED STATES MARKET SYSTEMConsumers and the Law of Demand; Firms and the Law of Supply, Market Equilibrium, and Market Structure

LAW OF DEMANDDemand: How much of a product consumers are both willing and able to purchase at each possible price during a given period

Law of Demand: the quantity demanded varies inversely with the price

Individual Demand = demand of an individual consumer

Market Demand = total demand of all individual consumers in a market

LAW OF DEMANDConsumers try to maximize their utility, this affects demand: (unlimited wants, scarce resources)1. Money Income v. Real Income - Use your money

income to maximize real income2. Substitution Effect: Change in prices of related

goods can effect the demand3. Law of Diminishing Marginal Utility: (Marginal

Utility: satisfaction you derive from an additional unit of a product)- The more of a good an individual consumes per period the smaller the marginal utility of each unit consumed (since each unit is worth less to you, you are therefore willing to pay less for it)

- first slice, second slice, third slice of pizza

- second ½ off, Buy 3 get the 4th freeAll of this results in the quantity demanded varying inversely with the price

DEMAND SCHEDULE AND CURVEShows the relationship between price and quantity demanded for a given period

Demand SchedulePrice of Root Beer Amount John would buy per month

.10 25

.20 20

.30 15

.40 10

.50 5

Demand Curve

MARKET DEMANDGraph the demand curve of lbs. of beef per week of the following members of the Social Studies Department:

Mr. Foley Ms. Hart Mr. Rupertus

Lbs. Price Lbs. Price Lbs. Price

1 $8 0 $8 0 $8

2 $6 0 $6 1 $6

3 $4 1 $4 2 $4

4 $2 2 $2 3 $2

Market

Demand

of Beef

Graph both the individual demands and market demands for Aquinas’ students demand of birthday balloons per school year.

Student A# of Balloons Price 30 $1 25 $1.50 20 $2 15 $2.50 10 $3 5 $3.50 0 $4

Student B# of Balloons Price 40 $1 35 $1.50 30 $2 25 $2.50 20 $3 15 $3.50 10 $4

Student C# of Balloons Price 15 $1 10 $1.50 5 $2 1 $2.50 0 $3 0 $3.50 0 $4

Student D# of Balloons Price 25 $1 20 $1.50 15 $2 10 $2.50 5 $3 1 $3.50 0 $4

Graph both the individual demands and market demand for gallons of gas per week.

Individual A# of Gallons Price 20 $2 17 $2.50 14 $3 11 $3.50 8 $4 5 $4.50 2 $5

Individual B# of Gallons Price 12 $2 10 $2.50 8 $3 6 $3.50 4 $4 2 $4.50 0 $5Individual C

# of Gallons Price 30 $2 26 $2.50 22 $3 18 $3.50 16 $4 12 $4.50 8 $5

PRICE ELASTICITY OF DEMAND

• Measures the percentage change in quantity demanded divided by the percentage change in price•Based on the idea that when prices drop, quantity sold will increase and vice versa•Used by suppliers to determine if it is profitable to change prices•If the demand is elastic (above 1.0) that means that it will be beneficial to change the price because overall revenue increase•If the demand is inelastic (below 1.0) suppliers should not change the price because revenue will fall

ELASTICITY OF DEMAND

8 14 20 26 32$0

$2

$4

$6

$8

$10

$12

$14

$16 15

12

9

6

3

Demand

Demand

Is the demand elastic if the price changes from $12 to $9?Is the demand elastic if the price changes from $6 to $3?

ELASTICITY OF DEMAND

4 8 12 16 20 24 28$0

$5

$10

$15

$20

$25

$30

$35 $32

$28 $24

$20 $16

$12 $8

Demand

Demand

Is the demand elastic if the price changes from $28 to $24?Is the demand elastic if the price changes from $16 to $12?

11 16 21 26 31 36$0

$5

$10

$15

$20

$25

$30

$35

$40

$35

$30

$25

$20

$15

$10

Demand

Is the demand elastic if the price changes from $30 to $25?Is the demand elastic if the price changes from $20 to $15?

ELASTICITY OF DEMANDElasticity can depend on:1. The availability of substitutes - more

competition=more elastic – Dollar Menus

2. The cost of the item – the greater portion of a person’s income the object is the more elastic – When housing prices drop, demand increases dramatically

3. How long the price change lasts – elasticity is greater in the long run than in the short run – consumers have more time to adjust

LAW OF SUPPLYLaw of Supply: the quantity supplied is usually directly related to the price (The higher the price, the larger quantity supplied)

Supply Curve: Quantities of a particular good supplied at various prices during a given time period (all other things constant)

Individual Supply v. Market Supply

LAW OF SUPPLYProducers try to maximize profits (Profit= Total Revenue – Total Cost), in order to do so, they control the supplyTotal Cost = Fixed Costs + Variable Costs

Fixed Cost = Costs that don’t change regardless of output

Variable Costs = Cost that increase with production

Supply = How much a good producers are willing and able to offer for sale per period at each possible price

Firms will increase their supply as long as their marginal revenue for each unit sold is more than the marginal cost is takes to produce

Marginal Revenue = market value of the unitMarginal Cost = Change in Total Cost/ Change in Quantity

Once you have completed the worksheet on costs, answer the following questions.

1. If the average costs are decreasing how do you explain the trend in marginal costs? 2. Would the average costs continue decreasing indefinitely?  3. How does this information on costs help explain the law of supply? 

SUPPLY SCHEDULE AND CURVE

Graph the supply curve for each of the following t-shirt companies. Then graph the market supply curve.

Tom’s Terrific T’sQuantity Price 50 $5 60 $6 70 $7 80 $8 90 $9

Tee-rrifficQuantity Price 30 $5 40 $6 50 $7 60 $8 70 $9

Tee-TimeQuantity Price 60 $5 70 $6 80 $7 90 $8 100 $9

ELASTICITY OF SUPPLY- The Percentage change in quantity supplied divided by the percentage change in price- Used to determine whether a company will respond to an increase in price by increasing supply - Companies want to supply more at higher prices – but will consumers buy more?- If the supply is elastic (above 1.0), producers are willing to raise production because it will increase total profits- If the supply is inelastic (below 1.0), producers will not raise production because a change in supply will not increase profits

ELASTICITY OF SUPPLY

3 6 9 12 15 18 21$0

$5

$10

$15

$20

$25

$30

$35

$8 $12

$16 $20

$24 $28

$32

Supply

Supply

Is the supply elastic if the price changes from $24 to $28?Is the supply elastic if the price changes from $12 to $16?

MARKET EQUILIBRIUMConsumers and Producers therefore work opposite one another (i.e. – if the price goes up, consumer demand decreases but producer supply increases ) Market forces resolve this conflict by working towards equilibrium

Market Equilibrium =

The quantity that consumers are willing and able to buy equals the quantity that producers are willing and able to sell at a given price - there is no incentive for a change in quantity or price

In order to reach equilibrium:-If there is a surplus (at a given price, the amount supplied exceeds the quantity demanded) prices are forced down-If there is a shortage (at a given price, the quantity demanded exceeds the amount supplied) prices go up

EQUILIBRIUM PRICEDemand Curves and Supply Curves meet at an equilibrium point which leads to an equilibrium price and quantity

Adam Smith’s Invisible Hand: millions of individuals and firms acting individually eventually promote the common good by encouraging producers to use resources for the products consumers most value – although in competition, both producers and consumers can win in a market

EQUILIBRIUM PRICEGraph the supply and demand curve using the information below.

Quantity Demanded Price Quantity Supplied

50 .10 10

40 .20 20

30 .30 30

20 .40 40

10 .50 50

What is the equilibrium price?

What is the equilibrium quantity?

Why can’t the supplier demand $.50?

Why can’t the buyer pay only $.10?

Graph the supply and demand curve using the information below.

Quantity Demanded Price Quantity Supplied

180 $5 30

150 $10 60

120 $15 90

90 $20 120

60 $25 150

30 $30 180

What is the equilibrium price?

What is the equilibrium quantity?

EQUILIBRIUM PRICE

SHIFTS IN DEMAND CURVEWhen there are shifts in supply and demand, adjustments need to be made in the market in order to reach a new equilibrium point

If the demand increases (demand curve shifts rightwards) – a shortage is created and producers raise prices and quantities

If the demand decreases (leftwards)– a surplus is created and prices and producers reduce prices and quantities

SHIFTS IN DEMAND

Besides Price and Quantity, Demand is affected by:1. Changes in consumer income – i.e. if

income increases - increases demand for normal goods and decreases demand for inferior goods

2. Changes in the price of related goods – - If the price of substitutes drops, demand

drops- If the price of complements drop the

demand increases and vice versa3. Changes in the size or composition of

the population4. Changes in consumer expectations

about future income and future prices5. Changes in consumer tastes

SHIFTS IN SUPPLY CURVE

If the supply increases (supply curve shifts rightwards) - quantities increase causing a surplus, producers will reduce prices

If the supply decreases (leftwards) – quantities decrease causing a shortage, producers will increase prices

SHIFTS IN SUPPLY

Besides the price, supply is affected by:1. The cost of the resources used to make

the good (if the cost of resources drops, supply increases)

2. The price of other goods these resources can make

3. Changes in the technology used to make the good – if technology improves production, supply can be increased

4. Producer expectation about future shifts in prices

5. The number of sellers in the market

MARKET STRUCTUREMarket structure includes the number of buyers and sellers, the uniformity of the item, the ease of entry into the market and the amount of competition between firmsHow much of a role the laws of supply and demand have over a specific market depends largely on the structure of the marketFour market structures exist in the United States:1. Perfect Competition2. Monopoly3. Monopolistic (Imperfect) Competition4. OligopolyIn order to encourage a competitive market,

the US government has antitrust laws

MARKET STRUCTURENumber of Buyers and Sellers

Uniformity of Product

Ease of entry into Market

Control over prices and supply

Examples in the United States

Perfect Competition

Many buyers and sellers

Complete uniformity

No barriers to entry

No control- 1 firm tiny part of market

Farmers – Bushel of Wheat

Monopoly One seller, many buyers

Unique product, no substitutes

Large barriers to entry- legal + financial

Complete control

Electric Company, Post Office

Monopolistic(Imperfect) Competition

Many buyers and sellers

Some differentiation in products

No barriers to entry

Limited Control – Market Forces

Grocery Stores, Restaurants, Clothing

Oligopoly Few sellers, many buyers

Some differentiation in products

Substantial barriers to entry

Some Control

Automobiles, Electronics