Unit 2 Review

Unit 2 Review

Chapter 3, 4, 5, and 6

Demand

Demand/Quantity is the amount of a good or service that a consumer is willing AND able to buy at various possible prices during a given time period Consumers must not only want the product, but have

means to pay for it Factors that change over time can affect demand for a

product

Law of Demand

An increase in a good or service’s price will cause a decrease in demand, and vice versa. In a free-enterprise system, price is the main variable

affecting demand Consumers will be less willing and/or able to buy

goods at higher prices in most cases.

3 factors Affecting Demand

1. Income effect = a change in price affects consumers’ purchasing power the amount of $ available to spend on g/s. Increased price = less purchasing power = decreased

demand

Factors Affecting Demand (Con’t)

2. Substitution effect = tendency of consumers to substitute similar, lower priced items for relatively higher priced ones Price increase in Mountain Dew will lead many to

switch to Moon Mist demand for Mountain Dew will decrease.

Milk may be substituted for Orange Juice if the price of OJ suddenly increases demand for OJ will decrease

Demand CurveShows a graphic

representation of the quantity demanded and the price of a g/s during a given time period Price is always

listed on the vertical axis

Quantity demanded is always listed on the horizontal axis

Note: As price increases, quantity demanded decreases downward slope

Determinants of Demand

Factors that cause a shift of the entire demand curve – a different quantity demanded at each and every price:

A shift to the right represents an increase in quantity demanded at each price

A shift to the left represents a decrease in the quantity demanded at each price

Determinants of Demand

Consumer tastes/preferences fashion and music tastes are most susceptible

Ex???

Determinants of Demand (Cont”)

2. Market Size an increase or decrease in the number of consumers in a market can have the same effect on some demand curves.

3. Income/Consumer expectations of income an increase in income will make consumers more willing and able to buy g/s at every price – shift to the right. --less income results in less quantity demanded at each price- shift to the left --If consumers are expecting an increase or decrease in income, that can have the same effects on the demand curve.

Determinants of Demand (Con’t)

Price of related goods: Substitute Goods:

If the price of hamburger increased, the demand for hamburgers would decrease. More people would then buy substitutes, such as hot dogs. The demand curve for hot dogs would shift to the right.

Determinants of Demand (Con’t)

Price of Related Goods (Con’t): Complementary Goods:

Ex: peanut butter and jelly, toothbrush and toothpaste, shampoo and conditioner, hot dogs and buns

If the price of hamburger decreased, people would buy more hamburger and thus, more hamburger buns.

Elasticity of DemandElastic demand = a

small change in price results in major change in quantity demanded: not a necessity have readily

available substitutes

cost represents large portion of consumer’s income.

Ex: art, designer clothes, eating out

Note: The curve is almost horizontal small price change = large demand change

Elasticity of Demand (Con’t)Inelastic Demand = when a price change has little or no effect on quantity demanded Necessity Few or no substitutes Small portion of

consumer’s incomeEX: gasoline, salt,

electricity

Note: The curve is vertical or near vertical price has little or no effect on demand

Elasticity of DemandElastic demand = a

small change in price results in major change in quantity demanded: not a necessity have readily

available substitutes

cost represents large portion of consumer’s income.

Ex: art, designer clothes, eating out

Note: The curve is almost horizontal small price change = large demand change

Elasticity of Demand (Con’t)Inelastic Demand = when a price change has little or no effect on quantity demanded Necessity Few or no substitutes Small portion of

consumer’s incomeEX: gasoline, salt,

electricity

Note: The curve is vertical or near vertical price has little or no effect on demand

Law of Supply

Quantity Supplied is the amount of goods and services that producers are willing to sell at each price in a given time period.

Law of supply states that producers supply more goods and services when they can sell them at a higher price and fewer goods when they must sell them at lower prices

Primary motive is profit = price – production costs Profit motive directs use of resources and signals

for other companies to enter or leave a market

Supply Curve

As price increases, quantity supplied increases upward slope

Elasticity of Supply

Elastic supply exists when a small change in price causes a major change in quantity supplied

Note: The curve is nearly horizontal Products can be made quickly, cheaply, and use few

resources. Ex: shoe laces, pencils, printed materials, T-Shirts

Elasticity of Supply (Con’t)

Inelastic Supply exists when a change in a good’s price has little impact on the quantity supplied

Production requires time, money, and resources

Ex: Gold/Diamonds, electronics, medications

Note: The curve is nearly vertical

Elasticity of Supply (Con’t)

Perfectly inelastic supply exists when producers cannot supply any more of a product, regardless of price.

Determinants of Supply

Non-price factors that shift the supply curve, instead of simply changing the quantity supplied along the original curve.

1. Prices of Resources: When the price of a resource increase, it adds to the costs of production and lowers profits supply curve shifts to the left (less supply)

Determinants of Supply

2. Government Tools: Taxes, Subsidies, and Regulations.

Taxes: payments made to the government to fund public services increase production costs shifts supply curve left

Subsidies: payments made by government to private businesses lower costs shifts supply curve right

Regulations: government rules about how companies conduct business increase costs shifts supply curve left

Determinants of Supply

3. Technology – new technology makes production more efficient cuts costs increase supply (shift right)

4. Competition – more competition leads to increased supply as producers enter the market to get a share of the market’s demand. Supply decreases as demand drops and producers leave the market

Determinants of Supply

5. Prices of Related Goods: Substitute Goods and Complementary Goods- Price changes have the same effect on a good’s complements – the supply curve will shift in the same direction (price increase = supply increase for comp)- Price changes have opposite effect on a good’s substitutes – if the price of a good falls, it’s substitute will see an increase in supply. (price decrease = supply increase for sub)

Determinants of Supply

6. Producer Expectations – When producers expect the price of a good to increase or decrease, they may take proactive steps to increase or decrease supply of a product.- Halloween USA is only open for 2 months of the year the rest of the year they store their product (decrease supply), and wait for the price/demand for their product to increase before releasing the product back on the market.

LAW OF DIMINISHING RETURNS

Describes the effect that varying the level of an input has on total and marginal product

3 stages of production that can be predicted by the law of diminishing return are

Increasing marginal returns Diminishing marginal returns Negative marginal returns

5 Benefits of the Price System

1. Information2. Incentives3. Choice4. Efficiency5. Flexibility

3 Limitations of the Price System

Externalities---Side effects for people not directly connected with production of g/s.

Public Goods

Instability

EQUILIBRIUM

Market EquilibriumQuantity supplied and quantity demanded for

a product are equal at the same priceAt this point, producers & consumers have

communicated effectively.

EQUILIBRIUM PRICE FOR TENNIS SHOES

0

15

30

45

60

75

90

105

30 60 90 120 150 180

QUANTITYPR

ICE

PER

PA

IR

Price per Pair of Tennis Shoes

Quantity Demanded

Quantity Supplied

$15 180,000 0

$30 150,000 30,000

$45 120,000 60,000

$60 90,000 90,000

$75 60,000 120,000

$90 30,000 150,000

$105 0 180,000

S1

D1

Equilibrium Point (E)

QS is EQUAL to QD at $60

SURPLUSES

SURPLUS OF TENNIS SHOES

$0

$15

$30

$45

$60

$75

$90

$105

30 60 90 120 150 180

QUANTITYPR

ICE

PER

PA

IR

Quantity supplied exceeds the quantity demanded at the price offered.

Need to re-examine costs to see if price can be lowered and still make a profit.

Any price above equilibrium will create a surplus

D1

S1

E

A BSURPLUS

SHORTAGES

SHORTAGE OF TENNIS SHOES

$0

$15

$30

$45

$60

$75

$90

$105

30 60 90 120 150 180

QUANTITYPR

ICE

PER

PA

IR

Exists when quantity demanded exceeds the quantity supplied at the price offered.

May producers that they are charging too little for the shoes.

Any price below equilibrium

S1

D1

E

C D

A BSURPLUS

SHORTAGE

EQUILIBRIUM SUPPLY SHIFT

$0

$15

$30

$45

$60

$75

$90

$105

30 60 90 120 150 180

QUANTITYPR

ICE

PER

PA

IR

EQUILIBRIUM DEMAND SHIFT

$0

$15

$30

$45

$60

$75

$90

$105

30 60 90 120 150 180

QUANTITY

PRIC

E PE

R P

AIR

E1

E2

S1

D1

D2

D1

S1

S2

E1

E2

RATIONING

System in which a government or other institution decides how to distribute a product.

Products are distributed on the basis of policy decisions rather than on the basis of prices determined by supply & demand.

CONSEQUENCES OF RATIONING

UNFAIR Goods & services not distributed fairly.

EXPENSIVE Costs are high for programs that determine rationing.

CREATES BLACK MARKETS Goods are exchanged illegally. Prices are higher than officially established.

PERFECT COMPETITIONAn ideal market

structure in which buyers (consumers) and sellers (producers) compete directly under the laws of supply & demand.

Examples: tomatoes, corn, milk, beef

Perfect competition exists when 4 conditions are met: MANY BUYERS AND

SELLERS IDENTICAL

PRODUCTS INFORMED BUYERS EASY MARKET

ENTRY AND EXIT

MONOPOLISTIC COMPETITIONSellers offer different,

rather than identical, products.

Companies strive for unique products.

Product variation is more common.

Monopolistic competition is more common than perfect competition.

Example: Jeans, cars, shoes

1. Product Differentiation

2. Nonprice Competition

3. Profits

Imperfectly Competitive Markets: OLIGOPOLIES

A market structure in which a few large sellers control most of the production of a good or service.

Example: Gas stations, soda companies

Exist when 3 conditions are present:

1. There are only a few large sellers.

2. Sellers offer identical or similar products.

3. Other sellers cannot enter the market easily.

OLIGOPOLIES AT WORK

NONPRICE COMPETITION

Control prices through nonprice competition.

AdvertisingBrand name loyalty.

INTERDEPENDENT PRICING

Maintain control by being responsive to the pricing actions of competitors.

OLIGOPOLIES AT WORK

COLLUSIONSellers secretly agree

to set production levels or prices for their products.

IllegalCarries penalties and

even prison sentences.

CARTELSCompanies openly

organize a system of price setting & market sharing.

Illegal in U.S.Unstable & short-

lived.

A market structure characterized by a single seller of a unique product with no close substitutes. Example: cable TV

Monopolies exist when three conditions are met:

1. There is a single seller.2. No close substitute goods are

available3. Other sellers cannot enter the

market easily.

Imperfectly Competitive Markets: MONOPOLIES

TYPES OF MONOPOLIES1. Natural Monopolies2. Geographical Monopolies3. Technological Monopolies4. Government Monopolies

EARLY ANTITRUST LEGISLATION

Antitrust Legislation Interstate Commerce Act - 1887 Sherman Antitrust Act - 1890 Clayton Antitrust Act - 1914 Federal Trade Commission Act - 1914 The Robinson-Patman Act – 1936*Primary goal is to encourage competition. Secondary

goal is to protect consumers against predatory pricing policies.