Supply, Demand and Competition Chapter 21, 23.1

Vocabulary chapter 21, 23.1 Demand Surplus Law of Demand Shortage Marginal Utility Equilibrium Price Substitutes Public Good Compliments Private Good Demand Elasticity Externality Supply Monopoly Law of Supply Antitrust Laws Productivity Merger Subsidy Natural Monopoly Supply Elasticity Recall

Both Buyer and Seller Essential Question: How are prices set? Seller??

Setting an Economy’s Price System To understand how a nation’s economy functions it is important to understand the nation’s price system The forces that determine price are called the forces of supply and demand The place where these two forces meet is called the marketplace Consumers have a great influence on the price of goods and services. Why?

Demand Demand shows consumers ability and willingness to buy goods and services. Consumers must want the good or service, be willing to buy it, and have the resources to buy it.

Demand Schedule Lists the different quantities of a product or service that someone is willing to buy based on different prices. The demand curve connects these points and will ALWAYS slope downward

Price per gallon of water Bottles per week As price decreases, the quantity demanded increases. As the price rises, the quantity demanded decreases P QD Price per gallon of water Bottles per week $ Jo Pat .75 90 50 .50 130 70 .35 180 100 .25 290

Demand for hot chocolate in December at the skating rink Price Quantity Demanded $.50 30 $1.00 25 $1.50 20 $2.00 15 $2.50 10 $3.00 5 $3.50

Law of Demand Concept that people will normally buy less of a product if the price is high and more of it if the price is low Three factors that affect what and how much people buy are diminishing marginal utility, real income, and substitution. Price goes up – Demand goes down Price goes down – Demand goes up

Diminishing Marginal Utility (DMU) Utility: Power of a good or service to satisfy. The utility of a good/service is different for different people. Certain goods/services may have no utility for some people. People will buy until price exceeds satisfaction. DMU – Our additional satisfaction tends to go down as we consume more and more of the good/service. Is it worth the money we must give up for the satisfaction we expect to gain? Marginal utility > marginal costs = purchase Marginal utility < marginal costs = don’t purchase

Real Income Effect Income limits the amount of money people can spend. People cannot keep buying the same amount if price increases and income stays the same. (Real income effect). People are forced to trade-off if price increases. If price decreases and you buy the same amount, your real income has increased.

Demand Determinants Factors that will affect the amount people will buy. Includes changes in population, income, and personal preferences. Prices of related goods, income, preference/taste, consumer expectations, population change

Demand Determinants Prices of Related Goods Substitutes: Goods that are related – can be used in place of one another. an increase in the price of one leads to an increase in the demand for the other. The cheaper alternative ex. Pepsi and Coke, store brand and name brand Compliments: Goods that are typically used together. An increase in the price of one leads to a decrease in the demand for the other ex. hamburgers and hamburger buns, cereal and milk

Income As income rises consumers will buy more and tend to switch from consuming the cheaper alternative goods – demand goes up ex. Steak instead of ground beef, car/plane ride instead of bus As income decreases consumers will buy less and consume more of the cheaper alternative – demand goes down

Preference/Taste - Likes and dislikes in consumption Consumer Expectations - Change in future prices, shortages of goods. Change in future income Population Change - As the number of consumers in a market changes the demand will change.

If the price increases how much less will consumer buy? Demand Elasticity How consumers react when prices change. The extent a change in price causes a change in the quantity demanded If the price increases how much less will consumer buy? Elasticity is determined by: Existence of substitutes. Percentage of income spent on a good or service. Time allowed to adjust to a change.

Types Elastic: Many competing brands. Price increases, people choose a substitute. Ex. Soda, clothing, certain foods Inelastic: Not much competition. Price increases, demand does not change. Ex. Meds, gas

Steak: Elastic or Inelastic ? Why? People as a whole can do without steak and will substitute chicken or other protein for expensive steak

Milk: Elastic or Inelastic ? Why? The population as a whole can do without steak….but can not do as easily without milk…especially families with children

Gasoline: Elastic or Inelastic ?

What Products are Subject to Elastic Demand ? If there is a substitute – a cheaper alternative If the purchase can be postponed Luxury items, durable goods – cars, computers, washer/dryers are in greater demand if the price drops

What Products are Subject to “Inelastic Demand”? Necessities (milk, gasoline) Drugs Legal (heart medicine antibiotics) Illegal (heroin, cocaine) Products with no good substitute insulin, cancer drugs, etc. salt in Middle Ages (preservative)

Why is Elasticity of Demand Important ? What happens if a florist increases the price of roses 400 % in October ? Will sales go up or down ? A. Probably, down What happens if a florist increases the price of roses on February 14th? Will sales go down or up? A. Probably up Why ? Frantic husbands and boyfriends will pay exorbitant prices for a dozen roses on Valentine’s Day.

Supply curve always slopes upward from left to right Explains the amount producers are willing to provide at various prices. Law of Supply – sellers will typically offer more goods/services at a higher price and less at a lower price As price increases, supply increases. As price decreases, supply decreases. Supply curve always slopes upward from left to right

Supply Schedule & Curves A Supply Schedule displays the quantity of a product supplied at each price Price Per Bottle Bottles Supplied .75 200 .50 130 .35 75 .25 50

Supply of shovels before a large snowstorm sold at Lowes Price Quantity Supplied $4.00 5 $8.00 10 $12.00 15 $14.00 20

Determinants of Supply – Factors affecting the cost of production Technology -If more efficient technology is discovered production costs will fall - suppliers will be more willing and able to supply more of the good at each price Price of Resources – If prices for resources decrease, cost of production decreases, producers can offer more product at each price

Productivity – Producing more in the same amount of time – efficiency. Producer Expectations - Shift production according to future demand Number of Producers -# of producers Increases then supply increases Government policies/regulations -Taxes, quotas, subsidies, licenses, etc. Relaxed/tighter gov’t regulations

Profit The primary goal for business owners in the economy is to make a profit – The money left over after covering all the costs to produce a product/service. What can businesses do with their profits? Increase wages or hire more employees Invest in the business – purchase new equipment, training, new buildings Keep it for themselves

Supply Elasticity Measures how the quantity supplied of a good/service changes as price changes Products that can be made quickly, inexpensively, or w/out skilled labor tend to be supply elastic – the amount produced will change based on price changes Products that cannot be made quickly, are expensive, or require skilled labor tend to be inelastic – the amount produced will not change based on price changes

Supply and Demand If price falls, demand will ? and supply will ? If price rises, demand will ? and supply will ? Supply and demand work together in markets to establish prices Prices form the basis of economic decisions

Shortage and surplus: When demand is greater than supply, a shortage occurs. Price is set too low When supply is greater than demand, a surplus occurs. Price is set too high. Prices will rise in a shortage and fall in a surplus. Equilibrium price: Point where supply and demand meet. Neither a surplus or shortage

Price Controls Price Ceiling – Gov’t set maximum price that can be charged for a good or service Price Floor – Gov’t set minimum price that can be charged for a good or service Prices help businesses and consumers make decisions and answer the 3 basic economic questions – What, How and Whom to produce

This should be appropriate for 6 year olds. In groups of 3-4, explain supply and demand to first graders. They need to understand the basic concepts and terms of supply and demand and how they work in a market economy. This can be done on paper or computer and will be presented to the class. This should be appropriate for 6 year olds.

Public vs Private Goods Public Goods – goods that can be consumed by one person without preventing consumption by another - no one is excluded from use whether or not they pay for it. Ex. Defense, parks, roads, clean air Private Goods – are goods that when consumed by one individual cannot be consumed by another – a person cannot use something until they pay for it Ex. Food, clothing

Dealing With Externalities Externality – unintended side effect of an action that affects someone not involved in the action. Public goods from the government produce positive externalities Government tries to encourage positive externalities and prevent negative externalities

Competition Competition will exist if different businesses produce similar products. Markets work best when there are many buyers and sellers. Monopolies can be harmful to the market. One group controls the entire market Single seller, no substitutes, complete control over prices Suppliers can raise prices without losing business.

Gov’t policies Late 1800’s the railroad industry was the biggest in the United States. Theodore Roosevelt set out to stop monopolies with his “trust-busting” policy, which would break up large businesses. Antitrust laws – To control monopolies - to preserve and promote competition Sherman Antitrust Act of 1890 banned monopolies that prevented competition; used to break up Standard Oil (1911) and AT&T (1984).

Gov’t approves all mergers Two or more companies join to form a single business Horizontal: Companies in the same business. Vertical: Company joins with one it buys from. Conglomerate: Buying of un-related businesses. Gov’t approves all mergers

Vertical or Horizontal? Nike and Adidas Horizontal Tostitos and Corn Fields Vertical Harris Teeter and Ace Hardware Conglomerate Pepsi and Coke

Oligopoly A few businesses in competition. Domination of a few sellers Identical or slightly different products Some control of price Price wars are common place.

Oligopoly Examples Movie Studios Columbia, 20th Century Fox, Warner Bros., Paramount, Universal, and MGM Television Disney/ABC, CBS Corp., NBC Universal, Time Warner, and News Corporation Food Processing Kraft Foods, PepsiCo, and Nestle Telecommunications AT&T, Verizon, Sprint, and T-Mobile

Monopolistic Competition Numerous sellers Different products Competition Some control of price Substitution and advertising are factors.

Regulating Market Activities Gov’t regulates some business activities to reduce negative externalities Makes sure businesses act fairly and follow the laws Sometimes it makes sense to have a single firm produce all of the goods or services for a market. To prevent

Natural Monopoly – market situation in which the costs of production are minimized by having a single firm produce the product. – Utility companies – water, electric, telecommunications Gov’t heavily regulates the sole provider to prevent abuses

Gov’t requires truth in advertising, product labeling, and safety Federal Trade Commission (FTC) – deals with false advertising and product claims Food and Drug Administration (FDA) – enforces the purity, effectiveness and labeling of food, drugs and cosmetics The Consumer Product Safety Commission (CPSC) – recalls unsafe products What is a recall?

Exit Ticket Using complete sentences, explain (in paragraph form) the following terms as they relate to government’s role in the economy – Private good Antitrust law Public good Merger Monopoly Natural monopoly Recall Your book could be helpful. Especially pages 633-635. Underline/highlight and number the terms when they are first explained in your writing.