Supply, Demand and Competition

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

Basic facts Consumers have a great influence on the price of goods and services. Why? Market: Represents the freely chosen action between buyers and sellers. Voluntary exchange: Buyers and sellers work out a deal that suits both sides.

Demand Demand shows consumers ability and willingness to buy goods and services. e.g. Swimming suits have a different price and quantity demanded in summer vs. winter How many of you would like a new car? How many of you are able?

Law of Demand Explains the amount people are willing to buy as prices change. Demand can only occur if a buyer is willing and able to buy. 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. People will buy until price exceeds satisfaction. Price decreases, people will buy more.

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 Curve Demand Curve is a line graph that shows the amount of a product that will be purchased at each price; it shows an inverse relationship and is always downsloping p D Qd

Law of Demand 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

Demand Determinants Characteristics 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 in such a way that an increase in the price of one leads to an increase in the demand for the other [goods that can be consumed in place of one another] (Pepsi and Coke) Compliments: Goods that are related in such a way that an increase in the price of one leads to a decrease in the demand for the other [goods that are normally consumed together] (hamburgers and hamburger buns)

Determinants cont. Income Normal Good: a good for which demand increases as consumer incomes rise (milk) Inferior Good: A good for which demand decreases as consumer incomes rise (ground chuck, bus rides) As income rises consumers tend to switch from consuming these inferior goods to consuming normal goods (ex. steak, car/plane)

Determinants cont. Preference/Taste Likes and dislikes in consumption Consumer Expectations Change in future price of goods Change in future income Population Change As the number of consumers in a market changes the demand will change

Supply Explains the amount producers are willing to provide at various prices. Law of Supply - As price increases, supply increases. As price decreases, supply decreases..

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 Technology If more efficient technology is discovered production costs will fall So suppliers will be more willing and able to supply more of the good at each price Price of Relevant Resources Those resources employed in the production of a good.

Determinants con’t Prices of Alternative Goods Price of a good that uses some of the same resources as used to produce the good in question Producer Expectations Shift production according to future prices Number of Producers # of Prod. Increases # of supply Government Restrictions Taxes, quotas, licenses, etc.

Supply and Demand If price falls, demand will increase and supply will decrease. If price rises, demand will decrease and supply will increase. Equilibrium price: Point where supply and demand meet. Shortage and surplus: When demand is greater than supply, a shortage occurs. When supply is greater than demand, a surplus occurs. Prices will rise in a shortage and fall in a surplus.

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

Price Elasticity How consumers react when prices change. 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. Inelastic: Not much competition. Price increases, demand does not change.

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 ? Luxury Items – Most customers want luxuries and will consider buying them if price drops If Price Represents a Large Portion of Family Income e.g. Mortgage Rates drop from 6.5 to 5.5% people will “refinance” Availability of Substitute Items e.g. Steak /chicken Durable Goods Computers, cars, washers, dryers will be 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.

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.

Competition Competition will exist if different businesses produce similar products. Perfect Competition Large Market Similar Product Easy entry and exit Information obtainable No control over price Market Price is equilibrium price. (decided by supply and demand)

Imperfect Competition One group can have an impact on price. Monopoly Oligopoly Monopolistic Competition Barriers to entry: Government regulations: Some goods and services are protected from duplication by the government. Cost of getting started: Large amount of capital is needed to begin. Ownership of raw materials: Companies control materials and do not sell to competitors.

Monopoly One group controls the market. Single seller No substitutes No entry Complete control over price Suppliers can raise prices without losing business.

Types of Monopoly Natural: Control of resources. Water company Geographic: Control of location Dick’s is the only sports store in the area Technological: Patent on technology Government: Created by the government. Illegal to enter. Post office Cartel: International form of monopoly (OPEC).

Oligopoly A few businesses in competition. Domination of a few sellers Barriers to entry 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 Easy entry Different products Competition Some control of price Substitution and advertising are factors.

Mergers One company joins with another. Horizontal: Companies in the same business. Vertical: Company joins with one it buys from. Conglomerate: Buying of un-related businesses.

Vertical or Horizontal? Google and Bing Horizontal Paper Company and Saw Mill Vertical Tostitos and Corn Fields Harris Teeter and Ace Hardware Conglomerate Pepsi and Coke

Government 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. All mergers must be approved by the Government.

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.