Chapter 4 Demand

Understanding Demand (4-1) The law of demand states that when a price is lower, consumers will buy more of it. When the price is higher, consumers will buy less of it. The law of demand is the result of two separate patterns of behavior. Substitution Effect Income Effect These two effects explain why an increase in price decreases the quantity purchased.

The law of demand explains how the price of any item affects the quantity demanded. A demand schedule is a table that lists the quantity of a good that a person will purchase at each price in a market. A market demand schedule shows the quantities demanded at each price by all consumers.

A demand curve is a graphic representation of a demand schedule. A demand curve graph shows only the relationship between the price of a good and the quantity that will be purchased. It assumes that all other factors will remain constant. A market demand curve can only predict how people will change their buying habits when the price of a good rises or falls.

Demand Schedule and Graph Demand Schedule for Coffee Price Quantity Demanded $1 20 $2 16 $3 12 $4 8 $5 4

Shifts of the Demand Curve (4-2) Ceteris paribus is Latin phrase economists use meaning “all things held constant.” A demand curve is accurate only as long as the ceteris paribus assumption is true. When ceteris paribus assumption is dropped, movement no longer occurs along the demand curve, rather the entire demand curve shifts.

Several factors lead to a shift in demand. Changes in consumer income affects demand. Normal Goods Inferior Goods Whether or not consumers expect a good to increase or decrease in price in the future greatly affects the demand for that good today.

Changes in the size of population also affects the demand for products. Advertising plays an important role in many trends and therefore influences demand. The demand curve for one good can be affected by a change in the demand for another good. Complements are two goods that are bought and used together. Substitutes are goods used in place of one another.

Elasticity of Demand (4-3) Elasticity of demand is a measure of how consumers react to a change in price. Demand for a good that consumers will continue to buy despite a price increase is inelastic. Demand for a good that is very sensitive to changes in price is elastic.

If demand is elastic a small change in price leads to a relatively large change in the quantity demanded. If demand is inelastic, consumers are not very responsive to changes in price, which will lead to only a small change in quantity demanded, or no change at all.

Several factors can affect elasticity of demand for a certain good. Availability of Substitutes Relative Importance Necessity vs. Luxury Change over Time The elasticity of demand determines how a change in prices will affect a firm’s total revenue or income.

Chapter 5 Supply

Understanding Supply (5-1) According to the law of supply, suppliers will offer more of a good at a higher price. As price increases, quantity supplied increases. As price falls, quantity supplied falls. Economists use the term quantity supplied to describe how much of a good is offered for sale at a specific price.

The promise of increased revenues when prices are high encourages firms to produce more. Rising prices draw new firms into a market and add to the quantity supplied of a good. A market supply schedule is a chart that lists how much of a good all suppliers will offer at different prices.

A market supply curve is a graph of the quantity supplied of a good by all suppliers at different prices. Elasticity of supply is a measure of the way quantity supplied reacts to a change in price. Elastic supply – very sensitive to changes in price Inelastic supply – not responsive to changes in price

Time is the number one factor that affects the elasticity of supply. In the short term, a firm cannot easily change its output level, so supply is inelastic. In the long term, firms are more flexible, so they can become more elastic.

Costs of Production (5-2) Business owners have to consider how the number of workers they hire will affect their total production. The marginal product of labor is the change in output from hiring one additional unit of labor, or worker. Increasing marginal returns occur when marginal production level increases with new investments.

Negative marginal returns occurs when the marginal product of labor becomes negative. Business owners also have to consider their costs of production and how it will affect their revenue. Fixed cost Variable cost Total cost Marginal cost – cost of producing one more item Marginal revenue –additional income from selling one more unit of a good = market price

To determine the best level of output, firms determine the output level at which marginal revenue is equal to marginal cost.

Changes in Supply (5-3) Any change in the cost of an input, such as the raw materials, machinery, or labor used to produce a good will affect supply. As input costs increase, the firms marginal costs also increase, decreasing profitability and supply. Input costs can also decrease increasing profitability and supply.

By raising or lowering the cost of producing goods, the government can encourage or discourage an entrepreneur or industry. Subsidy – government payment that supports a business or market Excise taxes Regulation Import restricitions

Expectations of higher prices will reduce the supply later Expectations of higher prices will reduce the supply later. Expectations of lower prices will have the opposite effect. If more firms enter a market, the market supply of a good will rise. If firms leave the market, supply will decrease.

Chapter 6 Prices

Combining Supply and Demand (6-1) The point at which quantity demanded and quantity supplied come together is known as equilibrium. If the market price or quantity supplied is anywhere but at the equilibrium price, the market is in a state called disequilibrium. There are two causes for disequilibrium: excess demand and excess supply. Excess demand occurs when quantity demanded is more than quantity supplied. Excess supply occurs when quantity supplied exceeds quantity demanded.

Interactions between buyers and sellers will always push the market back towards equilibrium. In some cases the government steps in to control prices. These interventions appear as price ceilings and price floors. Price ceiling is a maximum price that can be legally charged for a good. Example: rent control Price floor is a minimum price, set by the government that must be paid for a good or service. Example: minimum wage

Supply and Demand Graph

Changes in Market Equilibrium (6-2) Since markets tend toward equilibrium, a change in supply will set market forces in motion that lead the market to a new equilibrium price and quantity sold. A surplus is a situation in which quantity supplied is greater than quantity demanded. If a surplus occurs, producers reduce prices to sell their products. This creates a new market equilibrium.

The exact opposite will occur when supply is decreased The exact opposite will occur when supply is decreased. As a supply decreases, producers will raise prices and demand will decrease. A shortage is a situation in which quantity demanded is greater than the quantity supplied.

When demand falls, suppliers respond by cutting prices and a new market equilibrium is found.

The Role of Prices (6-3) Prices serve a vital role in a free market economy. Prices help move land, labor, and capital into the hands of producers and finished goods into the hands of buyers. Prices communicate to both buyers and sellers whether goods or services are scarce or easily available. Prices can encourage or discourage production.

A relatively high price is a signal to producers to make more of a good or service. A low price is a signal that producers should make less. Prices are more flexible than production levels, they can easily be increased or decreased to solve problems of excess supply or excess demand. Supply Shock Rationing A market system with its fully changing prices, ensures that resources go to the uses that consumer’s value most highly.

Problems with Price-based Market Systems Imperfect competition Spillover costs – extra costs that were not anticipated

Key Ideas from Chapter 7-Market Structures Perfect competition - market structure in which a large number of firms produce the same product and sell it at same price. Monopoly - market dominated by a single seller. Examples: DeBeers/Standard Oil/US Steel/Luxxotica A natural monopoly is a market that runs most efficiently when one large firm provides all the output. Example: Southern CA Edison/So Cal Gas

Key Ideas from Chapter 7 cont. Monopolistic competition – a market in which many companies compete to sell products which are similar but not identical. Non-price competition is a way to attract customers through style, image, service, or location. Oligopoly describes a market dominated by a few large, profitable firms = price fixing/price wars Beginning in the 1890s, the federal government began regulating monopolies. Example: Sherman Anti-Trust Act/Clayton Anti-Trust Act Deregulation is the removal of some government controls over a market. Example: Banks and Home Loans in the 1990-2007

Chapter 7 Market Structures

Perfect Competition (7-1) Perfect competition - market structure in which a large number of firms produce the same product and sell it at same price. Many buyers and sellers Identical products Informed buyers and sellers Free market entry and exit Barriers to entry can lead to imperfect competition, a market structure that does not meet the conditions of perfect competition.

Perfectly competitive markets are efficient and competition keeps both prices and production costs relatively low.

Monopoly (7-2) Monopoly - market dominated by a single seller. Monopolies form barriers to entry that prevent new firms from entering a market. Monopolies can take advantage of their power and charge high prices. A natural monopoly is a market that runs most efficiently when one large firm provides all the output.

Monopolistic Competition (7-3) Monopolist competition – a market in which many companies compete to sell products which are similar but not identical. Non-price competition is a way to attract customers through style, image, service, or location. Prices are higher in monopolistically competitive markets than in perfect competition.

Oligopoly describes a market dominated by a few large, profitable firms. Price fixing Price wars

Regulation and Deregulation (7-4) Beginning in the 1890s, the federal government began regulating monopolies. Anti-trust laws were passed to encourage competition in most markets. Regulate business practices Break up monopolies Block mergers Deregulation is the removal of some government controls over a market.