Unit 2: Microeconomics Supply and Demand

Demand Why do consumers buy more of a good or service when the price goes down, but less of that product when the price goes up?

Economics Chapter 3 In this chapter we will learn about consumer demand for certain products and discuss the nature of demand and the law of demand. We, as consumers have a great deal of power. What we want (or demand) influences what goods and services are available to us.

Demand vs. Quantity Demanded Demand- 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. Quantity Demanded- the amount of a good or service that a consumer is willing and able to buy at each given price during a given time period.

Demand Schedule for Stereos Price per Car Stereo $500 $400 $300 $200 $100 Quantity Demanded 500 1,000 1,500 2,500 5,000

Demand Curve Price 500 400 300 200 100 1000 1500 2500 5000 Quantity Demanded D

You see, any point on the curve is the DEMAND for stereos. But each point on the curve represents the QUANTITY DEMANDED for that particular price. The law of demand – “an INCREASE in a good’s price causes a DECREASE in the quantity demanded, and a DECREASE in a goods price causes an INCREASE in the quantity demanded.

Things to consider when discussing a product’s demand The Income Effect – Any increase or decrease in consumers’ PURCHASING POWER caused by a change in price. For example, if a store lowers the price of its smartphones from $150 to $100, a consumer can buy more phones with the same amount of income. A person spending $300 can buy 3 phones at the new price of $100, but could have only purchased 2 phones at the earlier price of $150. Of course, the two words “WILLING” and “ABLE” still apply to make the income effect work.

The Substitution Effect The Substitution Effect – Consumers’ tendency to SUBSTITUTE a similar, lower-priced product for another product that is relatively MORE EXPENSIVE. For example, when the price of steak INCREASES, many consumers reduce the quantity of beef demanded and buy more CHICKEN (a lower priced substitute.

Diminishing Marginal Utility The marginal utility of each unit consumed diminishes with each unit. Diminishing= LESSEN Marginal= ADDITIONAL STEP (means a difference of 1) Utility= USEFULNESS

Diminishing Marginal Utility The ADDITIONAL USEFULNESS of each unit consumed LESSENS with each unit. EX. 1st slice of pizza is well worth the $2 you paid. 2nd slice= $2 3rd slice=$1.50 4th slice=$.75 5th slice=$0

Diminishing Marginal Utility helps explain why demand for a product is not LIMITLESS. At some point, consumers cannot use any more of a product. There is a limit to a product’s UTILITY to consumers and thus a limit to consumers’ DEMAND.

Up until now, we saw that the only thing that affected the quantity demanded for a product was PRICE. But some factors can cause the entire demand for a product to change. This is called a SHIFT in demand.

CHANGES in Demand INCREASE in Demand DECREASE in Demand

What can cause a demand curve to shift to the right or left. Price. NO What can cause a demand curve to shift to the right or left? Price? NO. A change in price just causes a change in the Quantity Demanded. The curve doesn’t move. To make the curve move (change demand), other things must change: Income of consumers Number of consumers Complementary goods’ price Expectations of consumers Substitute goods’ price Tastes and preferences

Price Elasticity of Demand Elastic demand exists when a SMALL change in a good’s price causes a major, OPPOSITE change in the QUANTITY DEMANDED. Ex. Car stereos, movie tickets Usually wants

Price Elasticity of Demand Inelastic demand exists when a change in a good’s price has LITTLE IMPACT on the quantity demanded. Ex. Soap, milk, medications Usually needs

SUPPLY The Law of Supply and changes in quantity supplied vs. changes in supply

Chapter 5 Supply The actions of suppliers are based on one simple motivation: PROFIT PROFIT = when revenues are greater than cost of production Examples of cost of production include: wages, salaries, rent, bills, interest on loans, etc.

Like “demand” there are two important different definitions to understand: Supply – The quantity of goods and services that producers are willing to offer at various possible prices during a given time period. Quantity Supplied – The amount of a good or service that a producer is willing to sell at each particular price.

Supply Schedule Price per Car Stereo $500 $400 $300 $200 $100 Quantity Supplied 4000 3750 3500 2500

Supply Curve Price 500 400 300 200 100 1000 2000 3000 4000 5000 Quantity Supplied

Law of Supply – producers supply more goods and services when they can sell them at higher prices and fewer goods and services when they can sell them at lower prices.

When the entire supply of a product increases or decreases, the supply has shifted. Increase in Supply Decrease in Supply

What would cause a product’s supply to shift? (Changes in…) Resource Prices Expectations of producers Number of producers Technology (new technology or back to Stone Age…) Government actions (taxes, regulations, subsidies) Other (related) goods prices

Price Elasticity of Supply Elastic Supply exists when a SMALL change in price causes a MAJOR change in the quantity supplied. Usually products with elastic supplies can be made QUICKLY, inexpensively, and using FEW resources. An example would be T-shirts of a WINNING sports team.

Inelastic supply exists when a change in a good’s price has LITTLE IMPACT on the quantity supplied (usually because it will take too much time, money, and resources). Relatively VERTICAL What would cause a supply curve to be “perfectly inelastic?” THEY CAN”T INCREASE SUPPLY EX. GOLD How would the curve look? COMPLETELY VERTICAL

Combining Supply and Demand

Two Powerful Laws Law of Demand: As Price goes up people want less Explains wide variety: why people will sit in the upper deck of a stadium

Two Powerful Laws Law of Supply: The higher the price of a good, the greater the quantity suppliers will produce Explains why parking places at the beach are more expensive in the summer months, why people are paid overtime at a premium wage

Equilibrium The point where demand and supply curves intersect This is where both producers and consumers are satisfied Quantity demanded equals quantity supplied Only happens at one point

Disequilibrium If the price is anywhere but equilibrium, quantity supplied does not equal quantity demanded Leads to excess supply or excess demand

Excess Demand When the quantity demanded is greater than the quantity supplied Price is below market equilibrium Low price encourages buyers but not sellers When there is excess demand suppliers will raise their price

Excess Supplied When quantity supplied exceeds quantity demanded High price encourages sellers but not consumers Price is above equilibrium Suppliers will lower prices to sell excess supply

Effects of Excess When the market is in disequilibrium and prices are able to change, the market will naturally correct itself Suppliers may get tired of throwing away extra product if there is excess supply Suppliers may raises prices to increase profit when there is excess demand

The Role of Prices In a Market Economy Ch. 6 Section 3

Prices in the Free Market Aid in moving the factors of production to producers Aid in moving finished products to consumers

The Advantages of Prices Price as an incentive Buyers and Sellers look at prices to retrieve information on a product’s demand and supply Law of supply and law of demand show prices as a signal that tell producers and consumers how to adjust

The Advantages of Prices Prices as Signals Think of prices as a traffic light . . . Producers: if consumers buying at higher prices, producers produce more (GREEN LIGHT); low prices cause producers to produce less (RED LIGHT). Consumers: At low prices, consumers buy more (GREEN LIGHT); at high prices, consumers think carefully before buying (RED LIGHT).

The Advantages of Prices Flexibility When shifts occur in the supply or demand curve that change equilibrium, price can easily change to solve the problem of excess supply or excess demand

The Advantages of Prices Price System is “Free” It does not cost the government anything to regulate prices, the market regulates the prices (unlike a command economy)

Government Intervention What happens in markets when government gets involved?

Public Goods Public Good: a shared good or service for which it would be inefficient or impractical To make consumers pay individually and To exclude nonpayers I.E. Dams, Roads, Bridges, etc.

Price Ceilings A maximum price that can be charged for a good Set by law on goods considered essential and might become to expensive Rent control is the most famous example Symbolized on a curve by drawing a straight line across at the price ceiling

Price Ceilings Reduce quantity supplied and the price charged Means lower total revenue Lower revenue means no incentives to improve the product Excess demand is created

Consequences of a Price Ceiling Excess demand means some non-price factor will develop to determine who gets and who does not Wait list, discrimination, bribery, luck

Price Ceiling

Price Floors A minimum price that must be paid for a good or service Governments wants sellers to receive some reward for their efforts

Minimum Wage Most well known price floor Employers must pay at least a certain rate per hour

Minimum Wage If set above market equilibrium it will decrease the quantity of labor supplied Results in excess supply – more people looking for work at the wage than employers will hire

Price Floor