Unit 2 Supply & Demand and the Nature and Function of Markets

Demand Basics Demand Schedule and Demand Curve

Demand Basics Demand versus Quantity Demanded Demand- quantities consumers are willing and able to buy at various prices Quantity Demanded- quantity consumers are willing and able to buy at a given price

Demand Basics Demand versus Quantity Demanded Demand- the whole curve Quantity Demanded- a point on the curve

Demand Basics Demand versus Quantity Demanded Change in Demand- the whole curve shifts Change in Quantity Demanded- movement along the curve

Demand Basics Changes in Demand Consumer Income Population Normal v. Inferior Goods Population Preference/Taste Price of Other Goods Compliments Substitutes Expectation of Change in Price

Supply Basics Supply Schedule and Supply Curve

Supply Basics Supply versus Quantity Supplied Supply - quantities producers are willing and able to sell at various prices Quantity Supplied- quantity producers are willing and able to sell at a given price

Supply Basics Supply versus Quantity Supplied Supply - the whole curve Quantity Supplied- a point on the curve

Supply Basics Change in Supply - the whole curve shifts Change in Quantity Supplied- move from one point on the curve to another

Supply Basics- Changes # of Producers Technology Price of Inputs Taxes and Subsidies Other Regulations Producer expectations

Individual & Market Demand Curve Horizontal sum of individual demand curves

Individual & Market Supply Curve Horizontal sum of individual supply curves

What if they both shift? Equilibrium Price? Equilibrium Quantity? One change is certain The other is ambiguous

What if they both shift? Coffee New Rebecca Black Song New Fertilizer

What if they both shift? Same Shift- know Q Opposite Shift- know P

S & D for Non-Smart Phones (inferior good) Decrease in unemployment Increase in the price of Smart Phones

Equilibrium Price = Market Clearing Price

What can you tell me? OPEC breaks up EPA eliminates all regulation of oil industry

Why Demand Slopes Downward and what’s up with the shape? Income Effect Substitute Effect Diminishing Marginal Utility

Conspicuous Goods

Why Demand Slopes Downward and what’s up with the shape? Income Effect Substitute Effect Diminishing Marginal Utility

TVs Consumers EXPECT prices to increase significantly in the coming months Producers are plagued by a growing shortage of Europium

Why Demand Slopes Downward? Income Effect Higher price = Lower purchasing power Lower price = Higher purchasing power “ability to buy”

Why Demand Slopes Downward? Substitute Effect- think opportunity cost Higher price = Lower relative price of substitutes Lower price = Higher relative price of substitutes

Why? 1st pizza for full price ($10.00), get a 2nd for $5?

Why? Buy one pair at regular price and get the second pair half off? BOGO Days!

MU/$

Why Demand Slopes Downward? Diminishing Marginal Utility

Why Demand Slopes Downward? Diminishing Marginal Utility MU= satisfaction (quantified in dollars) of an additional unit of consumption Marginal Utility ALWAYS* decreases with additional consumption Total Utility increases at a decreasing rate

Why Demand Slopes Downward? Diminishing Marginal Utility/Benefit Cost-Benefit Analysis How many slices will you consume? OPTIMAL PURCHASE RULE MU=P

Optimizing Purchase of 2 or More Goods MU per $1

Consumer Equilibrium Maximize Total Utility MU per $1 (MU/$) MUx/Px = MUy/Py

New Housing Market- East Penn Emmaus High named the 280th best high school in the country (best in area) A decrease in the price of lumber (input of housing construction)

Races = $50 Musicals = $100 Budget = $300

If the market price is above equilibrium price…

If the market price is below equilibrium price…

Price Ceilings Non-Binding Set above equilibrium Market prices will remain below the ceiling **Graph shows BINDING

Price Floors Non-Binding Set below equilibrium Market prices will remain above the floor **Graph shows BINDING

Is minimum wage a binding price ceiling?

Now that you are thinking… Is minimum wage a binding price floor?

Price Controls Effects beyond Surpluses and Shortages

Price Controls Effects beyond Surpluses and Shortages BOTH reduce the quantity of a good bought and sold

Price Ceilings Shortages Inefficiencies Black Markets

Price Ceilings- Inefficiencies Misallocation of Resources Need and willingness to pay Wasted Resources Time and money spent overcoming the shortage Inefficiently Low Quality

Price Ceilings- Black Markets Illegal Markets Prices ABOVE equilibrium Prices account for additional cost in the form of risk

Price Floors Surpluses Inefficiencies Black Markets

Price Floors- Inefficiencies Misallocation of Resources Those willing to sell at the lowest price do not always succeed Wasted Resources Inefficiently High Quality

Price Floors- Black Markets Illegal Markets

Price Elasticity of Demand (PED)

PED Relationship between % change in price and % change in quantity

PED (absolute value) Perfectly Inelastic = 0 Unit Elastic = 1 Perfectly Elastic =

PED (expressed in absolute value) PED (expressed in absolute value) *PED will always be negative unless perfectly inelastic Perfectly Inelastic = 0 Unit Elastic = 1 Perfectly Elastic = Inelastic <1 Unit Elastic = 1 Elastic > 1

PED

*Total Revenue Method* Price Decrease – TR Increase Elastic Price Decrease – TR Constant Unit Elastic Price Decrease – TR Decrease Inelastic

*Total Revenue Method* Elastic Demand Price and Total Revenue Move in OPPOSITE directions Unit Elastic Demand- No Change in TR Inelastic Demand Price and TR move in the SAME direction

TIP of the DAY Remember 2 not 6

TIP of the DAY Remember 2 not 6 1. Inelastic PED- Increase in Price will Increase Total TR *Increase P will Increase TR 2. Perfectly Inelastic = 0

PES- Only difference?

Other Elasticities Price Elasticity- % Q/ % P PED versus PES Income Elasticity of Demand Normal Inferior goods Cross Price Elasticity Complements and substitutes

Income Elasticity of Demand % Q / % Income Normal Inferior

Income Elasticity of Demand % Q / % Income Normal = positive Inferior = negative

Income Elasticity of Demand % Q / % Income Necessity 0-1 Luxury > 1

Cross Price Elasticity % Qx / % Py Substitutes = Complements = Neither = 0

Cross Price Elasticity % Qx / % Py Substitutes = positive Complements = negative Neither = 0

Tip of the Day Study 2 days before the test as if it were the day before The review will expose your weaknesses

Tax Incidence

Tax Incidence Nominal (Statutory) versus Economic Incidence If “law” doesn’t matter, what does?

Draw TWO S & Ds Add a Binding Price Floor to one Add a Binding Price Ceiling to the other Shade DWL

Deadweight Loss Excess Burden Allocative Inefficiency Do subsidies produce DWL?? If so, where does it appear?