Understanding Supply & Demand

“all things held constant” Before we Begin: Important Economic Concept Alert!!! Ceteris Paribus “all things held constant” When using ceteris paribus in economics, assume all other variables except those under immediate consideration are held constant. For example, it can be predicted that if the price of Beef increases—the quantity of beef demanded by buyers will decrease.

Demand

Ponder

Demand Quantities of products consumers are willing and able to buy at various prices

Law of Demand price or demand demand price

Supply and Demand Simplified

Example= Generic Goods Inferior Goods A good that consumers demand less of when their income increases. (and more of when they have less income) Example= Generic Goods

Effect = You buy more of a similar product Substitution Effect When the price of a product rises the consumption of a substitute product increases. Effect = You buy more of a similar product (PS4vsXBox 1)

Complimentary Effect Complimentary Good: A good that's demand is connected to another good. Example: Tennis Balls/Tennis Racket, Hamburger Patties/Hamburger Buns

Income Effect When the price of product A rises the consumption of other products decrease. Why?= You feel POOR!!

Demand Curve The demand curve has a negative slope, consistent with the law of demand.

Demand Schedule Table that lists the quantity of a good a person will buy at each different price.

Catherine’s Demand Schedule

Figure 1 Catherine’s Demand Schedule and Demand Curve Price of Ice-Cream Cone $3.00 2.50 1. A decrease in price ... 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of 2. ... increases quantity of cones demanded. Ice-Cream Cones Copyright © 2004 South-Western

Changes in Quantity Demanded Price of Ice-Cream Cones A tax that raises the price of ice-cream cones results in a movement along the demand curve. B $2.00 A 1.00 D 4 8 Quantity of Ice-Cream Cones

Figure 3 Shifts in the Demand Curve Price of Ice-Cream Cone Increase in demand Decrease in demand Demand curve, D 2 Demand curve, D 1 Demand curve, D 3 Quantity of Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

Consumer Income Normal Good Price of Ice-Cream Cone $3.00 An increase in income... 2.50 Increase in demand 2.00 1.50 1.00 0.50 D2 D1 Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12

Consumer Income Inferior Good Price of Ice-Cream Cone $3.00 An increase in income... 2.50 2.00 Decrease in demand 1.50 1.00 0.50 D2 D1 Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12

Shifts in Demand 1. Income Normal Goods – consumer demands more when income increases Inferior Goods – consumers demand less as income increases

Change in Demand 2. Consumer Expectations – “items going on sale” 3. Population – “baby boom” 4. Consumer Tastes and Advertising

A measure of how consumers react to a change in price Elasticity A measure of how consumers react to a change in price

Demand that is very sensitive to price change. Elastic Demand that is very sensitive to price change. Ex.

Demand is not sensitive to price changes. Inelastic Demand is not sensitive to price changes.

Unitary Elastic If elasticity is exactly equal to one. This happens when the change in quantity demanded is exactly equal to the percentage change in the price.

Calculating Elasticity The formula used to calculate the percentage change in quantity demanded is: [QDemand(NEW) - QDemand(OLD)] / QDemand(OLD) The formula used to calculate the percentage change in price is: [Price(NEW) - Price(OLD)] / Price(OLD)

Calculating Elasticity Percentage Change in Demand Percentage Change in Price Answer is <1 = Inelastic Answer is >1 = Elastic Answer is 1 = Unitary

Understanding Supply

Quantities of products that are made available by the producers. Supply Quantities of products that are made available by the producers.

What is the Law of Supply?

Higher Production If a firm is earning a profit from the sale of a good or service, then an increase in the price will, in turn, increase the firm’s profits. In general, the search for profit drives the choices made by the producer.

Market Entry Checkpoint: Why do firms increase production when the price of a good goes up? Rising prices encourage new firms to join the market and will add to the quantity supplied of the good. Take, for example, the music market: When a particular type of music becomes popular, such as 70’s disco or 90’s grunge, more bands will play that type of music in order to profit from such music’s popularity. This action reflects the law of supply. Checkpoint Answer: Because the law of supply states that as prices rise, so does the amount of quantity supplied Checkpoint Answer: Because the law of supply states that as prices rise, so does the amount of quantity supplied

Supply schedule Supply schedule- shows the relationship between price and quantity supplied.

Figure 5 Ben’s Supply Schedule and Supply Curve Price of Ice-Cream Cone $3.00 2.50 1. An increase in price ... 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-Cream Cones 2. ... increases quantity of cones supplied. Copyright©2003 Southwestern/Thomson Learning

Change in Quantity Supplied Price of Ice-Cream Cone S C $3.00 A rise in the price of ice cream cones results in a movement along the supply curve. A 1.00 Quantity of Ice-Cream Cones 1 5

Figure 7 Shifts in the Supply Curve Price of Supply curve, S 3 Ice-Cream curve, Supply S 1 Cone Supply curve, S 2 Decrease in supply Increase in supply Quantity of Ice-Cream Cones Copyright©2003 Southwestern/Thomson Learning

How suppliers will react to a change in price. Elasticity of Supply How suppliers will react to a change in price.

Demand changes the supply Elastic Demand changes the supply Ex.

Demand does not change supply with price Inelastic Demand does not change supply with price Ex.

Labor and Output All business owners must decide how many workers they will hire. The addition of new workers will increase production until it reaches its peak, at which point, production actually decreases.

Marginal Returns The addition of more workers to a firm allow for a greater amount of specialization. Specialization increases the output and the firm enjoys increasing marginal returns.

Marginal Returns, cont. Eventually, though, the benefits of specialization end and the addition of more workers increases total output but at a diminishing rate. A firm with diminishing marginal returns will produce less and less output from each additional unit of labor. Answer: 5 beanbags per hour What is the marginal product of labor when the factory employs five workers?

Fixed Costs Production costs are divided into two categories - fixed costs and variable costs. Fixed costs mainly involve the production facility and include: Rent Machinery repair Property taxes Worker’s salaries

Variable Costs Variable costs include: Price of raw materials Some labor Electricity and heating bills Fixed costs and variable costs are added together to find the total cost.

Change in Cost Fixed Costs - FC Do NOT Change when products are produced RENT Property Taxes

Change in Cost Variable Costs - VC DO Change when products are produced Total Cost = FC + VC Electricity Hourly Workers Raw Materials

Shifting Supply Why does the supply curve shift? Several factors (Called Determinants) cause the supply curve to shift. These include: Shifts in prices Rising costs Technology Changes in the global economy Future expectations of prices Number of suppliers

Input Costs Any changes in the cost of an input used to make a good will affect supply. A rise in the cost of raw materials, for example, will result in a decrease in supply because the good has become more expensive to produce. The high input costs that dairy farmers pay for feed, labor, and fuel result in higher prices for milk and other dairy products.

Rising Costs and Technology If costs continue to rise, a firm will have to cut production and lower its marginal cost. It is possible for input costs to drop. In many industries, advances in technology can lower production costs. Examples of technology advances include: Automation Computers E-mail

Government’s Influence In addition to input costs, the federal government also has the power to affect the supplies of many types of good. Subsidies The government often gives subsidies to the producers of a good. Subsidies generally lower cost, which allows a firm to produce more goods. Reasons for subsidizing products include: To provide for people during food shortages To protect young industries from foreign competition.

Government Influences, cont. Subsidies The government helps pay for the product Such as milk, the government helps keep the product’s price low, and increases the supply Regulation and taxes Indirectly, government regulation often has the effect of raising costs. When the government regulated the auto industry to cut down on pollution, these regulations led to an increase in the cost of manufacturing cars Taxing things such as cigarettes and alcohol decreases supply

Non-Price Influences Changes in the global economy Since many goods and services are imported, changes in other countries can affect the supply of those goods. An increase in wages in one country or the increased supply of a good in another will cause the overall supply curve to shift. Restrictions on imports also affect supply.

Shifts in the Supply Curve Factors that reduce supply shift the supply curve to the left, while factors that increase supply move the supply curve to the right. Which graph best represents the effects of higher costs? Which graph best represents advances in technology? Answers: 1. Decrease in Supply graph. 2. Increase in Supply graph

Future Expectations of Prices Checkpoint: What happens to supply if the price of a good is expected to rise in the future? If a seller expects the price of a good to rise in the future, the seller will store the goods now in order to sell more in the future. If the prices of good is expected to drop in the near future, sellers will earn more by placing goods on the market immediately, before the price falls. Checkpoint Answer: Supply will decrease. Checkpoint Answer: Supply will decrease.

Number of Suppliers If more suppliers enter a market, the market supply will rise and the supply curve will shift to the right. If suppliers stop producing a good and leave the market, market supply will decline, causing the supply curve to shift to the left.

Where do Firms Produce? Checkpoint: When is a firm likely to locate close to its consumers? A key factor in where a firm will locate is transportation. When inputs such as raw materials are expensive to transport, a firm will locate close to the inputs. When outputs (the final product) are more costly to transport, firms will locate close to the consumer. Checkpoint Answer: When the final product is more expensive to transport. Checkpoint Answer: When the final product is more expensive to transport.