Words you need to know Market Demand/Supply Quantity Demanded/Supplied Change In Quantity Demanded/Supplied Change in Demand/Supply Equilibrium Price(Market clearing price) Surplus/Shortage

Markets Markets are where buyers and sellers trade We will look at only pure competitive markets These markets are the supply market and the demand market (resource and product)

Defining Demand a. willingness to purchase b. ability to purchase c. desire to purchase Demand must quantify the quantity demanded at each price for a specific period.

Law Of Demand Ceteris paribus, as P (Price) increases the quantity demanded of a product declines So there is an inverse relationship between P (price) and the quantity demanded. Consumers will buy more at lower prices than at higher prices. This is the law of demand. MEMORIZE IT! In this case ceteris paribus refers to anything that can affect demand or the quantity demanded except P

Explanations Why does the law of demand exist? 1. DMU-diminishing marginal utility 2. Income Effect 3. Substitution Effect The curve slopes downward from the left to indicate the inverse relationship between P and QD. This means that as P and QD change we can only move along the demand curve that already exists. We cannot move the curve itself to the left or to the right.

Fuller Explanations DMU-the decrease in added satisfaction as one consumes additional units of a product… less utility or satisfaction than the first Income Effect: a lower price increases the power of money to purchase without increasing or decreasing actual income Substitution Effect: a lower price gives incentive to substitute a lower priced good for a “now” relatively higher priced one

The “Other” things affecting Demand other than P Things other than P (which causes changes in QD only) can cause changes in Demand itself. These changes will indicate a movement of the Demand Curve itself and not movement along an existing Demand curve. Yes, I’ll explain. This is probably the most difficult thing to understand because we casually misuse the term demand in conversation and by doing so misunderstand it intellectually as well.

3. Changes in Income of consumers (normal goods and inferior goods) Determinants of demand that will indicate changes in the position of the demand curve 1. Tastes of consumers 2. Number of consumers 3. Changes in Income of consumers (normal goods and inferior goods) 4. Prices of related goods 5. Expectations of consumers

Supply and its law The Law of Supply: Producers will produce and sell more of their product at a high P than at a low P. So, there is a direct relationship between price and QS (quantity supplied.) The concept of the Law of supply is foreign to us. It will be hard for you to forego your consumer mentality when looking at supply. Just be aware of this.

On the board to the left… You will see a supply schedule and a graph that indicates a supply curve based on that supply schedule. A supply schedule indicates the amount of a product that producers are willing to sell at a variety of prices. The curve illustrates this. What does all of this mean?

Explanations Incentives with higher prices for producers There are some constraints on production even at higher prices. QS will only change with a change in P. A change in QS will be indicated ONLY by movement along an existing supply curve. Changes in the ceteris paribus conditions of non price determinants can and will result in a movement of the S curve itself. We have already run into this with Demand so you should be more familiar with it now.

1. Changes in resources prices 2. Changes in technology Determinants of Supply that will indicate changes in the position of the supply curve itself 1. Changes in resources prices 2. Changes in technology 3. Taxes and subsidies 4. Prices of related goods (if P of substitute gd increases) 5. Expectations 6. Number of sellers

On the board to the left… Several graphs have been supplied to show how supply may change in response to changes in supply determinants. Changes that increase supply will move the supply curve to the right; those that decrease supply will move the supply curve to the left. Important: you must be able to distinguish between a change in QS because of a change in P and a change in S because of a change in something other than price.

Combining Supply and Demand or creating equilibrium The point where demand curve and supply curve intersect is the equilibrium point in this particular market. That is where the EQP and EQQ are. At prices above EQP there is a surplus At prices below EQP there is a shortage EQP is also called the market clearing price There is also an EQQ or equilibrium quantity. We do not say demand and supply are equal at the equilibrium point instead we simply call it the equilibrium price and quantity point.

Rationing function of price In a free market the movements of price are essentially the governors of how much of a product can be produced and sold. What this means is that price serves as a means of rationing goods and services.