1 Why do prices change? Inflation/Deflation (times of generally rising/declining prices) reflect the changes Change in market conditions for a particular product/service –change in factors that affect consumers’ demand for the good –change in factors that affect producers’ supply of the good

2 Consumer Demand Households get less satisfaction from later units of a product/service than they get from earlier units -- diminishing marginal utility (declining marginal value) –why the first run of the season down the ski slope is more exciting than the second –why the second donut doesn’t taste as good as the first Implies that consumers are only willing to buy more of a good if the price declines

3 Consumer Demand (cont.) Demand Curve - depicts the relationship between the price of the product and the quantity of the product that consumers will purchase. For this class, Demand Curves will always have a negative slope

4 Demand for Donuts Quantity of Donuts (in 1,000’s) Price/donut D1D1

5 What affects the shape/position of the demand curve? Household income –as income rises families increase their demand for “normal” goods and decrease their demand for “inferior” goods Household preferences –some people don’t like to eat sweet things in the morning while others do The availability and price of substitutes –e.g., bagels vs. donuts The availability and price of complements –e.g., coffee and donuts

6 Defining Terms Normal Goods: a good for which consumption increases as an individual’s income rises. Inferior Goods: a good for which consumption decreases as an individual’s income rises

7 Producer Supply Producers’ willingness to provide a product or service is dependent on the price they can get for the good/service in the market… –the higher the price, the more they are willing to produce Producers’ supply is a positive function of price For this class, Supply Curves will always have a positive slope

8 Supply of Donuts Quantity of Donuts (in 1,000’s) Price/donut S1S1

9 What affects the shape of the supply curve? Production technology –e.g., must donuts be made by hand or can a machine do it? Cost of inputs (a.k.a Input Costs) –e.g., price of labor, machines, space

10 Supply & Demand Intersect to Determine Market Price Quantity of Donuts (in 1,000’s) Price/donut S1S1 D1D1 P1P1 Q1Q1 E1E1

11 Examples... California has the best strawberry crop in years. What will happen to the price of chocolate and whipped cream? May shift demand for chocolate and whipped cream to the –right (increasing both equilibrium quantity and price). Strike of union workers may raise employee costs and shift supply curve to the left (raising equilibrium price and decreasing quantity).