Supply, Demand and Competition

Essential Question: How are prices set? Both Buyer and Seller

Setting an Economy’s Price System  To understand how a nation’s economy functions it is important to understand the nation’s price system  The forces that determine price are called the forces of supply and demand  The place where these two forces meet is called the marketplace

Basic facts  Consumers have a great influence on the price of goods and services.  Why?  Market : Represents the freely chosen action between buyers and sellers.  Voluntary exchange : Buyers and sellers work out a deal that suits both sides.

Demand  Demand shows how many of a product consumers are willing and able to buy at a particular price during a specified time period.  e.g. Swimming suits have a different price and quantity demanded in summer vs. winter  How many of you would like a new car?  How many of you are able?

Law of Demand  Explains the amount people are willing to buy as prices change.  Demand can only occur if a buyer is willing and able to buy.  Three factors that affect what and how much people buy are diminishing marginal utility, real income, and substitution. Price goes up – Demand goes down Price goes down – Demand goes up

Diminishing Marginal Utility (DMU)  Utility : Power of a good or service to satisfy.  Total satisfaction rises with additional units purchased, but additional satisfaction diminishes.  People will buy until price exceeds satisfaction.  Price decreases, people will buy more.

Real Income Effect  Income limits the amount of money people can spend.  People cannot keep buying the same amount if price increases and income stays the same. (Real income effect).  People are forced to trade-off if price increases.  If price decreases and you buy the same amount, your real income has increased.

Demand Curve  Demand Curve is a line graph that shows the amount of a product that will be purchased at each price; it shows an inverse relationship and is always downsloping  p D Qd

Remember:  A change along the curve indicates a change in price and a change in quantity demanded  A change of the curve (right or left) indicates an across the board change in demand

Law of Demand  As price decreases, the quantity demanded increases. As the price rises, the quantity demanded decreases  PQD Price per gallon of water Bottles per week $JoPat

Demand for hot chocolate in December at the skating rink Price Quantity Demanded $.5030 $ $ $ $ $3.005 $3.500

Demand Determinants  Characteristics that will affect the amount people will buy. Includes changes in population, income, and personal preferences. Prices of related goods, income, preference/taste, consumer expectations, population change

Demand Determinants  Prices of Related Goods  Substitutes: Goods that are related in such a way that an increase in the price of one leads to an increase in the demand for the other [goods that can be consumed in place of one another] (Pepsi and Coke)  Compliments : Goods that are related in such a way that an increase in the price of one leads to a decrease in the demand for the other [goods that are normally consumed together] (hamburgers and french fries)

Determinants cont.  Income  Normal Good : a good for which demand increases as consumer incomes rise (milk)  Inferior Good : A good for which demand decreases as consumer incomes rise (ground chuck, bus rides)  As income rises consumers tend to switch from consuming these inferior goods to consuming normal goods (ex. steak, car/plane)

Determinants cont.  Preference/Taste  Likes and dislikes in consumption  Consumer Expectations  Change in future price of goods  Change in future income  Population Change  As the number of consumers in a market changes the demand will change

Law of Supply  The amount producers are willing to provide at various prices.  As price increases, supply increases.  As price decreases, supply decreases.  Law of diminishing returns : Adding units of a factor of production will increase output for a time. Eventually output will decrease.

Supply Schedule & Curves  A Supply Schedule displays the quantity of a product supplied at each price Price Per Bottle Bottles Supplied

Supply of shovels before a large snowstorm sold at Lowes Price Quantity Supplied $4.005 $ $ $

Determinants of Supply  Technology  If more efficient technology is discovered production costs will fall  So suppliers will be more willing and able to supply more of the good at each price  Price of Relevant Resources  Those resources employed in the production of a good.

Determinants con’t  Prices of Alternative Goods  Price of a good that uses some of the same resources as used to produce the good in question  Producer Expectations  Shift production according to future prices  Number of Producers  # of Prod. Increases # of supply  Government Restrictions  Taxes, quotas, licenses, etc.

Supply and Demand  If price falls, demand will increase and supply will decrease.  If price rises, demand will decrease and supply will increase.  Equilibrium price : Point where supply and demand meet.  Shortage and surplus :  When demand is greater than supply, a shortage occurs.  When supply is greater than demand, a surplus occurs.  Prices will rise in a shortage and fall in a surplus.

Price Controls  Price Ceiling – Gov’t set maximum price that can be charged for a good or service  Price Floor -- Gov’t set minimum price that can be charged for a good or service

Price Elasticity  How consumers react when prices change.  Elasticity is determined by:  Existence of substitutes.  Percentage of income spent on a good or service.  Time allowed to adjust to a change.

Elastic : Many competing brands. Price increases, people choose a substitute. Inelastic : Not much competition. Price increases, demand does not change. Types

Steak: Elastic or Inelastic ?  Elastic  Why? People as a whole can do without steak and will substitute chicken or other protein for expensive steak

Milk: Elastic or Inelastic ?  Inelastic  Why?  The population as a whole can do without steak….but can not do as easily without milk…especially families with children

Gasoline: Elastic or Inelastic ?

What Products are Subject to Elastic Demand ?  Luxury Items – Most customers want luxuries and will consider buying them if price drops  If Price Represents a Large Portion of Family Income  e.g. Mortgage Rates drop from 6.5 to 5.5% people will “refinance”  Availability of Substitute Items  e.g. Steak /chicken  Durable Goods  Computers, cars, washers, dryers will be in greater demand if the price drops

What Products are Subject to “Inelastic Demand”?  Necessities (milk, gasoline)  Drugs  Legal (heart medicine antibiotics)  Illegal (heroin, cocaine)  Products with no good substitute  insulin, cancer drugs, etc.  salt in Middle Ages (preservative)

Why is Elasticity of Demand Important ?  What happens if a florist increases the price of roses 400 % in October ? Will sales go up or down ?  A. Probably, down  What happens if a florist increases the price of roses on February 14 th ? Will sales go down or up?  A. Probably up Why ? Frantic husbands and boyfriends will pay exorbitant prices for a dozen roses on Valentine’s Day.

Competition  Competition will exist if different businesses produce similar products.  Perfect Competition 1. Large Market 2. Similar Product 3. Easy entry and exit 4. Information obtainable 5. No control over price  Market Price is equilibrium price. (decided by supply and demand)

Imperfect Competition  One group can have an impact on price.  Monopoly  Oligopoly  Monopolistic Competition  Barriers to entry:  Government regulations : Some goods and services are protected from duplication by the government.  Cost of getting started : Large amount of capital is needed to begin.  Ownership of raw materials : Companies control materials and do not sell to competitors.

Monopoly  One group controls the market. 1. Single seller 2. No substitutes 3. No entry 4. Complete control over price  Suppliers can raise prices without losing business.

Types of Monopoly 1. Natural : Control of resources. Water company 2. Geographic : Control of location Dick’s is the only sports store in the area 3. Technological : Patent on technology 4. Government : Created by the government. Illegal to enter. Post office 5. Cartel : International form of monopoly (OPEC).

Oligopoly  A few businesses in competition. 1. Domination of a few sellers 2. Barriers to entry 3. Identical or slightly different products 4. Some control of price  Price wars are common place.

Oligopoly Examples  Movie Studios  Columbia, 20 th Century Fox, Warner Bros., Paramount, Universal, and MGM  Television  Disney/ABC, CBS Corp., NBC Universal, Time Warner, and News Corporation  Food Processing  Kraft Foods, PepsiCo, and Nestle  Telecommunications  AT&T, Verizon, Sprint, and T-Mobile

Monopolistic Competition 1. Numerous sellers 2. Easy entry 3. Different products 4. Competition 5. Some control of price  Substitution and advertising are factors.

Mergers  One company joins with another.  Horizontal : Companies in the same business.  Vertical : Company joins with one it buys from.  Conglomerate : Buying of un- related businesses.

Vertical or Horizontal?  Google and Bing  Horizontal  Paper Company and Saw Mill  Vertical  Tostitos and Corn Fields  Vertical  Harris Teeter and Ace Hardware  Conglomerate  Pepsi and Coke  Horizontal

Government policies  Late 1800’s the railroad industry was the biggest in the United States.  Theodore Roosevelt set out to stop monopolies with his “trust-busting” policy, which would break up large businesses.  All mergers must be approved by the Government.