DEMAND Section 4.1

Demand Two requirements for demand – the desire to own something, and – the ability to pay for it An inverse relation of quantity demanded and price of a good

The Law of Demand Consumers buy more if price decreases and less if price increases As price drops, demand rises

Demand Curve A graphic representation of a demand curve Vertical axis – Price of the good Horizontal axis – Number of units demanded of the good Price $ Demand units

Demand Schedules Demand Schedule – A table that lists the quantity of a good each person will buy at each different price Market Demand Schedule – A table that lists the quantity of a good that all consumers in a market will buy at each different price

Simple Demand Curves Demand CurveMarket Demand Curve

Demand for Cookies Demand ScheduleDemand Curve

Substitution Effect A substitute is a nearly equivalent good If the price of pizza goes up, you might substitute tacos. When consumers react to an increase in a good’s price by consuming less of that good and more of other goods

Income Effect The change in consumption resulting from a change in real income Consumption – the amount of a good that is bought As income increases, demand increases

SHIFTS IN THE DEMAND CURVE Section 4.2

Ceteris paribus “all other things held constant” Economists simplify models by changing only one thing at a time

Shift in the Demand Curve Price $ Demand units Price $ Demand units Price $ Demand units Change Along a Curve Left Shift Decrease in Demand Right Shift Increase in Demand Demand Decrease Demand Increase

Changes in Demand Income – People buy more if income increases Expectations – People buy more if the economy is improving Population – Demand increases if the number of customers increases Tastes and advertising Prices of related goods

Related Goods Complements – purchased along with other goods skis ski boots Substitutes – purchased in place of other goods skis snowboards

Effect of Related Goods on Demand Increase in price for one good reduces demand for complementary goods – Price of skis ↑ Demand for skis ↓ Demand for ski boots ↓ Increase on price of one good increases demand for substitute goods – Price of skis ↑ Demand for skis ↓ Demand for snowboards ↑

ELASTICITY OF DEMAND Section 4.3

Definitions Elasticity of Demand – How consumers react to a change in price Inelastic Demand – Demand is NOT SENSITIVE to a change in price – If price changes, demand does NOT change Elastic Demand – Demand is VERY SENSITIVE to a change in price – If price changes, demand DOES change

Factors Affecting Elasticity Availability of substitutes Relative importance Necessities vs. luxuries Changes over time

Test for Elasticity of Demand ELASTIC 1.There are substitutes, or 2.Buyer’s budget is limited, or 3.Good is perceived as a luxury INELASTIC 1.There are no substitutes, or 2.Buyer’s budget is not limited, or 3.Good is perceived as a necessity

Supply Chapter 5

UNDERSTANDING SUPPLY Section 5.1

Thinking Backwards Now you understand DEMAND – You naturally think like a CONSUMER – Demand occurs AFTER the goods are made You must think backwards to understand SUPPLY – You must think like a SUPPLIER – Supply planning occurs BEFORE the goods are made

Supply – The amount of goods available Quantity Supplied – The amount of a good offered for sale at a specific price

The Law of Supply Law of Supply – The tendency of suppliers to offer more of a good at a higher price – New suppliers will enter a market as prices rise – DIRECT relationship between price and supply Price $ Quantity Supplied units

Simple Supply Curves Individual Supply CurveMarket Supply Curve

Supply of Cookies Supply ScheduleSupply Curve

Elasticity of Supply – The measure of the way quantity supplied reacts to a change in price Inelastic Supply – Supply is NOT SENSITIVE to a change in price – Agricultural products in the short term Elastic Supply – Supply is VERY SENSITIVE to a change in price – Barber shops in the short term

COSTS OF PRODUCTION Section 5.2

Cost Elements (Consumables) Labor – Workers assigned to production of a good or service Materials – Other resources required to produce a good or service

Production Costs Fixed – Does not change, no matter how much output is produced Variable – Rises or falls depending on the level of output Total – Fixed plus variable costs Marginal – Cost of producing one more unit of output

Marginal Analysis - Revenue Marginal Revenue – Revenue received from one additional unit of output – Usually the market price Total Revenue – Revenue received from all units of output at each level

Marginal Analysis - Cost Marginal Cost – Cost to produce one additional unit of output Total Cost – Cost to produce all units of output at each level

Marginal Analysis - Profit Profit – Total Revenue minus Total Cost Marginal Profit – Profit generated by one additional unit of output – Marginal Revenue – Marginal Cost

Production Cost Schedule

Optimum Production Level - 1 Total Cost and RevenueMarginal Cost and Revenue

Optimum Production - 2

Maximum Profit when MC = MR

Conclusion The optimum production level is the one that gives maximum profit Maximum profit occurs when Marginal Cost = Marginal Revenue

Marginal Product of Labor Increasing the number of workers increases the output of the good or service, until … Increasing Marginal Returns More workers – more output Diminishing Marginal Returns More workers – less output Negative Marginal Returns More workers – output stops

Marginal Product of Labor – cont’d. Adding workers improves productivity … until it doesn’t “Too many cooks spoil the broth”

CHANGES IN SUPPLY Section 5.3

Shifts in the Supply Curve Firms change the supply in order to maximize profits

Factors That Affect Supply Input Costs Government Influence Global Economy Other Influences Supplier Location

Input Costs Higher Costs → Lower Profits – e.g., higher raw material costs – Marginal costs increase – Firms reduce supply Lower Costs → Higher Profits – e.g., higher process efficiency from improved technology – Marginal costs decrease – Firms increase supply

Government Influence Subsidies – Payments by the government to firms – Encourage production by lowering costs – e.g., farm subsidies Excise taxes – Payments collected by the government from firms – Discourage production by raising costs – e.g., cigarette and alcohol taxes

Government Influence (cont’d.) Regulation – Government intervention in the market that affects price, quantity or quality – Usually increases costs Compliance with regulation Design changes – Can decrease revenue Restrictions on advertising – Firms often reduce supply

Influences of Global Economy Changes in supply in manufacturing countries Import restrictions Ban – import not allowed Quota – limited number of imports Duty – tax on imports – Import restrictions affect supply Reduce supply directly Increase costs

Other Influences on Supply Future Expectations – Expected price rise Sellers hold product off the market until prices rise – Expected price drop Seller push supply onto the market to capture the current price Number of Suppliers – As suppliers enter the market, supply increases – As suppliers leave the market, supply decreases

Supplier Location Transportation costs – If transportation costs are high, suppliers tend to be local Truck, train delivery e.g., bottled water – If transportation costs are low, suppliers can be farther away Internet delivery e.g., customer service call centers

Prices Chapter 6

COMBINING SUPPLY AND DEMAND Section 6.1

Market Equilibrium Equilibrium – The point at which quantity demanded and quantity supplied are equal Equilibrium Price – The price at which the market is in equilibrium Disequilibrium – When the quantity supplied is not equal to the quantity demanded in a market

Equilibrium Point Equilibrium Price – The price at which supply and demand are equal Equilibrium Quantity – The quantity at which supply and demand are equal Price $ Quantity Demand Supply

Supply and Demand for Pizza Equilibrium Price Equilibrium Quantity

Disequilibrium and Excess Disequilibrium – Any price or quantity not at equilibrium – When quantity supplied is not equal to quantity demanded in a market Excess Demand – Quantity demanded is more than quantity supplied at a given price Excess Supply – Quantity supplied is more than quantity demanded at a given price

Excess Demand for Pizza Supplier sets a price BELOW EQUILIBRIUM PRICE Consumers DEMAND MORE than the firm can provide Demand exceeds supply EXCESS DEMAND

Excess Supply for Pizza Supplier sets a price ABOVE EQUILIBRIUM PRICE Consumers DEMAND LESS than the firm can provide Supply exceed Demand EXCESS SUPPLY

Excess Supply Example Wall Street Journal, 11 March, 2009

Government Intervention Usually intended to benefit one party over another Price Ceiling – Government sets a MAXIMUM price that can be charged for a good or service Price Floor – Government sets a MINIMUM price that can be charged for a good or service

Price Ceilings Price BELOW EQUILIBRIUM PRICE stimulates demand Creates EXCESS DEMAND

Price Floor Price ABOVE EQUILIBRIUM PRICE stimulates SUPPLY Creates EXCESS SUPPLY Suppliers increase output – Agricultural price supports – Minimum Wage Workers supply Employers demand Price Floor

The Whole Story! Price - $ Quantity - Units Demand Curve Supply Curve Price Floor Price Ceiling Excess Supply Excess Demand P E, Q E QCQC QFQF PCPC PFPF Surplus Shortage

CHANGES IN MARKET EQUILIBRIUM Section 6.2

Causes of Disequilibrium Changes in supply or demand can move the equilibrium point Increase in supply – Moves supply curve to the right Decrease in supply – Moves supply curve to the left Increase in demand – Moves demand curve to the right Decrease in demand – Moves the demand curve to the left

Increase in Supply Lower production costs Firms are able to increase supply and lower price Demand adjusts to the new price Increased supply lowers price

Decrease in Supply A parts shortage limits the firms ability to produce output This results in a shift to the right New equilibrium point at a higher price Reduced supply increases price

Falling Demand Consumers lose interest in a product Demand curve shifts to the left New equilibrium point at a lower price Reduced demand lowers price

Market Structures Chapter 7

Types of Market Structures Perfect Competition Monopoly Monopolistic Competition Oligopoly

Characteristics of Markets Number of firms – Are there many sellers? Just a few? Only one? Are they well informed? Variety of goods – Do buyers have choices from among competing goods or services? Barriers to entry – How difficult is it for new sellers to enter the market? Control over prices – Are sellers able to set prices without regard for buyer preferences?

PERFECT COMPETITION Section 7.1

Perfect Competition Idealized model with no government intervention Singapore comes close

MONOPOLY Section 7.2

Monopoly Single supplier Often occurs in utilities – Public water – Natural gas – Electricity Supplier reaps all benefits of economies of scale

Monopoly (cont’d.) Natural Monopoly – A market that runs most efficiently when one large firm supplies all of the output Government Monopolies – Patent Exclusive right to sell a certain product – Franchise Exclusive right to sell a good within a geographic market – License Right to operate a business

MONOPOLISTIC COMPETITION AND OLIGOPOLY Section 7.3

Monopolistic Competition Many firms Some variety of goods Easy for firms to enter the market Firms do not control price Firms do not compete on price Differentiated Products

Price Discrimination Division of customers into groups based on how much they will pay for a good or service Occurs in healthcare – No insurance but has money usually pays highest price – Insurance pays price negotiated by the insurance company – No insurance but has no money Government pays negotiated price

Nonprice Competition Differentiation – Making a product different from other similar products Physical Characteristics – Automobiles Location – Real estate Service Level – Nordstrom’s vs. Macy’s Advertising, image, or status

Oligopoly Few large suppliers dominate Some variety of goods Difficult for competitors to enter Suppliers can control prices

Controlling Prices Suppliers in an oligopoly can work together to act like a monopoly Cooperation – Firms play follow-the-leader on price increases – Can lead to price wars Collusion – Secret agreements to control prices Cartel – Formal organization of suppliers

Market Structures Summary