Economics for Leaders Open Markets: Demand and Supply

Economics for Leaders Choices are made at the Margin Our only choice is the next choice Marginal = additional, next, a little more or a little less

Economics for Leaders How much should we do? Work Play Study Sleep

Economics for Leaders As long as the marginal benefit is greater than the marginal cost you should continue the activity MB=MC

Economics for Leaders Price IS an extremely powerful incentive Analyze: When the money price changes, the opportunity cost of using a good or resource changes. The changed opportunity cost provides an incentive for people – consumers and producers – to change their behavior. ERP #3: People respond to incentives in predictable ways.

Economics for Leaders How are prices set? By the Market! Interaction of buyers (consumers) and sellers (producers).

Economics for Leaders Necessary Conditions for markets 1.) Property Rights 2.) Clear “Rules of the Game” 3.) Freedom to Exchange 4.) Information

Economics for Leaders When incentives (Prices) change, behavior changes in predictable ways. When prices go up consumers demand a larger/smaller quantity? Demand willingnessability The willingness and ability to purchase goods and services at various prices.

Economics for Leaders When incentives (Prices) change, behavior changes in predictable ways. When prices go up consumers demand a larger/smaller quantity? Smaller When prices go down consumers demand a larger/smaller quantity? Larger Always? Law of Demand P Q

Economics for Leaders LAW OF DEMAND Price Demand As the price of a product increases, consumers buy less of a product ~~~~~~~~~~~~~~~~~ As the price of a product decreases, consumers buy more of a product increases

Economics for Leaders The Law of Demand If P then QD and If P then QD Note: What causes the change in the consumers’ behavior ? (think: price effect)

Economics for Leaders What Is the Law of Demand? The law of demand is the result of two separate behavior patterns that overlap, the substitution effect and the income effect. These two effects describe different ways that a consumer can change his or her spending patterns for other goods.

Economics for Leaders The Substitution Effect and Income Effect The Substitution Effect The substitution effect occurs when consumers react to an increase in a good’s price by consuming less of that good and more of other goods. The Income Effect The income effect happens when a person changes his or her consumption of goods and services as a result of a change in real income.

Economics for Leaders The Demand Schedule An Individual demand schedule is a table that lists the quantity of a good a person will buy at each different price. Chapter 4, Section 1 A market demand schedule is a table that lists the quantity of a good all consumers in a market will buy at each different price. Demand Schedules Individual Demand Schedule Price of a slice of pizza Quantity demanded per day Market Demand Schedule Price of a slice of pizza Quantity demanded per day $.50 $1.00 $1.50 $2.00 $2.50 $ $.50 $1.00 $1.50 $2.00 $2.50 $ jf What is the difference between a market and individual demand schedule?

Economics for Leaders The Demand Curve Market Demand Curve Slices of pizza per day Price per slice (in dollars) Demand Chapter 4, Section 1 A demand curve is a graphical representation of a demand schedule. Three characteristics of every demand curve: 1.Downward sloping 2.Must assume ceteris paribus: EVERYTHING ELSE REMAINS THE SAME 3.Relationship between price and quantity What is the one factor that causes a shift in the quantity demanded? PRICE!!

Economics for Leaders Pictures of Demand Price QD 0 $8 90

Economics for Leaders Movement along the demand curve price. 1.) is a result in a consumer changing their behavior based on a change in price. 2.) Increase in quantity demanded is demonstrated by moving down the demand curve 3.) Decrease in quantity demanded is demonstrated by moving up the demand curve Why can’t a change in demand from other factors be demonstrated by moving along the demand curve?

Economics for Leaders Changes in Demand Demand Shifters: When we drop the ceteris paribus rule and allow other factors to change we no longer move along the demand curve. Instead, the entire demand curve shifts

Economics for Leaders Shift=Change in demand Means At every price, consumer buy a different quantity than before

Economics for Leaders Drinking beer will help you lose weight! Americans Demand more Beer! Americans demand more pints of beer at every price An increase in demand appears as a shift to the right D1-origanl demand curve D2 – New demand curve adjusted for beer causing weight loss.

Economics for Leaders Drinking beer will turn your teeth black and your skin to break-out in permanent acne! Americans demand less beer! Americans demand less beer at every price! A decrease in demand appears as a shift to the left D- original demand curve D1-adjusting for beer causing black teeth & pimples

Economics for Leaders What influences demand? Demand Shifters Income Consumer Expectations Population Taste and preference and advertising Price of related goods

Economics for Leaders 1.) Income Most products we purchase are normal goods If, Ben’s income increases from $200 per week to $300 per week, it will cause him of buy more Starbuck’s ground coffee at every price level. If we plotted his new demand schedule on a graph it would produce a curve to the right of Ben's original curve. For each of the prices on the vertical axis, the quantity demanded will be greater for normal goods This is called an increase in demand

Economics for Leaders Inferior goods are goods that you would buy in smaller quantities, or not at all, if you income were to rise and you could afford something better. Ben gets demoted. He takes a pay-cut - his income decreases He now instead of making $200 dollars a week, he is making $50.  He can’t afford his Starbucks! He now has to buy Folgers; and less Starbucks  This causes a decrease in his demand for Starbucks & the demand curve to shift to the left. Income increases- Starbucks demand increases at every price Income decreases: Starbucks demand decreases at every price

Economics for Leaders 2.) Consumer Expectations: Our expectations about the future can affect our demand for certain goods today Ms. Morse has been eyeballing a pair of Jimmy Choos for months. A very nice salesperson lets me know the price on the shoes will go up in a week I’m buying the shoes today to make sure I get the lower price The expectation of a higher price in the future causes my immediate demand to increase!

Economics for Leaders What if the salesperson lets me know that the shoes are going to be on sale next week! My immediate demand for my Jimmy Choos is going to fall to zero! I’m going to wait to buy the shoes next week If expectation that price will drop, current demand will decrease.

Economics for Leaders 3.) Population When the population grows, what do they need; what do they demand? there is an increase in demand for goods and services

Economics for Leaders 4.) Consumer Tastes and Advertising Fanny packs – who would have thunk this would trend? How about Ed Hardy? People used to pay $65- $100 per t-shirt. Now you can get them for $4.99 at Ross! Rock Rivals, Uggs, Air Jordans – how long will these trends last? Changes in taste and preferences cannot be explained by changes in income or populations or worries about future price increase

Economics for Leaders Companies spend copious amounts of money on advertising; hoping to increase demand – seems like it’s paying off. All you have to do is consider the amount of money spent on one minute of advertising during the Super Bowl every year.

Economics for Leaders 5.) Price of Related Goods The demand curve for one good can be affected by a change in the demand for another Complements: Demand for skis go up Demand for ski boots go up Price $ increase in skis go up What happens to the demand for skis? How about the demand for ski boots?

Economics for Leaders Substitutes If the price of snowboard rises, what would the effect on the demand for skis? Snowboards are considered a substitute for skis, because consumer often buy one or the other, but not both. Demand for skis will increase What if there is a decrease in the price of snowboards? How would this affect the demand for skis? Consumer will buy fewer skis at every price.

Economics for Leaders Demand shifters: examples What will happen to the demand for hamburger if the price of hotdogs increases? What will happen to the demand for Snickers if it is discovered that chocolate makes you beautiful?

Economics for Leaders Shifting the Curve (cont.) An increase in demand is shown by moving the demand curve to the right – What would cause an increase in demand? A decrease in demand is shown by moving the demand curve to the left – What would cause a decrease in demand? ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Economics for Leaders What Is Elasticity of Demand? Demand for a good that consumers will continue to buy despite a price increase is inelastic. Elasticity of demand is a measure of how consumers react to a change in price. Demand for a good that is very sensitive to changes in price is elastic. Chapter 4, Section Why would a prescription drug, like insulin, have inelastic demand for a person with diabetes?

Economics for Leaders The elasticity of demand determines how a change in prices will affect a firm’s total revenue or income. Elasticity and Revenue: A company’s total revenue is the total amount of money the company receives from selling its goods or services. Firms need to be aware of the elasticity of demand for the good or service they are providing. If a good has an elastic demand, raising prices may actually decrease the firm’s total revenue.

Economics for Leaders Elasticity and Revenue Elastic Demand: Total revenue rises As the price is lowered…. As the price is raised…. Total revenue falls

Economics for Leaders Elasticity and Revenue Inelastic Demand: Total revenue falls As the price is raised….

Economics for Leaders Factors Affecting Elasticity Chapter 4, Section What are some other factors that you feel could impact a consumers response to a change in the price of a product?