Unit 2- Microeconomics: Prices and Markets Chapters 4-7

Unit 2 Chapters This unit covers: 4.1 4.2 4.3 5.1 5.2 6.1 6.2

Supply and Demand Chapter 4 Section 1

An Introduction to Demand DEFINED: Demand is the desire, ability, and willingness to buy a product. Knowing the concept of demand is really essential to learning how a market economy works. Knowledge of it is important sound business planning. It’s impossible to determine WHAT, HOW, and FOR WHOM to produce something if you don’t know if anyone wants it, or what they want. Demand is consumer-based. An Individual Demand Curve illustrates how the quantity that a person will demand varies, depending upon the price of a good or service. Example on Page 92 (Figure 4.1)

Quantity Demanded by Bill Second Example Demand Schedule for Taco Bell Tacos – Price ($) Quantity Demanded by Bill $5 $4 $3 1 $2 2 $1 4 $0.50 6

Demand Curve for Taco Bell Tacos Demand Curve for Taco Bell Taco’s $5 $4 $3 Cost of Taco’s $2 $1 0 1 2 3 4 5 6 Quantity Demanded By Bill

The Demand Curve Economists analyze demand by listing prices and desired quantities in a demand schedule (chart). When the demand data is graphed, it forms a demand curve with a DOWNWARD slope. QUESTION: Another example. Think of something you want to buy. Think of the price? At what price would you be willing to buy the item?

The Law of Demand (Pages 93-94) Defined: The Law of Demand states that the quantity demanded of the good or service varies INVERSELY with the price. When the price goes up, the quantity demanded goes down. When the price goes down, the quantity demanded goes up. (Think big sale).  A market demand curve illustrates how the quantity that all interested persons’ (THE MARKET) demand varies depending upon the price of a good or service. GRAPH ON PAGE 94 (Figure 4.2)

Market Demand Curve Adding Sarah and Greg to the taco chart gets the MARKET DEMAND CURVE. See below: Price ($) Quantity Demanded by Bill Quantity Demanded By Sarah Quantity Demanded by Greg Total $5 $4 $3 1 2 $2 5 $1 4 3 9 $0.50 6 13

Market Demand Curve for Taco Bell Tacos   $5 Cost $4 for Taco $3 $2 $1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity Demanded By Market

Demand and Marginal Utility DISCUSSION QUESTION: Why is price an obstacle to buying? Demand and Marginal Utility (Page 93) Marginal Utility is the extra usefulness or satisfaction a person receives from getting or using one or more unit of a product. Principle of diminishing marginal utility states that the satisfaction we gain from buying a product lessens as we buy more of the same product. The book gives the example of cola as an example of diminishing marginal utility. Food does not always follow this path as strictly as others Other examples include Xbox, cars (the same), shoes, etc http://www.youtube.com/watch?v=Cq7xP382FZg

Factors Affecting Demand Chapter 4 Section 2

I. Change in the Quantity Demanded The change in the quantity of demand shows a change in the amount of the product purchased when there is a change in price. Notice what happens to the quantity when $P goes up/down

Changes in Demand A change in demand is when people buy different amounts of a product at the same prices. As a result the entire demand curve shifts to the right to show an increase in demand OR to the left to show a decrease to in demand Thus creating an entirely new demand curve

Change in Demand (p. 99-102) A change in demand is when people buy different amounts of a product at the same prices. A change in demand can be caused by changes in the following: Income. If you get a raise you can afford more. If you lose your job, you can afford less. Tastes: In / Out of style Successful advertising. Bad PR hit (Milli Vanilli– lip syncing) Product becomes obsolete (Sony’s PlayStation lost customers to Xbox).

Substitutes and Complements A price change in a related product (substitutes) Coke/Pepsi; Butter/Margarine; Burger King/McDonalds – those are substitutes. The demand for a product tends to increase if the price of its substitute goes up and vice versa. A price change in a related product (complements) PS2s/Games; hot dogs/buns; DVDs/DVD players; etc. The use of one increases the use of the other. When price of one decreases, consumers buy more of both and vice versa. QUESTION: What are some examples you can think of?

Income Effect Means that as prices drop, consumers are left with extra real income. Vice Versa. How do people feel when the $P goes up? A B

Change in Demand Consumer expectations. Always deals with the way people think about the future. Stocking up before a big storm/hurricane. Choosing not to buy a product that may soon become obsolete/improved upon: Waiting for PS3 instead of a cheaper PS2 Waiting for 3D TV instead of buying plasma or LCD TV The number of buyers (consumers) More buyers, more total demand. Less buyers, less total demand.

Factors Affecting Demand On a piece of paper, list three “trendy” items that you really wanted, dating back to 2004. Try to determine which of the factors related to demand made them more or less desirable. Income Tastes: In/Out of style Successful advertising Bad PR hit Price change in related product (complement or substitute) Consumer expectations (future) Number of buyers

Tastes In / Out of style Successful advertising. http://www.washingtonpost.com/wp- srv/artsandliving/features/2013/year-in-review/the-list.html Successful advertising. Bad PR hit (Milli Vanilli and now Brittney Spears in Australia – lip syncing) http://www.youtube.com/watch?v=ovMNl0gGFNY Product becomes obsolete (Sony’s PlayStation 3 lost customers to PlayStation 4).

4. Consumer Expectations Always deals with the way people think about the future. Examples: Stocking up before a big storm/hurricane. Choosing not to buy a product that may soon become obsolete/improved upon: Waiting for PS3 instead of a cheaper PS2 Waiting for 3D TV instead of buying plasma or LCD TV

5. Number of Consumers More buyers, more total demand. Less buyers, less total demand.

McDonald’s Makeover Why would McDonald’s go to the trouble AND expense of redesigning its restaurant? http://www.youtube.com/watch?v=x32XrepgKvw

McDonald’s Makeover The company recognizes that the consumer demand is changing. Which means the company has to change too Or What?

McDonald’s Makeover Risk losing business to competitors that meets customer demands Such changes in demand have an effect on both the demand schedule AND the demand curve When it comes to demand – there are two types of changes 1. Price Changes while all other factors are the same OR 2. Other factors change while the price stays the same In the case of McDonald’s what are some of these “other factors?”

1. If the price goes from $20 to 12.50, how much money am I saving? 2. How might that make me feel? 3. What might I do with the extra savings? 4. Might this savings account for movement along the demand curve? 5. What happens in the opposite scenario? 6. Are there any real world examples you can think of?

Both Income Effect and Substitution Effect affects movement along the demand curve. The change in quantity demanded can either be an increase or decrease BUT the demand curve itself does not shift

Elasticity of Demand Chapter 4 Section 3

Focus Question Why do governments tend to tax items like gas, cigarettes and alcohol more heavily than things like vegetables or red meat? This is where we get deeper into the cause and effect relationship in economics.

Group Activity Groups of 4: (5 mins) List four things you purchase regular units of every week/month (example: gas). Write your list up on the board QUESTION TO CLASS: How much do you spend on each item? Are your purchases dependent upon price?

Dependent vs. Independent Variable http://www.youtube.com/watch?v=urQnwlm4F88 Elasticity tells us how a dependent variable – such as quantity demanded, responds to a change in an independent variable – such as price.

Elasticity Elasticity is a general measure of responsiveness; it tells us how a dependent variable – such as quantity demanded, responds to a change in an independent variable – such as price. Explaining dependant and independent: If you have 20 iPods ordered by a group of people, that number is pretty concrete. We know that only 20 iPods were ordered. Conversely, the price is an independent variable. It’s set by the supplier, and can be arbitrary – meaning anything the supplier wishes to order. Other measures, such as income or supply can also be understood in terms of elasticity.

Elastic Demand Vs Inelastic Demand

Elastic Demand Economists say that the demand is elastic when a given change in price causes a relatively larger change in quantity demanded. A B

Elasticity Consumers react to a change in the price of a good by changing the amount they demand. Of course, the size of the reaction – either higher or lower, and to what degree – can vary. This response is known as demand elasticity. The difference between ELASTIC and INELASTIC. When the quantity demanded for a good / service changes as a result of the price change, then the demand for that good is considered “ELASTIC”

Reasons for Elasticity Availability of Good Quality Substitutes: Easily substitutable goods will enable buyers to switch to an alternative good and thus such goods will exhibit greater elasticity than goods that do not have substitutes available. The better the substitute(s) can replace the original good in terms of desirability, affordability, practicality etc. the more elastic the good will become. A contrasting inelastic good would be water which is non- substitutable so a local community faced with rising water costs will be left with little choice but to pay the increased costs. Goods and services for which no substitutes exist are generally inelastic.

Reasons for Elasticity Whether the good is habit forming or obligatory: Addictive drugs, whether psychologically addictive or physically Goods where dependency plays a key role will naturally exhibit inelastic properties. Classic examples of such goods would be gasoline, alcohol and tobacco or in an extreme case, heroin. Governments often place taxes on these types of goods, because of their highly inelastic demand since consequently such goods are assured revenue generators. (GRAPHS ON PAGES 104-105.)

How do you determine Elasticity of Demand?  Demand Elasticity – also known as PED – price elasticity of demand is determined by a number of factors that essentially all fall under the umbrella of "choice". By choice we mean the power of choice that the consumer of a given good holds to give up the consumption of said good. How easy is it to give that item up and not buy it at all, or buy a substitute? The greater this choice the more price elastic the good will be and, by contrast, as the balance of this power falls in favor of the supplier the more inelastic the good will be.

Perceived Value Perceived Value represents the absolute maximum price a consumer is willing to pay for a good. When the price exceeds this level, the consumer will give up consumption of this good. Why aren’t more people dropping Verizon and AT&T and switching to T-Mobile and Sprint for cellular phone service when their pricing is so much better?

Perceived Value The proportion of the consumer's income the good represents: Goods which typically make up a small proportion of people's income will exhibit inelastic qualities. Conversely, goods which form a large proportion of people's income will cause greater responses in demand to comparable % increases or decreases in price. For example, if cinema ticket costs rise by 20%, decreases in demand are unlikely to be pronounced. However a 15% drop in a "luxury" good such as a car or LCD Television changes in demand are likely to be relatively greater.

Perceived Value How closely the good is defined: Taking our example from (# 2), cigarettes in general are, as discussed, an inelastic good. However a particular brand of cigarettes will exhibit far more elastic properties if its price rises. In general therefore, the exact type of good will affect its PED properties.

Perceived Value How closely the consumer (end-user) is defined?: “Choice" is very subjective and factors 1,2 and 3 vary relative to the individual consumer because every single consumer can potentially have a different Perceived Value of a good. At nationwide level, if the cost of butter rises significantly consumers can choose to consume margarine instead but a shop who makes and sells butter cookies will not have this option and thus the PED will be far more inelastic in the latter case. A driver faced with rising gas bills may opt to switch to using the train. However an airline company has no choice but to absorb rising fuel costs and will accordingly have a much more inelastic demand curve for essentially the same good.

Perceived Value How closely the time period is defined: The greater the time period, the more possible it may be for a good to be replaced with a substitute. Using home energy as an example, a gas user faced with rising gas bills will unlikely be able to switch to electric alternatives overnight. However over three months, a switch is far more viable and the PED will be accordingly more elastic. Likewise, prices are dynamic. Over short time periods, prices of substitutes maybe static, over longer periods, the price of substitutes may drop, making them more appealing.

What products can you think of where the graph looks like this?

A contrasting inelastic good would be water which is arguably non-substitutable so a local community faced with rising water costs will be left with little choice but to pay the increased costs forming a price inelastic good.

Determining Elasticity- Without Math CAN THIS PURCHASE BE DELAYED? If YES – elastic If no – inelastic What is the Availability of Good Quality Substitutes? Easily substitutable goods will exhibit greater elasticity. Whether the good is habit forming or obligatory. Does the purchase use a large portion of income? If amount is large, then demand tends to be elastic. If the amount is small, the demand tends to be inelastic.

Chapter 5: Supply

What is Supply? Chapter 5 Section 1

Supply The concept of supply is based on voluntary decisions made by producers (both big and small) A producer might decide to offer one amount for sale at one price and a different quantity at another price Amount of a product offered for sale at all possible prices (that could prevail in the market place)

Law of Supply Because producers receive payment for their products, they will offer more at higher prices Principle that more will be offered for sale at higher prices than at lower prices http://video.yahoo.com/watch/398277/2357614

Supply Schedule/Curve Is a listing of the various quantities of a particular product supplied at all possible prices in the market. Supply curve – a graph Showing the various Quantities supplied at All possible prices That might prevail in the Market any given time

Law of Supply/Demand For the Law of Supply, quantity varies DIRECTLY with price, rather than INVERSELY. OR It slopes in the opposite direction (of demand)

Individual and Market Supply Curves Bill, Duane and Sarah are all babysitters. Each supplies their services on an hourly basis for a fee.   At $20 an hour, Bill will make himself available for 30 hours a week. At $15 an hour, he is still willing to work up to 30 hours. At $12 an hour he is only available for 25 hours a week. At $10 an hour, he is willing to work 20 hours a week. At $8 an hour, he’ll work 10 hours. At $5 an hour, he’ll work five hours. And at $3 an hour, he would rather do homework and won’t work any hours. At $20 an hour, Duane will make himself available for 20 hours a week. At $15 an hour, he is willing to work up to 18 hours. At $12 an hour he is only available for 15 hours a week. At $10 an hour, he is willing to work 10 hours a week. At $8 an hour, he’ll work 5 hours. At $5 an hour, he’ll work 2 hours. And at $3 an hour, he too would rather do homework and won’t work any hours. At $20 an hour, Sarah will make herself available for 30 hours a week. At $15 an hour, she is still willing to work up to 30 hours. At $12 an hour she continues to be available for 30 hours a week. At $10 an hour, she is willing to work 20 hours a week. At $8 an hour, she’ll work 15 hours. At $5 an hour, she’ll work 10 hours. And at $3 an hour, she’ll work 5 hours.

Individual Supply Schedule Bill Duane Sarah $ Price Quantity Supplied $Price Quantity Supplied $20 $15 $12 $10 $8 $5 $3 30 25 20 10 5 18 15 2

Market Supply Chart $ Price Quantity Supplied $20 $15 $12 $10 $8 $5 $3 80 78 70 50 30 17 5

Graph of Market Supply Curve   $25 $20 * $15 * * $10 * $5 * 10 20 30 40 50 60 70 80 A Change in the Quantity Supplied Is the change in amount offered for sale in Response to a change in price.

Change in Supply Sometimes something happens to cause a change in supply A situation where suppliers offer different amounts of products for sale at all possible prices in the market This is NOT the same as quantity supplied Why? Because we are looking at situations where the quantity changes even though the price remains the same

Change in Supply When both old and new quantities are plotted in the form of a graph, it appears as if the supply curve has shifted to the right, showing an increase in supply

Why – Determinants that Change Supply Productivity Cost of Resources Land, labor, capital Technology Taxes and Subsidies Expectations Government Regulations Number of Sellers

Elasticity of Supply Just as demand has elasticity, supply also has an elasticity Supply Elasticity is a measure of the way in which the quantity supplied responds to a change in price If an increase in price leads to a proportionally larger increase in output, supply is elastic If an increase in price causes a proportionally smaller change in output, supply is inelastic Similar to elasticity we learned with demand – In both cases, elasticity is simply a measure of the way quantity adjusts to a change in price

Three Elasticities 1. Elastic Supply 2. Inelastic Supply 3. Unit Elastic Supply

Elastic Supply The change in price causes a proportionally larger change in quantity supplied I.E. Doubling the price from $1 to $2 causes the quantity brought to market to triple from two to six units

Inelastic Supply In this case, a change in price causes a proportionally smaller change in quantity supplied When the price doubles from $1 to $2, the quantity brought to market goes up only 50 %, or from 2 units to 3.

Unit Elasticity A change in price causes a proportional change in quantity supplied I.E. as the price doubles from $1 to $2, the quantity brought to market also doubles.

1. Elastic Supply – EXAMPLES – toys, candy, and other products that can be made quickly without huge amounts of capital and skilled required. 2. Inelastic Supply – Nuclear power – No matter what price is being offered , electric utilities will find it difficult to increase output because of the huge amount of capital and technology needed before nuclear production can be increased. 3. Unit Elastic Supply

Unlike demand elasticity – the number of substitutes has no bearing on supply elasticity Instead only production considerations determine supply elasticity If a firm can react quickly to a changing price, then supply is likely to be elastic If it cannot then supply will be inelastic

Prices as Signals 6.1

What do you think when you see this picture?

What do you think when you see this picture now? Brand new 32’ TV, $99

What do you think when you see this picture now? Brand new 32’ TV, $299

What do you think when you see this picture?

What do you think when you see this picture now? Cheeseburger only 99 ¢

What do you think when you see this picture now? Cheeseburger only $25.99

Advantages of prices Prices are neutral Prices are flexible People understand prices No cost to administer

What to do without prices? Deals with the problem “For Whom to Produce” First come, first serve Corruption Rationing

Problems with Rationing Share is too small Administrative cost Negative impact on the incentive to produce

If Rationing is so bad, why do we do it?

Supply and Demand 6.1 & 6.2

Dynamic Pricing http://www.clipsyndicate.com/video/play/1477909/dyna mic_ticket_pricing_gaining_traction_for_sports_video Kind of neat.

The Price System at Work The process of establishing a price can complicated because buyers and sellers have opposite hopes and desires: Buyers want to find a great deal Sellers want to het high prices and make large profits Economists agree that as long as there is competition – prices will be about right under a bidding system

The Price Adjustment Process Transactions in a market are voluntary Buyers and sellers both compromise to settle the differences so they both gain some benefit

A Market Model Figure 6.1 There is a market demand curve There is a market supply curve When both are put together on the same graph – you have a “Market Model” Or some clue as to how buyers and sellers will find the price that is mutually agreeable.

Equilibrium Curve The intersection of the two curves is called the equilibrium price A “perfect price” – it is the place where no surplus will occur and no shortage will occur either. This equilibrium price is arrived at through trial and error.

Price per Unit Quantity Demanded Quantity Supplied $2 14,000 2,000 4 Market Demand and Supply Schedule for Flu Shots Price per Unit Quantity Demanded Quantity Supplied $2 14,000 2,000 4 12,000 4,000 6 10,000 6,000 8 8,000 10 12 14 16 16,000 Surplus Shortage

Surplus The quantity supplied is greater than the quantity demanded Suppliers must lower the price to sell the surplus

Shortage The quantity demanded is greater than the quantity supplied at a given price The supplier realizes people might have been willing to spend more because there was a shortage at the price being offered The supplier will raise the price and the supply to avoid a shortage

Equilibrium Price The price “clears the market” – there is no surplus or shortage The correct price that buyers and sellers can both “be happy with”

II. Explaining and Predicting Prices Economists use market models to explain changes in prices Prices change due to: Change in supply – which can be caused by a change in: 1. Cost of Resources 2. Productivity 3. Technology 4. Taxes and/or Subsidy 5. Expectations 6. Government Regulations 7. Number of Sellers

Change in Demand 1. Income Effect 2. The Substitution Effect 3. A change in consumer income 4. A change in consumer taste 5. A change in the price of a complementary product 6. A change in customer expectations (waiting for the latest model) 7. A change in the number of consumers

Changes in Both Prices and competitive markets Economists like to see competitive markets because that is when the price system is most effective Advantages of a competitive markets is they allocate resources efficiently A. Sellers compete to meet demand of customers – they have to keep prices low B. To keep their prices low – they have use their resources wisely – watch their costs C. Competition among buyers (to have what they want and need) keep prices from falling too low. A competitive market requires NO ONE to run it.