Unit 2: Consumer Choice, Demand, and Supply Introduction to Markets, Supply, and Demand

The Circular Flows in a Market Economy

The Circular Flows in a Market Economy with Government

A Description of Production Natural resources are transformed by human and capital resources into goods and services. Thus, human and capital resources do the work of production, while natural resources provide the material that they transform. Because human and capital resources require energy to work, natural resources also provide the energy required for these resources (i.e., food for workers and fuel for machines).

Productive Resources Human resources People: the mental and physical abilities that allow them to make contributions in the workforce. Examples: construction workers, factory workers, teachers, doctors, truck drivers, farmers, secretaries, actors, engineers, garbage collectors, and many other occupations

Productive Resources Capital resources Goods that were specifically produced in order to produce other goods. Examples: machines, equipment, tools, office and factory buildings, tractors, assembly lines, computers, grinders, trucks, and many other things that help in the production process

Productive Resources Natural resources An actual or potential form of wealth extracted or harvested from the natural environment. Examples: trees, fish, soil, minerals (such as copper, aluminum, iron ore, gold, and zinc), air, water, fossil fuels (such as coal, oil, and natural gas), as well as the space provided by a plot of land

The Role of Money How would you obtain something you want without using money? Why is money an essential component of our production process?

Why Money? 1. Medium of Exchange: used to determine the value during the exchange of goods and services alternative to barter 2. Unit of Account: allows you to compare the value of goods and services 3. Store of Value: keeps if you decide to hold on to it

Markets Institutions or mechanisms which bring together buyers and sellers of particular goods, services, or resources.

The Law of Demand States that there is an INVERSE relationship between price and quantity demanded… If Price increases, Quantity Demanded decreases… PQ If Price decreases, Quantity Demanded increases… PQPQ

Law of Supply States that there is a direct relationship between quantity supplied by producers and price… If Price increases, Quantity Supplied increases… PQ If Price decreases, Quantity Supplied decreases… P Q

Demand vs. Quantity Demanded Demand is the amount of a good and service that a consumer is willing and able to buy at various possible prices during a given time period. Quantity Demanded is the amount at each particular price a consumer is willing and able to buy at during a given time period. How many will you buy at one specific price? KNOW THE DIFFERENCE!!!!!

Supply vs. Quantity Supplied Supply represents the total amount of goods a producer is willing and able to sell at various possible prices during a given time period. Quantity Supplied refers to the amount of a good that a producer is willing and able to sell at a particular price during a given time period.

Representing Quantity Demanded Demand Schedules – table that shows the relationship between demand and price of a given product Demand Curves – graph where the x-axis represents the quantity demanded from a given product and the y-axis represents various prices  Demand Curves slope DOWNWARD

The Demand Schedule…

The Demand Curve… DOWNWARD SLOPING!!!! (p) P r i c e Quantity Demanded(q)

Catherine’s Demand Schedule

Figure 1 Catherine’s Demand Schedule and Demand Curve Copyright © 2004 South-Western Price of Ice-Cream Cone Quantity of Ice-Cream Cones $ A decrease in price increases quantity of cones demanded.

0 D Price of Ice- Cream Cones Quantity of Ice-Cream Cones A tax that raises the price of ice- cream cones results in a movement along the demand curve. A B $ Changes in Quantity Demanded

MARKET VS. INDIVIDUAL DEMAND Each consumer has his individual demand curve for a product The market demand curve for that product is the sum of all of the individual demand curves

Representing Quantity Supplied Supply Schedule (same idea as demand schedule) – shows the relationship between price and quantity supplied Supply Curve – Price is ALWAYS on Y-Axis & Quantity supplied on X-Axis graph slopes upward (positive)

Supply Curve (p)UPWARD SLOPING P r i c e Quantity Supplied (q)

Ben’s Supply Schedule Supplied

Figure 5 Ben’s Supply Schedule and Supply Curve Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone Quantity of Ice-Cream Cones $ An increase in price increases quantity of cones supplied. Supplied

1 5 Price of Ice- Cream Cone Quantity of Ice-Cream Cones 0 S 1.00 A C $3.00 A rise in the price of ice cream cones results in a movement along the supply curve. Change in Quantity Supplied

MARKET SUPPLY VS. INDIVIDUAL SUPPLY Each producer has his own individual supply curve The market supply curve is the sum of all the individual supply curves

Unit 2: Microeconomic Concepts Supply, Demand and the Market

SUBSTITUTION EFFECT At a lower price buyers have an incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive. The lower priced product is seen as a “better deal” Why do you think products like Coke run specials?

INCOME EFFECT The impact a change in price of a product has on a consumer’s real income and consequently on the quantity demanded of that good

The Market Never Stands Still ENTIRE curves for both supply and demand can shift to the left or right Changes that INCREASE supply and demand shift the curve to the right Changes that DECREASE supply and demand shift the curve to the left CHANGES IN PRICE OF A PRODUCT NEVER SHIFT A CURVE

Figure 3 Shifts in the Demand Curve Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone Quantity of Ice-Cream Cones Increase in demand Decrease in demand Demand curve,D 3 Demand curve,D 1 Demand curve,D 2 0

Consumer Behavior There are several factors that change overall consumer demand

Determinants of Demand 1) Change in Consumer Taste and Preferences 2) Change in Consumer Income 3) Change in Consumer Expectations 4) Change in the Price of Related Goods… SUBSTITUTE GOODS COMPLEMENTARY GOODS 5) Change in the Number of Consumers

Substitutes and Complements Substitute Goods A product that is used in place of another Chick-fil-a has a huge sale on sandwiches…it impacts the demand for burgers Complementary Goods A product that is used together with another good. If cost of peanut butter rises, demand for jelly would decrease and shift its curve to the left

$ Price of Ice- Cream Cone Quantity of Ice-Cream Cones 0 Increase in demand An increase in income... D1D1 D2D2 Consumer Income Normal Good

$ Price of Ice- Cream Cone Quantity of Ice-Cream Cones 0 Decrease in demand An increase in income... D1D1 D2D2 Consumer Income Inferior Good

Producer Behavior There are several factors that change overall producer supply…

DETERMINANTS OF SUPPLY R esource Prices O ther goods prices T axes and subsidies T echnology E xpectations of Producers N umber of sellers (competition)

Figure 7 Shifts in the Supply Curve Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 Increase in supply Decrease in supply Supply curve,S 3 curve, Supply S 1 curve,S 2

PRICE ELASTICITY Price Elasticity of Demand – the responsiveness of consumers to changes in price Price Elasticity of Supply – the responsiveness of producers to changes in price

ELASTICITY OF DEMAND Demand is INELASTIC when the percentage change in the price of a good is greater than the percentage change in quantity demanded for that good. Demand is ELASTIC when the percentage change in the price of a good is less than the percentage change in the quantity demanded of that good.

RELATIVELY ELASTIC DEMAND D 1 (q) (p) Large change in Q with change in P

PERFECTLY ELASTIC DEMAND D 1 (q) (p) Q increases despite no change in P

RELATIVELY INELASTIC DEMAND (q) (p)D 1 Little change in Q when P changes

(q) PERFECTLY INELASTIC DEMAND (p)D 1 No change in Q when P changes

ELASTICITY OF SUPPLY Supply is INELASTIC when the percentage change in the price of a good is greater than the percentage change in the quantity supplied for that good. P or = Little or no change in Q S

ELASTICITY OF SUPPLY Supply is ELASTIC when the percentage change in the price of a good is less than the percentage change in the quantity supplied for that good. P or = MUCH change in Q S

RELATIVELY ELASTIC SUPPLY S 1 (q) (p) Large change in Q with change in P

PERFECTLY ELASTIC SUPPLY S 1 (q) (p) Q changes when P stays the same

RELATIVELY INELASTIC SUPPLY (q) (p) S 1 Little change in Q with change in P

PERFECTLY INELASTIC SUPPLY (q) (p) S 1 No change in Q with change in P

Ways to think about elasticity…

EQUILIBRIUM Producers want high prices while consumers want low prices… How do they work together in the market?

EQUILIBRIUM When quantity demanded=quantity supplied at the same price There is an equilibrium (market clearing) price There is also an equilibrium quantity The intersection of the supply and demand curves shows the equilibrium point

EQUILIBRIUM Law of supply and demand The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance. The market always seeks equilibrium!!!!

At $2.00, the quantity demanded is equal to the quantity supplied! SUPPLY AND DEMAND TOGETHER Demand Schedule Supply Schedule

Figure 8 The Equilibrium of Supply and Demand Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone Quantity of Ice-Cream Cones 13 Equilibrium quantity Equilibrium price Equilibrium Supply Demand $2.00

The Answer… They are used to illustrate how the market determines… PRICE where we sell all goods

Thinking About the Market The market ALWAYS seeks the market-clearing price where goods sell out Price below equilibrium = SHORTAGE Price above equilibrium = SURPLUS

SURPLUS A surplus occurs when quantity supplied exceeds quantity demanded at the market price (the market is not in equilibrium – also called disequilibrium)

Figure 9 Markets Not in Equilibrium Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0 Supply Demand (a) Excess Supply Quantity demanded Quantity supplied Surplus Quantity of Ice-Cream Cones 4 $

SHORTAGE A shortage occurs when quantity demanded exceeds quantity supplied at the market price (the market is not in equilibrium)

Figure 9 Markets Not in Equilibrium Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones Supply Demand (b) Excess Demand Quantity supplied Quantity demanded $ Shortage

Determining Price Outside of the Market Market does not reach equilibrium due to government intervention Price Controls – occur when a local, state, or national government decide a legal minimum/maximum for a good or service… 1. Price Floors 2. Price Ceilings

Price Floors A legal MINIMUM price for a good, service, or factor of production Set ABOVE equilibrium Charging BELOW that price can be illegal (ex. Minimum Wage) Surpluses result because producers are willing to produce more than consumers are willing to consume

Price Floor (q) (p) MARKET EQUILIBRIUM Price Floor S1S1 B D1D1 A

Price Ceilings A legal MAXIMUM price for a good, service, or factor of production Set below equilibrium price Charging ABOVE that price can be illegal Causes Shortages: Consumer demand is greater than producers are willing/able to provide Creates potential for a black market (like ticket scalpers)

Price Ceiling (q) (p) MARKET EQUILIBRIUM Price Ceiling S1S1 B D1D1 A

Graphing Shifts Practice  Graph each situation and state what happens to the equilibrium price a) Supply decreases and demand is constant. b) Demand decreases and supply is constant. c) Supply increases and demand is constant. d) Demand increases and supply increases. e) Demand increases and supply is constant. f) Supply increases and demand decreases. g) Demand increases and supply decreases. h) Demand decreases and supply decreases.