1. Chapter 4: Demand Section 1

2. Key Terms
demand: the desire to own something and the ability to pay for it
law of demand: consumers will buy more of a good when its price is lower and less when its price is higher
substitution effect: when consumers react to an increase in a good’s price by consuming less of that good and more of a substitute good

3. Key Terms, cont.
income effect: the change in consumption that results when a price increase causes real income to decline
demand schedule: a table that lists the quantity of a good a person will buy at various prices in a market
market demand schedule: a table that lists the quantity of a good all consumers in a market will buy at various prices
demand curve: a graphic representation of a demand schedule

4. Demand
Demand is the desire to own something and the ability to pay for it.
The law of demand states that when a good’s price is lower, consumers will buy more of it. When the price is higher, consumers will buy less of it.
The law of demand is the result of the substitution effect and the income effect --two ways that a consumer can change his or her spending patterns. Together, they explain why an increase in price decreases the amount consumers purchase.

6. The Law of Demand in Action
Checkpoint: What happens to demand for a good when the price increases?
Changes in price are an incentive; price changes always affect quantity demanded because people buy less of a good when its price goes up.
Checkpoint Answer: The demand for that good goes down.

7. Demand Schedules
The law of demand explains how the price of an item affects the quantity demanded of that item.
To have demand for a good, you must be willing and able to buy it at a specified price.
A demand schedule is a table that lists the quantity of a good that a person will purchase at various prices in the market.

8. Market Demand Schedules
A market demand schedule shows the quantities demanded at various prices by all consumers in the market.
Market demand schedules are used to predict the total sales of a commodity at several different prices.
Market demand schedules exhibit the law of demand: at higher prices the quantity demanded is lower.

9. Demand Schedules
Demand schedules show that demand for a good falls as the price rises.
How does market demand change when the price falls from $3 to $2 a slice?
Answer: Market demand increases.

10. The Demand Graph
A demand curve is a graphic representation of a demand schedule.
The vertical axis is always labeled with the lowest possible prices at the bottom and the highest prices at the top.
The horizontal axis should be labeled with the lowest possible quantity demanded at the left and the highest possible quantity demanded on the right.

11. Demand Curves
Ashley’s demand curve shows the number of slices she is willing and able to buy at each price, while the market demand curve shows demand for pizza in an entire market.
How are the demand curves similar?
Answer: They both have a negative slope.

12. Market Demand Curves
All demand schedules and demand curves reflect the law of demand.
Market demand curves are only accurate for one very specific set of market conditions. They cannot predict changing market conditions.

13. Chapter 4: Demand Section 2

14. Key Terms
ceteris paribus: a Latin phrase that means “all things held under constraint”
normal good: a good that consumers demand more of when their income increases
inferior good: a good that consumers demand less of when their income increases

15. Key Terms, cont.
demographics: the statistical characteristics of populations and population segments, especially when used to identify consumer markets
complements: two goods that are bought and used together
substitutes: goods that are used in place of one another

16. The Substitution Effect
The substitution effect takes place when a consumer reacts to a rise in the price of one good by consuming less of that good and more of a substitute good. The substitution effect can also apply to a drop in prices.

17. The Income Effect
The income effect is the change in consumption that results when a price increase causes real income to decline.
Economists measure consumption in the amount of a good that is bought, not the amount of money spent on it.
The income effect also operates when the price is lowered. If the price of something drops, you feel wealthier. If you buy more of a good as a result of a lower price, that’s the income effect at work.

18. Changes in Demand
A demand schedule takes into account only changes in price. It does not consider the effects of news reports of any one of the thousands of other factors that change from day to day that could affect the demand for a particular good.
A demand curve is accurate only as long as there are no changes other than price that could affect the consumer’s decision.

19. Changes in Demand, cont.
A demand curve is accurate only as long as the ceteris paribus assumption—that all other things are held constant—is true.
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.
A shift in the demand curve means that at every price, consumers buy a different quantity than before; this shift of the entire demand curve is what economists refer to as a change in demand.

20. Graphing Changes in Demand
When factors other than price cause demand to fall, the demand curve shifts to the left. An increase in demand appears as a shift to the right.
If the price of a book rose by one dollar, how would you show the change on one of these graphs?
Answer: By shifting the demand curve to the left.

21. Change in Demand Factors
Several factors can lead to a change in demand, rather than simply changing the quantity demanded.
Income
Most items that we purchase are normal goods, which consumers demand more of when their income increases.
A rise in income would cause the demand curve to shift to the right, indicating an increase in demand. A fall in income would cause the demand curve to shift left, indicating a decrease in demand.

22. Consumer Expectations
Checkpoint: How will an anticipated rise in price affect consumer demand for a good?
The current demand for a good is positively related to its expected future price.
If you expect the price to rise, your current demand will rise, which means you will buy the good sooner.
If you expect the price to drop your current demand will fall, and you will wait for the lower price.
Checkpoint Answer: It causes the demand for a good to increase.

23. Population
Changes in the size of the population will also affect the demand for most products.
Population trends can have a particularly strong effect on certain goods.

24. Demographics
Demographics are the characteristics of populations, such as age, race, gender, and occupation.
Businesses use this data to classify potential customers.
Demographics also have a strong influence on packaging, pricing, and advertising.

25. Demographics, cont.
Hispanics, or Latinos are now the largest minority group in the United States.
Firms have responded to this shift by providing products and services for the growing Hispanic population.

26. Advertising
Advertising is a factor that shifts the demand curve because it plays an important role in many trends.
Companies spend money on advertising because they hope that it will increase the demand for the goods they sell.

27. Complements and Substitutes
The demand curve for one good can also shift in response to a change in demand for another good.
There are two types of related goods that interact this way:
Complements are two goods that are bought and used together.
Substitutes are goods that are used in place of one another.
NOTE TO TEACHERS: The snowboard and boots are two goods that are complements because they are bought and used together.

28. Chapter 4: Demand Section 3

29. Key Terms
elasticity of demand: a measure of how consumers respond to price changes
inelastic: describes demand that is not very sensitive to price changes
elastic: describes demand that is very sensitive to a change in price
unitary elastic: describes demand whose elasticity is exactly equal to 1
total revenue: the total amount of money a company receives by selling goods or services

30. Consumer Response
Elasticity of demand is the way that consumers respond to price changes; it measures how drastically buyers will cut back or increase their demand for a good when the price rises or falls.
Your demand for a good that you will keep buying despite a price change is inelastic.
If you buy much less of a good after a small price increase, your demand for that good is elastic.

31. Elastic Demand Elastic Demand comes from one or more of these factors:
The availability of substitute goods
A limited budget that does not allow for price changes
The perception of a good as a luxury item.

32. Calculating Elasticity of Demand
In order to calculate elasticity of demand, take the percentage change in the quantity of the good demanded and divide this number by the percentage change in the price of the good. The result is the elasticity of demand for the good.
The law of demand implies that the result will always be negative. This is because increases in the price of a good will always decrease the quantity demanded, and a decrease in the price of a good will always increase the quantity demanded.

34. Factors Affecting Elasticity
Availability of Substitutes
If there are a few substitutes for a good, then even when its price rises greatly, you might still buy it.
If the lack of substitutes can make demand inelastic, a wide choice of substitute goods can make demand elastic.

35. Other Factors Relative Importance Necessities v. Luxuries
A second factor in determining a good’s elasticity of demand is how much of your budget you spend on a good.
Necessities v. Luxuries
Whether a person considers a good to be a necessity or a luxury has a great impact on a person’s elasticity of demand for that good.

36. Other Factors, cont. Change Over Time
Consumers do not always react quickly to a price increase, because it takes time to find substitutes. Because they cannot respond quickly to price changes, their demand is inelastic in the short term.
Demand sometimes becomes more elastic over time as people eventually find substitutes.

37. Total Revenue
Elasticity is important to the study of economics because elasticity helps us measure how consumers respond to price changes for different products.
The elasticity of demand determines how a change in price will affect a firm’s total revenue or income.

38. Total Revenue and Elastic Demand
The law of demand states that an increase in price will decrease the quantity demanded.
When a good has elastic demand, raising the price of each unit sold by 20% will decrease the quantity sold by a larger percentage. The quantity sold will drop enough to reduce the firm’s total revenue.
The same process can also work in reverse. If the price is reduced by a certain percentage, the quantities demanded could rise by an even greater percentage. In this case, total revenues would increase.

39. Total Revenue and Inelastic Demand
If demand is inelastic, consumers’ demand is not very responsive to price changes. If prices increase, the quantity demanded will decrease, but by less than the percentage of the price increase. This will result in higher total revenues.

40. Elasticity and Revenue
Elasticity of demand determines the effect of a price change on total revenues.
Why will revenue fall if a firm raises the price of a good whose demand is elastic?
What happens to total revenue when price decreases, but demand is inelastic?
Answers: 1. Because people will not pay the higher prices for that good. 2. Total revenue decreases as well.

41. Elasticity and Price Policies
Checkpoint: Why does a firm need to know whether demand for its product is elastic or inelastic?
Knowledge of how the elasticity of demand can affect a firm’s total revenues helps the firm make pricing decisions that lead to the greatest revenue.
If a firm knows that the demand for its product is elastic at the current price, it knows that an increase in price would reduce total revenue.
If a firm knows that the demand for its product is inelastic at its current price, it knows that an increase in price will increase total revenue.
Checkpoint Answer: So that they know whether an increase or decrease in the price of the good will cause total revenue to increase or decrease.

42. Chapter 5: Supply Section 1

43. Key Terms supply: the amount of goods available
law of supply: producers offer more of a good as its price increases and less as its price falls
quantity supplied: the amount that a supplier is willing and able to supply at a specific price
supply schedule: a chart that lists how much of a good a supplier will offer at various prices
variable: a factor that can change

44. Key Terms, cont.
market supply schedule: a chart that lists how much of a good all suppliers will offer at various prices
supply curve: a graph of the quantity supplied of a good at various prices
market supply curve: a graph of the quantity supplied of a good by all suppliers at various prices
elasticity of supply: a measure of the way quantity supplied reacts to a change in price

45. The Law of Supply Supply is the amount of goods available.
As the price of a good increases, producers will offer more of it and as the price decreases, they will offer less.
The law of supply includes two movements:
Individual firms changing their level of production
Firms entering or exiting the market

46. What is the Law of Supply?

47. Higher Production
If a firm is earning a profit from the sale of a good or service, then an increase in the price will, in turn, increase the firm’s profits.
In general, the search for profit drives the choices made by the producer.

48. Market Entry
Rising prices encourage new firms to join the market and will add to the quantity supplied of the good.
Take, for example, the music market:
When a particular type of music becomes popular, such as 70’s disco or 90’s grunge, more bands will play that type of music in order to profit from such music’s popularity.
This action reflects the law of supply.
Checkpoint Answer: Because the law of supply states that as prices rise, so does the amount of quantity supplied

49. The Supply Schedule
Supply of a good can be measured using a supply schedule.
A supply schedule shows the relationship between price and quantity supplied for a particular good.
An individual supply schedule shows how much of a good a single supplier will be able to offer at various prices. A market supply schedule shows how much of a good all firms in a particular market can offer at various prices.

50. Supply Schedule
The supply schedule lists how many slices of pizza one pizzeria will offer at different prices. The market supply schedule represents all suppliers in a market.
What does the individual supply schedule tell you about the pizzeria owner’s decisions?
How does the market supply schedule compare to the individual supply schedule?
Answers: 1. That the higher the price of pizza, the more the pizzeria owner will supply. 2. It follows a similar patter as the individual supply schedule with a larger quantity of slices supplied each day, which reflects the entire market.

51. The Supply Graph
A supply schedule can be represented graphically by plotting points on a supply curve.
A supply curve always rises from left to right because higher prices leads to higher output.
Checkpoint: What are the two variables represented in a supply schedule or supply curve?
Checkpoint Answer: price and quantity supplied

52. Elasticity of Supply
Elasticity of supply, based on the same concept of elasticity of demand, measures how firms will respond to changes in the price of a good.
Elastic
When elasticity is greater than one, supply is very sensitive to price changes
Inelastic
When elasticity is less than one, supply is not very responsive to price changes.

53. Elasticity in the Short Run
In the short run, it is difficult for a firm to change its output level, so supply is inelastic.
Many agricultural businesses, such as harvesting cranberries, have a hard time adjusting to price changes in the short term.

54. Elasticity in the Long Run
In the long run, supply can become more elastic.
Just like demand, supply becomes more elastic if the supplier has a longer time to respond to a price change.

55. Chapter 5: Supply Section 2

56. Key Terms
marginal product of labor: the change in output from hiring one additional unit of labor
increasing marginal returns: a level of production in which the marginal product of labor increases as the number of workers increases
diminishing marginal returns: a level of production in which the marginal product of labor decreases as the number of workers increases
fixed cost: a cost that does not change, no matter how much of a good is produced

57. Key Terms, cont.
variable cost: a cost that rises and falls depending on the quantity produced
total cost: the sum of fixed costs plus variable costs
marginal cost: the cost of producing one more unit of a good
marginal revenue: the additional income from selling one more unit of a good
average cost: the total cost divided by the quantity produced
operating cost: the cost of operating a facility

58. Labor and Output
All business owners must decide how many workers they will hire.
The addition of new workers will increase production until it reaches its peak, at which point, production actually decreases.

59. Marginal Returns
The addition of more workers to a firm allow for a greater amount of specialization.
Specialization increases the output and the firm enjoys increasing marginal returns.

60. Marginal Returns, cont.
Eventually, though, the benefits of specialization end and the addition of more workers increases total output but at a diminishing rate.
A firm with diminishing marginal returns will produce less and less output from each additional unit of labor.
Answer: 5 beanbags per hour
What is the marginal product of labor when the factory employs five workers?

61. Fixed Costs
Production costs are divided into two categories - fixed costs and variable costs.
Fixed costs mainly involve the production facility and include:
Rent
Machinery repair
Property taxes
Worker’s salaries

62. Variable Costs Variable costs include:
Price of raw materials
Some labor
Electricity and heating bills
Fixed costs and variable costs are added together to find the total cost.

63. Marginal Cost of Production
Knowing the total cost of several levels of output helps determine the marginal cost of production at each level, or the additional costs of producing one more unit.
One way to find the best level of output is to figure out where marginal cost is equal to marginal revenue, or the additional income from selling one more unit of a good.

64. Setting Output A firm’s primary goal is to maximize profits.
The firm wants to make the most profit with the least amount of total production cost to the firm.
Answer: Because that is the market price for each beanbag and does not change regardless of how many beanbags are produced.
Why is the marginal revenue always equal to $24?

65. Determining a Firm’s Profit
The graph to the right shows how a firm’s profit per hour can be determined by subtracting total cost from total revenue.
What would happen to output if market price fell to $20?
Why would the firm increase output if the price of a beanbag rose to $37?
Answers: 1. Output would decrease. 2. Because the firm stands to make a larger profit when a beanbag costs $37.

66. The Shutdown Decision
What happens to a factory that starts to lose money?
Sometimes, even though a factory is producing at its most profitable level, the market price is so low that the factory’s total revenue is still less than its total cost.
The factory owners have two choices:
Continue to produce goods and lose money
Shut down the factory

67. Option 1: Continue to Produce
Checkpoint: When should a firm keep a money-losing factory open?
The firm should keep the factory open if the total revenue from the goods is greater than the cost of keeping the factory open.
This would work if the benefit of operating the factory is greater than the variable cost.
Checkpoint Answer: The firm should keep the factory open if the total revenue from the goods is greater than the cost of keeping the factory open

68. Option 2: Shut Down the Factory
If a firm shuts the factory down it still has to pay all of its fixed costs so it would have money going out but nothing coming in.
The firm would lose an amount equal to its fixed costs.

69. Chapter 5: Supply Section 3

70. Key Terms
subsidy: a government payment that supports a business or market
excise tax: a tax on the production or sale of a good
regulations: government intervention in a market that affects the production of a good

71. Input Costs
Any changes in the cost of an input used to make a good will affect supply.
A rise in the cost of raw materials, for example, will result in a decrease in supply because the good has become more expensive to produce.
The high input costs that dairy farmers pay for feed, labor, and fuel result in higher prices for milk and other dairy products.

72. Rising Costs and Technology
If costs continue to rise, a firm will have to cut production and lower its marginal cost.
It is possible for input costs to drop.
In many industries, advances in technology can lower production costs.
Examples of technology advances include:
Automation
Computers

74. Government’s Influence
In addition to input costs, the federal government also has the power to affect the supplies of many types of good.
Subsidies
The government often gives subsidies to the producers of a good.
Subsidies generally lower cost, which allows a firm to produce more goods.
Reasons for subsidizing products include:
To provide for people during food shortages
To protect young industries from foreign competition.

75. Government Influences, cont.
Taxes
Excise taxes increase production costs by adding an extra cost for each unit sold.
They are sometimes used to discourage the sale of a good the government deems harmful, such as cigarettes and alcohol.

76. Government Influences, cont.
Regulation
Indirectly, government regulation often has the effect of raising costs.
When the government regulated the auto industry to cut down on pollution, these regulations led to an increase in the cost of manufacturing cars.

77. Non-Price Influences Changes in the global economy
Since many goods and services are imported, changes in other countries can affect the supply of those goods.
An increase in wages in one country or the increased supply of a good in another will cause the overall supply curve to shift.
Restrictions on imports also affect supply.

78. Shifts in the Supply Curve
Factors that reduce supply shift the supply curve to the left, while factors that increase supply move the supply curve to the right.
Which graph best represents the effects of higher costs?
Which graph best represents advances in technology?
Answers: 1. Decrease in Supply graph. 2. Increase in Supply graph

79. Future Expectations of Prices
Checkpoint: What happens to supply if the price of a good is expected to rise in the future?
If a seller expects the price of a good to rise in the future, the seller will store the goods now in order to sell more in the future.
If the prices of good is expected to drop in the near future, sellers will earn more by placing goods on the market immediately, before the price falls.
Checkpoint Answer: Supply will decrease.

80. Number of Suppliers
If more suppliers enter a market, the market supply will rise and the supply curve will shift to the right.
If suppliers stop producing a good and leave the market, market supply will decline, causing the supply curve to shift to the left.

81. Where do Firms Produce?
Checkpoint: When is a firm likely to locate close to its consumers?
A key factor in where a firm will locate is transportation.
When inputs such as raw materials are expensive to transport, a firm will locate close to the inputs.
When outputs (the final product) are more costly to transport, firms will locate close to the consumer.
Checkpoint Answer: When the final product is more expensive to transport.