1. UNIT 2
Chapters 4, 5 & 6

2. Chapter 4 - Demand
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
Income Effect – the change in consumption that results when a price increase causes real income to decline
Substitution effect can go both ways – as price for item A increase you look elsewhere, as price for item A decrease it may become the best option
When prices go up but your income stays the same you are in effect poorer. You can’t afford as much

4. Demand
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

5. Demand The Demand Graph:
Demand Curve – a graphic representation of a demand schedule
Label quantities demanded on horizontal axis – lowest quantity on left highest on right
Label possible prices on the vertical axis – lowest prices on bottom and highest prices on top
Reading the demand curve
It does keeps constant all outside factors like income, price of other goods etc.
It follows the law of demand that higher prices result in lower demand and as price falls the demand increases
Limits of Demand Curve
The demand curve only depicts information for a giving set of circumstances, it cannot predict changing market conditions, like prices for other items decreasing

6. Chapter 4.1 Questions What two qualities make up demand?
Under the substitution effect, what will happen when the price of a good drops?
Suppose you are a small business owner. How would a market demand schedule or a market demand curve be useful to you?

7. Changes in Demand
A demand curve is accurate only as long as there are no changes other than price that could affect the consumer’s decision
When other factors are allowed to change the demand curve, the curve will shift.
What causes a shift?
Income
Normal Goods – a good a consumer demands more of when income increases
Inferior Goods – goods that you would buy in smaller quantities, or not at all, if your income were to rise and you could afford something better
We will look at a Demand curve that shifts in a minute, but if the curve shifts left there is a Decrease in Demand if the curve shifts right there is an increase in demand
Inferior Goods
Anybody buy Generic. How about the generic mac & cheese ($0.89) vs Kraft ($1.49) , other examples

8. Change in Demand What causes a shift cont’d? Consumer Expectations –
Consumers’ expectations for the future
Population –
When population increases certain goods & services will see increasing demand
Demographics – the statistical characteristics of populations and population segments
Shifts in age, race, gender, income level and so on in a given market will change demand for goods & services
Consumer Tastes & Advertising
Advertising and publicity play an important role in setting many trends
Consumer expectations
If price is going to rise in the future our demand would increase now
If there is going to be a sale in the future our demand would decrease now
What about new products coming out??? Instead of buying the old model you decide to wait a little while and get the newest model
Population
More housing, more food, more diapers, etc.
Baby boomers aging will increase demand for medicare, RVs, homes in the sunbelt
Demographics
Hispanics and asians buy differently that caucasians or africans americans
Consumer Tastes & Advertising
In 2008 ad spending on Facebook and MySpace was estimated at $1.9 Billion
Facebook IPO based on advertising revenue

9. Changes in Demand

10. Changes in Demand Prices of Related Goods:
Prices for some goods shift if demand for another good changes
Complements – two goods that are bought and used together
Substitutes – goods that are used in place of one another
Complements
Ski’s and ski boots
Snow boards and snow boots
Can you think of other complimentary goods???
Substitutes
Snow boards are a substitute for ski’s

11. Chapter 4.2 Questions
Name at least three goods that could be bought as complements to hamburgers?
List at least three goods that could be considered substitutes for movie tickets.
Does a change in the price of a good cause the demand curve to shift? Why or why not?
What kinds of changes cause shifts in the demand curve?

12. Elasticity of Demand
Elasticity of Demand – a measure of how consumers respond to price changes
Inelastic – demand that is not very sensitive to price changes
Elastic – demand that is very sensitive to a change in price
Inelastic
Food from safeway like Milk, eggs etc.
Gas - $4 summer
Elastic
Xbox – what if it cost $1000

13. Give as a handout

14. Elasticity of Demand
Calculating Elasticity:

15. Elasticity of Demand Price Range: Values of Elasticity
Elasticity of demand for a good varies at every price level
Demand for a good can be highly elastic at one price and inelastic at a different price
Values of Elasticity
In mathematical terms, if the elasticity of demand is less than 1 then the good is inelastic
If elasticity of demand is greater than 1then the good is elastic
Unitary Elastic – when elasticity of demand is exactly 1
When percent change in quantity demanded is exactly equal to the percent change in the price
Price range example
12 oz can of pop was $0.5 and raised to $0.75 would you still buy it? How about if it was $2 and raise to $3

16. Elasticity of Demand Factors Affecting Elasticity:
Availability of Substitutes
If there are few substitutes, then even if price rises you still probably buy a good
If there are many substitutes, then the demand for the good is probably elastic
Relative Importance
How much do you spend on the good
If it is a big budgetary item and it increases in price significantly, can you afford it???
Necessities Versus Luxuries
Consumers will typically purchase a necessity regardless of a price increase (inelastic)
Luxury goods can be cut out (elastic)
Change Over Time
When prices change it takes time for consumers to react, so demand may be inelastic in short-term
Once substitutes are found demand becomes elastic.
Relative importance
- Child care example, paying $1000 a month, already a large chunk of our monthly pay, if she raised her prices to $1500 a month could we still afford to go to her? Maybe but we wouldn’t get TV, Internet, Furniture etc.

17. Elasticity of Demand Elasticity and Revenue:
Computing a Firm’s Total Revenue:
Total revenue – amount of money a company receives by selling goods or services
= quantity sold x price per item
Total Revenue and Elastic Demand
Raises in price will result in lower total revenue

18. Elasticity of Demand Elasticity and Revenue cont’d:
Total Revenue and Inelastic Demand
Price and total revenue move in the same direction
Increase in price would increase Total Revenue
Elasticity and Pricing Policies
Companies need to know elasticity of a good to set the price of a good

19. Chapter 4.3 Questions
Name three factors that determine a good’s elasticity.
Suppose demand for a product is elastic at a given price. What will happen to the company’s total revenue if it raises the price of that product? Why?
How does the percentage of your budget you spend on a good affect its elasticity? Why is this the case?

20. Chapter 5 - Supply Supply – the amount of goods/services 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
As prices for a good increase more firms will enter the market to make a piece of the pie.
As prices for a good drop firms will produce less or drop out of a market completely and move on to something else (typewriters vs. computers)

21. Supply Law of Supply Higher Production Market Entry
If prices rise a firms total profits will increase
Rise in prices will encourage a firm to increase production
Market Entry
If an industry is profitable, people will want to enter the industry to make money

22. Supply The Supply Schedule
Supply schedule – a chart that lists how much of a good a supplier will offer at various prices
Market Supply Schedule – a chart that lists how much of a good all suppliers will offer at various prices
Chart lists multiple variables – A variable is a factor that can change
Like a demand schedule, the supply schedule lists supply for a very specific set of conditions
Remember the chart shows that a change in price will change the quantity produced but doesn’t change the chart. If other factors are changed then a new chart has to be made

23. Supply The Supply Schedule cont’d
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
Supply curve always rises from left to right
Price is on the vertical axis and output on the horizontal axis

24. Supply Supply and Elasticity
Elasticity of Supply – a measure of the way quantity supplied reacts to a change in price
Elasticity of Supply & Time
Major determining factor for elasticity of supply is time
Short run – some firms cannot change supply very fast so it is Inelastic
Long run – supply becomes more elastic as suppliers have time to react to price changes
Like with elasticity of demand – we have elastic, inelastic and unitary elastic supply. They act in the same manner.
Elastic – means as price increases or decreases the output will do the same. If it is above 1 supply is very sensitive to change in price
Inelastic means that as price increases or decreases the output will stay the same. If it is below 1 supply is not sensitive to change in price
Unitary elastic – means that price and supply mirror each other
Short-Run – Christmas trees, how long do they take to grow??? Can you increase the quantity of trees tomorrow if you have a price increase??? This would be inelastic
Some firms can change quicker like haircuts. Could you cut hair faster or higher more stylist to increase supply?? Could this happen quickly? More elastic
Long-run – christmas trees, could increase output 5 years down the road

25. Chapter 5.1 Questions
What is the difference between supply and quantity supplied?
State whether you think the supply of the following services is elastic or inelastic, and explain why:
A lawn-care service
Making movies
Professional baseball

26. Costs of Production Labor and Output
Marginal Product of Labor – the change in output from hiring one additional unit of labor

27. Cost of Production Labor and Output cont’d
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 at which the marginal product of labor decreases as the number of workers increases
A company should still hire employees until the diminishing returns turn to negative returns. So in the chart 7 employees is optimal

29. Cost of Production Production Costs
Costs are split into two categories
Fixed Cost – a cost that does not change, no matter how much of a good is produced
ex. Rent, property taxes, salaries of management, depreciation on machinery/equipment
Variable Cost – a cost that rises or falls depending on the quantity produced
ex. Utility bills, materials for producing goods, shipping
Total Cost – sum of fixed costs plus variable costs

30. Cost of Production Production Costs cont’d
Marginal Cost – the cost of producing one more unit of a good

31. Cost of Production Setting Output
Basic goal is to maximize profits at all times
Profit = total revenue – total cost
Best Level of output happens when:
Marginal Revenue = Marginal Cost
Marginal Revenue – the additional income from selling one more unit of a good; sometimes equal to price
Another look at Figure 5.5
Average Cost = total cost / quantity produced

32. Costs of Production Setting Output
When a firm changes the price of a good the marginal revenue changes.
The firm can then produce more:

33. Chapter 5.2 Questions
What are examples of fixed costs and variable costs for a farm?
Why would a company produce more units of a good if its marginal cost is less than its marginal revenue?
Why would a company not simply produce more and more units?

34. Changes in Supply Input Costs
Any change in cost of an input to produce a good will affect supply
If inputs become more expensive supply will decrease
If inputs become less expensive supply will increase
Effects of Rising Costs:
If an input price increases then Marginal Costs increases. Thus, a firm must produce less otherwise it will lose money
This shifts the supply curve left
Technology:
Can lower production costs which would decrease marginal costs and increase production
This shifts the supply curve to the right
Technology – automation like robotic tools, assembly lines, computers

35. Changes in Supply

36. Changes in Supply Government’s Influence on Supply
Government can raise or lower cost of producing goods
Subsidies – a government payment that supports a business or market
These lower the cost of production and allow higher production
Governments subsidize to protect young industries, maintain lifestyle, and maintain a sense of national pride
Subsidies typically happen in the food industry – farmers and ranchers get the majority of subsidies
In france they subsidize farms in the country because after WWII they had food shortages, they don’t want that to happen again. Subsidies offset cheaper imports
In malaysia they subsidize car manufacturers because it is a sense of national pride

37. Changes in Supply Government’s Influence on Supply Taxes
Excise tax – a tax on the production or sale of a good
This increases marginal cost and decreases production
Can be used to discourage use of a product i.e. cigarettes, alcohol, high pollutant gas, etc.
These are built directly into the price of the item so consumers don’t realize they pay them
Regulation – government intervention in a market that affects the production of a good
This typically raises production costs
Regulation of the car industry has resulted in technology to reduce pollution from exhaust. The Catalytic Converter ($350 to $750) helps reduce emissions

38. Changes in Supply Other Influences on Supply
Changes in the Global Economy
Rising wages
Import restrictions
Supply increases
Future Expectations of Prices
If prices are expected to rise in the future, suppliers will store goods until later causing a shortage in the short-term
If prices are expected to fall, suppliers will flood the market with goods now
Number of Suppliers
More suppliers = higher supply
Less suppliers = lower supply

39. Changes in Supply Where do Firms Produce?
What are the costs of transportation:
To bring inputs to the facility
To ship final products to consumers
Locate near specialized workforce
Locate in areas with tax breaks
Locate in areas with low energy costs
What are some examples of companies that locate in wyoming and must???
Tax breaks for companies that move in to a state or town, why???

40. Chapter 5.3 Questions
Analyze and explain the impact on the supply curve for the American-made computers from each of the following events:
The government places an excise tax on laptops
An engineer invents a way to produce desktop cases more cheaply
European countries end an import quota on American-made computers
If regulation increases price and decreases supply, why does the government issue regulations?

41. Chapter 6 - Prices
Combining Supply and Demand
Reaching Equilibrium

42. Combining Supply and Demand
Equilibrium – the point at which the quantity demanded equals the quantity supplied
Benefits include buyers being able to find what they want and firms having enough buyers for their goods
Do you like when you go to the store and they are sold out of what you need or want? Do you go back there or do you find another store to buy the good?

43. Combining Supply and Demand
Disequilibrium – occurs when the quantity supplied is not equal to quantity demanded
Shortage – when the quantity demanded in the market is more than the quantity supplied
Caused by price being below the equilibrium price
Surplus – when quantity supplied exceeds quantity demanded
Caused by price being above the equilibrium price
Another look at Figure 6.1
If you are selling out and can’t keep up with demand what would you do???
raise price and increase supply
If you have a bunch of goods that you can’t sell every single day what would you do???
lower price and reduce supply

44. Combining Supply and Demand

45. Combining Supply and Demand
Price Ceiling – a maximum price that can be legally charged for a good or service
Government set the price ceiling below equilibrium price
Set on some goods that are considered essential
Example is “Rent Control” in NYC
Allows “more” people to afford housing
Negative effects of Price Ceilings
Rent control creates a shortage of apartments
To get an apartment, tenants must:
Get on waiting list
Use a lottery system
Face discrimination by landlords
Bribe landlords

46. Combining Supply and Demand
Price Floor – a minimum price, set by the government, that must be paid for a good or service
set to ensure sellers get rewarded for their efforts
Example is Minimum Wage
Do the benefits of minimum-wage outweigh the loss of some jobs?
If you look at the chart, employers will hire 2 million fewer low-skilled workers including teenagers than if wages were lower.
Real world is more difficult to gauge, and some economists think the effect isn’t as bad as this example.
Another Example is Price Supports in Agriculture
gov set floors for some commodities
if price fell below certain floor the gov would by up excess crop to help ag industry
congress got rid of these in 1996
04/01/1991
$4.25
10/01/1996
$4.75
09/01/1997
$5.15
07/24/2007
$5.85
07/24/2008
$6.55
07/24/2009
$7.25 4
91’ - $4.25
96’ - $4.75
97’ - $5.15
07’ - $5.85
08’ - $6.55
09’ - $7.25

47. Chapter 6.1 Questions
Under what conditions is a market at equilibrium?
When supply exceeds demand, what happens to prices? How will the market return to equilibrium?
What action will a producer usually take when the price charged is higher than the equilibrium price? Why might the producer choose to keep the price as it is?

48. Changes in Market Equilibrium
Changes in supply and demand upset market equilibrium and cause prices to change
Moving Toward Equilibrium
Over time price and supply will gradually move toward equilibrium levels
Two ways to push a market in equilibrium into disequilibrium
Shift demand curve
Shift supply curve
Moving toward equilibrium
Why
shortages cause an increase in price
higher prices cause quantity supplied to rise and demand to go down
etc.

49. Changes in Market Equilibrium
Increase in Supply
This changes equilibrium price which will change quantity sold
Ex. Digital Cameras
Remember chapter 5, what can shift a supply curve
advances in technology
new government taxes and subsidies
changes in prices of raw materials or labor

50. Changes in Market Equilibrium
Looking at the chart:
the original supply has increased to the new supply, what had to happen to the price to reach equilibrium
Point B results in Surplus
Supply curve continues to shift to the right for digital cameras today
Typically equilibrium is in constant movement, which can be seen by price changes, sales, and rebates for products. Known as MOVING TARGET

51. Changes in Market Equilibrium
Decrease in Supply
Results in a rise in price and falling demand
Increase in Demand
Fad – a product that enjoys enormous popularity for a fairly short time
Causes a shortage which will result in increased price and increased supply
Search Costs – the financial and opportunity costs that consumers pay in searching for a product or service
What causes a supply curve to shift left???
higher prices for inputs
higher cost of labor
Fad products – Tickle Me Elmo
IPhone 4 – lines at mall of america
What other fad products can you think of???
Search costs – Black Friday shopping. Went to target in Rapid City, there at 4:30 am line was 500 long for store opening at 5 a.m. by the time I got to the shelf they were sold out.

52. Changes in Market Equilibrium
Decrease in Demand
Surplus of products results in lowering prices and decreasing supply
When a fad has passed, demand drops
What is the thing of yesterday???

53. Chapter 6.2 Questions
Why is equilibrium described as a “moving target”?
What does a rapid increase in demand for a good mean for a consumer?
What are some signs of a shortage in a market? What signs indicate that a market has a surplus?

54. The Role of Prices Prices in a Free Market Advantages of prices
A tool for distributing goods and resources in the economy
Nearly always the most efficient way to allocate, or distribute, resources
Advantages of prices
Provide a common language for buyers and sellers
Price as an Incentive
Higher prices will cause current firms to produce more and new firms to enter the market
Price as Signals
High price signals a good is in demand to suppliers
Low price signals a good is oversupplied to suppliers
Low price signals consumer to purchase more of a product
High price signals consumer to be careful and think twice
If we didn’t have prices how would goods move?
Barter system, with trading of goods and people who value things differently (two pair shoes for 1 sweater

55. The Role of Prices Flexibility Price System is “Free”
Price can change as needed
Supply Shock – a sudden shortage of a good, such as gasoline or wheat
How do you decide who gets what’s left???
Rationing – a system of allocating goods and services using criteria other than price
Raising price is quickest way to resolve a shortage
Price System is “Free”
Costs nothing to administer a free flowing price
Pricing distributes goods through millions of decisions made on a daily basis by consumers and suppliers
Hurricane wipes out an orange crop. How long does it take to regrow the crop???
When supply of gas decreased a few summers ago, what happened to the price of gas and diesel???
Rationing water for lawns – only even days or odd days during a drought
Centrally planned economy requires administrators to collect information on production and decide how resources are to be distributed.

56. The Role of Prices Choice and efficiency
Consumers have a variety of goods and services to choose from
Price allows consumers to narrow choices
Rationing and Shortages such as those done in USSR are expensive and inconvenient and leaves consumers unhappy
This can lead to Black Markets
Black Market – when people conduct business without regard for government controls on price or quantity
Prices allow efficient resource allocation and ensure resources will be used for their most valuable purposes
Shoes
Payless for $20
Kohls or JCPenny’s for $50
Niketown for $150
Cars
I can’t afford an Escalade
I can afford a Tahoe

57. The Role of Prices
Prices and the Profit Incentive

58. The Role of Prices The “Wealth of Nations” Market Problems
Written by Adam Smith in 1776
Business prosper by finding out what people want and then providing it.
Market Problems
Imperfect Competition – monopolies, oligopolies
Negative Externalities – pollution
Imperfect Information – need to make informed decisions to do what is best
Imperfect competition leads to higher prices and that affects consumer decisions
Because what we buy determines what is sold, we indirectly contribute to things like pollution, etc. Green movement
In Dubois, a local shop is now offering green transportation (two green bikes) that people can borrow for free and are asked to return them.

59. Chapter 6.3 Questions How does supply shock affect equilibrium price?
What does a higher price for a good tell a producer?
What is the quickest way to solve a shortage?
What is the quickest way to eliminate a surplus?