# Chapter 3. Markets Demand and Supply analysis takes place while looking at markets For now, we will be looking only at competitive markets These markets.

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Chapter 3

Markets Demand and Supply analysis takes place while looking at markets For now, we will be looking only at competitive markets These markets have many buyers and sellers influencing price and quantity

Demand Curve Shows: The various amounts of product consumers are willing and able to purchase at possible prices Only shows demand for a specific period of time

Demand Curve

Demand Curve – 2 nd Period Demand for Ice Cream pints PriceQuantity Demanded \$39 \$47 \$54 \$63 \$71 \$80

Demand Curve – 4 th Period Demand for Geek Chic table PriceQuantity Demanded \$1,0007 \$2,0005 \$3,0004 \$3,5002 \$4,0001 \$5,0000

Demand Curve – 6 th Period Demand for Jones Scones PriceQuantity Demanded \$210 \$37 \$43 \$51 \$60

Movements Along a Demand Curve Caused by a price change of that good/service If… Price increases quantity demanded decreases Imagine a soda in the vending machine costs \$5…would you still be willing to buy as many?

Movements Along a Demand Curve

If price decreases ….. Quantity demand increases What if a soda from the vending machine cost 10 cents? Would you buy more?

Movements Along the Demand Curve

When there is a movement along the demand curve we say there is a CHANGE IN THE QUANTITY DEMANDED A movement along the curve is not a change in demand.

Law of Demand o Ceteris paribus, as the price of a good/service decreases, the quantity demanded increases o Ceteris paribus, as the price of a good/service increases, the quantity demanded decreases o Inverse relationship between price and quantity demanded o Demand curve is downward sloping

How do we know this is true? 1. Observation of consumer and business behavior 2. Diminishing marginal utility: as consumption of a good/service increases, consumers gain less and less satisfaction (marginal utility) from each additional unit. Therefore, they will only buy more units at lower prices because they value each extra unit less.

How do we know this is true? In other words…. With each additional starburst I eat I am less and less satisfied. Therefore, at some point, my starbursts are less valuable to me and I will want to pay less for them.

How do we know this is true? 3. Income Effect: as price decreases, real income increases, which allows consumers to buy more of that good/service If I have \$10 to buy \$1 packets of starburst, I can buy 10 of them. If the packets cost \$0.50, I can buy 20. My income is getting me more as the price decreases!

How do we know this is true? 4. Substitution Effect: as price decreases, consumers will substitute more of the now relatively cheaper good As starbursts get cheaper…I might just start buying them to replace my \$5 lunch.

Market Demand Summation of individual market demand schedules ++ = 4 4 4 00 00 4 4 4 48 8 8 12 24

Market Demand In other words, if I add up my demand curve for starburst, yours, yours, you in the back – yours too, and yes you also…I get the market demand for starbursts in this class.

What makes the demand curve shift?

1. Tastes/Preferences Good/service becomes more popular increase in demand Good/service becomes less popular decrease in demand

Tastes and Preferences Would you pick this? Or This?

Tastes and Preferences Would you pick this? Or This?

Tastes and Preferences Its not just technology…

2. Population Increase in number of buyers increase in demand More people move into area increase in demand Decrease in number of buyers decrease in demand People move out of area decrease in demand

Population Atlanta, GA = 432,427 Humansville, MO = 1,049 Assume everyone wants at least one cell phone Demand in ATL = 432,427 Assume everyone wants at least one cell phone Demand in Humansville – 1,049

Population Atlanta, GA = 432,427 Humansville, MO = 1,049 Assume everyone wants at least one cell phone Demand in ATL = 432,427 Population in ATL decreases by 100,000 *all moving to Humansville Demand in ATL = 332,427 Assume everyone wants at least one cell phone Demand in Humansville – 1,049 Population in Humansville increases by 100,000 Demand in Humansville – 101,049

3. Income Income impacts our demand for products. First must distinguish between a normal and inferior good Taste Test Time!

3. Income Normal Goods: If income increases increase in demand for good/service If income decreases decrease in demand for good/service

3. Income Inferior Goods If income increases decrease in demand for good/service If income decreases increase in demand for good/service

4. Change in Price of Substitute If the price of a substitute for good/service A decreases decrease in demand for good/service A If the price of a substitute for good/service A increases increase in demand for good/service Lets examine my flavored water obsession….

5. Change in the Price of a Complementary Good What is a complementary good? One that complements the other! One often consumed with the other.

5. Change in the Price of a Complementary Good Two goods/service which go together If the price of a complement for good/service A decreases increase in demand for good A If the price of jelly goes down, I can get more of it and make more sandwiches. This means Ill need more peanut butter so my demand for peanut butter goes up!

5. Change in the Price of a Complementary Good Two goods/service which go together If the price of a complement for good/service A increases decrease in demand for good A If the price of jelly goes up, that means I wont want to buy as much and I will have to make a different kind of sandwich…I will be sad and I also wont need as much peanut butter.

6. Expectations/Fears If consumers expect that the price of a good/service will increase in the future increase in demand for that good/service now Think about when gas prices are due to go up…ie the gas shortage in 2008!

6. Expectations/Fears If consumers expect that the price of a good/service will decrease in the future decrease in demand for that good/service now Ever waited to buy a new phone because you knew a newer version was going to come out? This could be because a. you know that you want the new technology or b. YOU KNOW THE PRICE OF THE OLDER VERSION WILL BE LESS!!!

Supply Schedule or a curve showing the various amounts of a product producers are willing and able to produce and make available for sale at each of a series of possible prices during a specified period of time

Movements along the Supply Curve Caused by a price change of that good/service Price increases quantity supplied increases Price decreases quantity supplied decreases

Law of Supply Ceteris paribus, as the price of a good/service increases, the quantity supplied increases Ceteris paribus, as the price of a good/service decreases, the quantity supplied decreases Direct relationship between price and quantity supplied Supply curve is upward sloping

Why is the Law of Supply True? To producers, price is = to revenue. Therefore, at higher prices, producers have more of an incentive to produce more Increasing costs. As production (q) increases, the costs per unit may fall at first, but eventually they rise (decreasing returns to scale). In order to cover these rising costs, the producer would want to charge a higher price.

Why is the Law of Supply True? Labor supply: workers will supply more labor at higher wages (the price of their labor)

What causes the supply curve to shift?

1. Resource Prices If costs of production decrease increase in supply If costs of production increase decrease in supply Examples: wages, price of raw materials

Example: Oil rising If the price of oil as an input rises, the supply of all the following goods will decrease. Bicycle tires Dresses Mops Umbrellas Shampoo Heart valves Food preservatives Nail polish Tents Telephones

2. Technology If technology improves increase in supply If technology deteriorates decrease in supply

3. Subsidies and Taxes If subsidies increase increase in supply -Subsidy: government helps to pay the cost of producing a good/service EX: Farming If taxes increase or imposed decrease in supply If taxes decrease or removed increase in supply

4. Prices of Other Goods If prices of other goods/services, which a firm can easily adapt its plant and equipment to produce, increase decrease in supply of good/service presently produced

4. Prices of Other Goods Example: I have a plant where all I manufacture are soccer balls…every day, all day. I discover that the price of footballs has increased relative to soccer balls My plant can easily switch and make footballs instead of soccer balls and make more money I will increase the amount of footballs I supply And decrease the amount of soccer balls I supply

5. Expectations Increases and decreases in supply depend on circumstances If agriculture prices are expected to increase in the future decrease in supply (farmers might not bring as much to the market now) If I know my crop is going to be worth more money next month…why pick it now and see it? I can wait a month and sell it when its worth more money!

5. Expectations Increases and decreases in supply depend on circumstances If manufacturing prices are expected to increase in the future increase in supply now If I know that the cost of producing my product is going to go up in the future, I want to make as much of it before that happens as I can! I will make more now so I have a stockpile going when the costs of production go up!

6. Number of Sellers If number of sellers increases increase in supply If number of sellers decreases decrease in supply

NOW LETS PUT THESE TWO TOGETHER We can now combine our supply and demand curves. The point where the two curves meet is where we want to be…and heres why

Surpluses Quantity supplied is greater than the quantity demanded S D Q P 0 Price QDQD QSQS

Shortages Quantity demanded is greater than the quantity supplied S D Q P 0 Price QDQD QSQS

Equilibrium Quantity demanded is equal to the quantity supplied Rationing: the ability of the market system to eliminate surpluses and shortages by changing prices and quantities supplied and demanded Equilibrium price clears the market

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