Demand and Supply

Demand

 Consumers influence the price of goods in a market economy.  Demand : the amount of a good or service that consumers are able and willing to buy at various possible prices during a specified time period  Supply : the amount of a good or service that producers are able and willing to sell at various prices during a specified time period  A market represents actions between buyers and sellers.

 The basis of activity in a market economy is the principle of voluntary exchange.  Voluntary Exchange : a transaction in which a buyer and seller exercise their economic freedom by working out their own terms of exchange  The seller sets the price and the buyer agrees to the product and price through the act of purchasing the product  Supply and demand analysis is a model of how buyers and sellers behave in the marketplace.

 Demand is created only when the customer is both willing and able to buy the product.  The law of demand states:  As price goes up, quantity demanded goes down.  As price goes down, quantity demanded goes up.

 Real Income Effect  People are limited by their income as to what they can purchase.  Real income effect forces people to make trade-offs.  Substitution Effect  People can replace one product with another if it satisfies the same need.  Amazon Prime Music vs. iTunes

 Diminishing Marginal Utility  People will purchase additional items until the satisfaction from the last unit is equal to the price.  The lessening of this satisfaction with each additional purchase is called diminishing marginal utility.  Utility : the ability of any good or service to satisfy consumer wants

The Demand Curve and Elasticity of Demand

 Demand schedule : a table of prices and the quantity demanded at each price.  To draw a demand curve:  List the quantity demanded at each price.  The Curve will graph the quantity demanded of a good or service at each possible price.

 A change in quantity demanded is caused by a change in the price of a good.  If something other than price causes demand to increase or decrease, this is known as a change in demand and shifts the demand curve.

 Population  When population increases, opportunities to buy and sell increase.  Demand for most products increases, shifting the curve to the right.  Income  An increased income allows consumers to buy more products or a greater quantity of a single product.  Tastes and preferences, including facts  Refers to what people like and prefer to choose.

 Substitutes  When a new competitor is added or an old competitor leaves the market.  Butter vs. Margarine  Complementary goods  Products that rely upon one another, demand for one affects demand for the other.  The decrease in the price of one product will cause an increase in demand for both products.  Cameras and film

 Elasticity : economic concept dealing with consumers’ responsiveness to an increase or decrease in price of a product  Price Elasticity of Demand : economic concept that deals with how much demand varies according to changes in price

 Elastic Demand  Occurs when the demand for some goods is greatly affected by the price.  One particular brand of coffee increases in price; consumers will purchase more of the other brands.  Inelastic Demand  Occurs when the demand for some goods is less affected by price.  Salt, pepper, and sugar are products consumers will purchase at almost any cost.

 What Determines Price Elasticity of Demand?  How many substitutes exist and how closely they provide the same quality and service.  Fewer or no substitutes make demand inelastic.  Percent of a personal budget spent on an item  The higher the percent of budget, the more elastic the demand.  How much consumers have to adjust to the new price.  More time makes for greater elasticity.

The Law of Supply and the Supply Curve

 Supply is the willingness and ability to provide goods to the consumers.  The Law of Supply states:  As the price rises for a good the quantity supplied generally rises.  As the price falls, the quantity supplied also falls.  A direct relationship exists between price and quantity supplied.

 Increase in price and increase in production leads to an increase in profits.  Higher prices encourage more competition to join the market.  Higher prices turn potential suppliers into actual suppliers, adding to the total output.

 As with demand, graphs and tables can explain the Law of Supply.  Supply schedule : shows the quantity supplied at each given price.  A supply curve graphs the quantities supplied at each possible price.  The relationship between quantity and price is direct and always moving in the same direction.

 A change in quantity supplied is caused by a change in price.  Something other than price can cause a change in supply as a whole to increase or decrease.

 Price of Inputs  The price of inputs, or the costs of production- raw materials, wages, insurance, utilities, etc.- can cause an increase in supply.  Number of Firms in the Industry  Competition, or the number of companies in an industry, can cause an increase in supply

 Taxes  An increase in taxes can cause a decrease in supply.  If taxes increase, businesses will not be willing to supply as much as before because the cost of production will rise.  Technology  An improvement in technology can cause an increase in supply  Technology : the science used to develop new products or methods of production and distribution.

 Adding units to increase production increases total output for a limited time period.  The extra output for each additional unit will eventually decrease.  Businesses will continue to add units of a factor of production until doing so no longer increases revenue.

Putting Supply and Demand Together

 In the real world, demand and supply work together.  As the price of goods goes down, the quantity demanded rises and the quantity supplied falls.  As the price goes up, the quantity demanded falls and the quantity supplied rises.

 Sellers and buyers work together indirectly to place goods and the equilibrium price.  Equilibrium Price : the price at which the amount producers are willing to supply is equal to the amount consumers are willing to buy

 If the demand curve shifts due to something other than price, the equilibrium price will change.  If the supply curve shifts due to something other than price, the equilibrium price will change.

 Rising prices signal producers to make more and consumers to purchase less.  Falling prices signal producers to make less and consumers to purchase more.

 Types of Signals:  Shortages  Occurs when the quantity demanded (at equilibrium price) is greater than the quantity supplied.  Surpluses  Occurs when the quantity supplied (at equilibrium price) is grater than quantity demanded.  Market Forces  Can cause the prices to rise or fall to correct shortages and surpluses.

 On occasion the government will get involved in setting prices.  If the government believes the market forces of supply and demand are unfair it may try to protect consumers and suppliers.  Special interest groups use pressure on elected officials to protect certain industries.

 Price Ceilings  Price Ceilings : a maximum price set by the government to prevent prices from going above a certain level.  Items in short supply might be rationed.  Shortages can lead to a black market, or illegal places to purchase such products at exorbitant prices.  Price Floors  Price Floors : a minimum price set by the government to prevent prices from going below a certain level  Price floors set minimum wage levels and support agricultural prices.