1. Unit 2
The Product Market
20 to 30%

2. Supply & Demand

3. LAW OF DEMAND
An inverse relationship exists between price and quantity demanded
As Price Falls…
…Quantity Demanded Rises
As Price Rises…
…Quantity Demanded Falls

4. DOWNWARD SLOPE Diminishing Marginal Utility Income Effect
Substitution Effect

5. GRAPHING DEMAND Increase in Quantity Demanded P QD $5 4 3 2 1 10 20 35
Price of Corn P
Increase
in Quantity
Demanded $5 4 3 2 1
CORN P QD $5 4 3 2 1 10 20 35 55 80 30 40 60 80 +
Increase in
Demand D2 D1 o Q
Quantity of Corn

6. DETERMINANTS OF DEMAND
Tastes (Preferences)
Prices of Related Goods
Substitutes & Complements
Unrelated Goods
Income
Normal (Superior) & Inferior Goods
Number of Buyers
Expectations

7. LAW OF SUPPLY
A direct relationship exists between price and quantity supplied
As Price Rises…
…Quantity Supplied Rises
As Price Falls…
…Quantity Supplied Falls

8. GRAPHING SUPPLY Increase in Supply P QS $5 4 3 2 1 60 50 35 20 5 80 70
Price of Corn P
Increase in
Supply S2 S1 $5 4 3 2 1
CORN P QS $5 4 3 2 1 60 50 35 20 5 80 70 60 45 30
Increase
in Quantity
Supplied o Q
Quantity of Corn

9. DETERMINANTS OF SUPPLY
Resource Prices
Prices of Other Goods
Technology
Taxes & Subsidies
Price Expectations
Number of Sellers

10. DETERMINANTS OF SUPPLY
Resource Prices
Technology
Taxes & Subsidies
Prices of Other Goods
Price Expectations
Number of Sellers
Combining
with
Demand

11. MARKET DEMAND & SUPPLY Surplus Shortage P QD P QS $5 4 3 2 1 2,000
Price of Corn P
CORN
MARKET
CORN
MARKET
Surplus S $5 4 3 2 1 P QD P QS $5 4 3 2 1
2,000
4,000
7,000
11,000
16,000 $5 4 3 2 1
12,000
10,000
7,000
4,000
1,000
Shortage D 7 11 o Q
Quantity of Corn

12. Consumer and Producer Surplus in the Market Equilibrium
Price A C B D E
Consumer
surplus
Demand
Supply
Equilibrium
price
quantity
Producer
surplus
Quantity

13.   % Q % P Commonly Expressed as… PRICE ELASTICITY OF DEMAND P D Q
The percentage change in quantity
The percentage change in price %  Q d  % P P2 P1
Elasticity is .5 D Q2 Q1 Q

14.  Price Elasticity is... Inelastic 0 < X < 1
PRICE ELASTICITY OF DEMAND
Price Elasticity is...
Inelastic 0 < X < 1
Typical of necessities one must have
Elastic from 1 < X < 
Typical of luxuries one wants
Unit elastic when exactly = 1
Quantity change offsets Price change

15. Extreme Cases PRICE ELASTICITY OF DEMAND Perfectly Inelastic Demand
Ed = 0 Q
Perfectly Elastic Demand P D2
Ed =  Q

16.  Ed = More Accurate Calculation – The Midpoint Formula
PRICE ELASTICITY OF DEMAND
More Accurate Calculation –
The Midpoint Formula Ed = ΔQ
AVG Q ΔP
AVG P 

17. TOTAL REVENUE TEST Another way to determine elasticity P x Q = TR
P and Q move opposite each other
So how do we know what happens to TR?
If P and TR move together demand is inelastic
If Q and TR move together demand is elastic
If TR doesn’t move demand is unit elastic

18. CONTROLS ON PRICES Price Ceiling Price Floor
A legal maximum on the price at which a good can be sold.
Price Floor
A legal minimum on the price at which a good can be sold. 4 4

19. A Market with a Price Ceiling
(b) A Price Ceiling That Is Binding
Price of
Ice-Cream
Cone
Supply
Demand
Equilibrium
price $3 2
Price
ceiling 75
125
Shortage
Quantity of
Ice-Cream
Quantity
supplied
Quantity
demanded
Cones

20. A Market with a Price Floor
(b) A Price Floor That Is Binding
Price of
Ice-Cream
Supply
Cone
Demand
Surplus $4
Price
floor 80
120 3
Equilibrium
price
Quantity of
Ice-Cream
Quantity
demanded
Quantity
supplied
Cones

21. How a Tax Affects Market Participants
Tax Revenue
T = the size of the tax
Q = the quantity of the good sold
T  Q = Tax Revenue

22. Tax Revenue Price Demand Supply Quantity with tax Price buyers pay
Price sellers
receive
Tax
revenue
(T × Q)
Size of tax (T)
Quantity
without tax
Quantity
sold (Q)
Quantity

23. How a Tax Affects Welfare
Price
Demand
Supply = PB Q2 PS
Price
buyers
pay
sellers
receive A F B D C E = P1 Q1
Price
without tax
Quantity

24. DETERMINANTS OF DEADWEIGHT LOSS
What determines whether the deadweight loss from a tax is large or small?
Elasticities of Demand & Supply
More elastic curves bring more loss

25. Tax Incidence
Who pays for the tax?
The more inelastic curve pays more

26. the last dollar spent on
UTILITY MAXIMIZING COMBINATION
Product A:
Price = $1
Product B:
Price = $2
$ 10 income
Marginal
utility per
dollar
(MU/price)
Marginal
utility per
dollar
(MU/price)
Marginal
utility,
utils
Marginal
utility,
utils
Unit of
product
First
Second
Third
Fourth
Fifth
Sixth
Seventh
Income is gone...
the last dollar spent on
each good gave the same
utility (8) per dollar

27. Algebraic Restatement of the Utility Maximization Rule
Consumption Bundles
Algebraic Restatement of the
Utility Maximization Rule
MU of A
Price of A
MU of B
Price of B =
8 Utils $1
16 Utils $2 =