1. © 2014 Pearson Education, Inc. Publishing as Prentice Hall CASE  FAIR  OSTER PRINCIPLES OF MICROECONOMICS E L E V E N T H E D I T I O N PEARSON Prepared by: Fernando Quijano w/Shelly Tefft

2. 2 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall CHAPTER OUTLINE 3 Demand, Supply, and Market Equilibrium Firms and Households: The Basic Decision-Making Units Input Markets and Output Markets: The Circular Flow Demand in Product/Output Markets Changes in Quantity Demanded versus Changes in Demand Price and Quantity Demanded: The Law of Demand Other Determinants of Household Demand Shift of Demand versus Movement Along the Demand Curve From Household Demand to Market Demand Supply in Product/Output Markets Price and Quantity Supplied: The Law of Supply Other Determinants of Supply Shift of Supply versus Movement Along the Supply Curve From Individual Supply to Market Supply Market Equilibrium Excess Demand Excess Supply Changes in Equilibrium Demand and Supply in Product Markets: A Review Looking Ahead: Markets and the Allocation of Resources

3. 3 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall firm An organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy. entrepreneur A person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business. households The consuming units in an economy. Firms and Households: The Basic Decision-Making Units

4. 4 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  FIGURE 3.1 The Circular Flow of Economic Activity Diagrams like this one show the circular flow of economic activity, hence the name circular flow diagram. Here goods and services flow clockwise: Labor services supplied by households flow to firms, and goods and services produced by firms flow to households. Payment (usually money) flows in the opposite (counterclockwise) direction: Payment for goods and services flows from households to firms, and payment for labor services flows from firms to households. Note: Color Guide—In Figure 3.1 households are depicted in blue and firms are depicted in red. From now on all diagrams relating to the behavior of households will be blue or shades of blue and all diagrams relating to the behavior of firms will be red or shades of red. The green color indicates a monetary flow.

5. 5 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall product or output markets The markets in which goods and services are exchanged. input or factor markets The markets in which the resources used to produce goods and services are exchanged. labor market The input/factor market in which households supply work for wages to firms that demand labor. capital market The input/factor market in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods. land market The input/factor market in which households supply land or other real property in exchange for rent. Input Markets and Output Markets: The Circular Flow

6. 6 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  Market ◦ A group of buyers and sellers of a particular good or service  Can be highly organized  E.g.: agricultural commodities  Can be less organized  E.g.: ice cream, espresso carts, Freemont Sunday market 6

7. 7 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  Market Types ◦ 1. Perfect Competition  No individual buyer/seller has a significant influence on market price ◦ 2. Monopoly  Single producer of good; chooses output (quantity supplied) that max’es profit ◦ 3. Oligopoly  Small number of suppliers; may “collude” to set price like a monopolist ◦ 4. Monopolistic Competition  Compete on both price and quality against several producers 7

8. 8 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  Perfectly competitive market ◦ Each buyer/seller has a negligible impact on market price ◦ Why? (Key assumptions)  Goods offered for sale - exactly the same  Buyers and sellers – numerous  No single buyer or seller has any influence over the market price  Must accept the price determined on the market  Price takers  At the market price  Buyers - buy all they want  Sellers - sell all they want 8

9. 9 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  Basic Vocabulary ◦ Quantity demanded  Amount of a good purchased at a given price  A point on the demand curve ◦ Demand  The entire schedule (curve)  Quantity demanded at various prices ◦ Difference between a change in quantity demanded and demand  Movement along the Demand Curve (change in price) versus movement of the D Curve 9

10. 10 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  Demand schedule - a table ◦ Relationship between  Price of a good  Quantity demanded  Demand curve - a graph ◦ Relationship between  Price of a good  Quantity demanded  Individual demand vs Market Demand ◦ One individual vs all people in buying the good 10

11. 11 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall A household’s decision about what quantity of a particular output, or product, to demand depends on a number of factors, including:  The price of the product in question.  The income available to the household.  Normal good – buy/want more as income increases  Inferior good - buy less as income increases  The prices of other products (substitutes or complements) available to the household.  The household’s expectations about future income and prices.  The household’s tastes and preferences. Demand in Product/Output Markets

12. 12 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall TABLE 3.1 Alex’s Demand Schedule for Gasoline Price (per Gallon) Quantity Demanded (Gallons per Week) $ 8.000 7.002 6.003 5.005 4.007 3.0010 2.0014 1.0020 0.0026  FIGURE 3.2 Alex’s Demand Curve The relationship between price (P) and quantity demanded (q) presented graphically. negative slope, lower prices cause quantity demanded to increase.

13. 13 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall 1.They have a negative slope. 2.They intersect the quantity (X) axis as a result of time limitations and diminishing marginal value of the good. 3.They intersect the price (Y) axis, a result of limited income and wealth. Other Properties of Demand Curves The actual shape of an individual household demand curve—whether it is steep or flat, whether it is bowed in or bowed out—depends on the unique tastes and preferences of the household and other factors.

14. 14 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  Shifts in demand ◦ Increase in demand  Any change that increases the quantity demanded at every price  Demand curve shifts right ◦ Decrease in demand  Any change that decreases the quantity demanded at every price  Demand curve shifts left 14

15. 15 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  Shifts versus Movement Along a Demand Curve – Change in Price of Related Goods 1. Along the demand curve: price of hamburger rises, the quantity of hamburger demanded declines 2.Movement of the demand curve: (change in price of substitute or complement) same price rise for hamburger shifts the demand for chicken (a substitute for hamburger) to the right and the demand for ketchup (a complement to hamburger) to the left.

16. 16 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall TABLE 3.2 Shift of Alex’s Demand Schedule Due to Increase in Income Schedule D 0 Schedule D 1 Price (per Gallon) Quantity Demanded (Gallons per Week at an Income of $500 per Week) Quantity Demanded (Gallons per Week at an Income of $700 per Week) $ 8.0003 7.0025 6.0037 5.00510 4.00712 3.001015 2.001419 1.002024 0.002630  Shift of a Demand Curve following a Rise in Income Increase in income changes the relationship between price and quantity; there is a shift of the demand curve, in this case from D 0 to D 1. Gasoline is a normal good. Shift of Demand versus Movement Along a Demand Curve

17. 17 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall normal goods Goods for which demand goes up when income is higher and for which demand goes down when income is lower. inferior goods Goods for which demand tends to fall when income rises.

18. 18 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  FIGURE 3.4 Shifts versus Movement Along a Demand Curve a. When income increases, the demand for inferior goods shifts to the left and the demand for normal goods shifts to the right.

19. 19 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  Variables that can shift the demand curve ◦ Prices of related goods (substitutes or complements) ◦ Income ◦ Number of buyers(market vs individual demand) ◦ Expectations ◦ Individual Tastes and Preferences 19

20. 20 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  Market demand ◦ Sum of all individual demands for a good or service  Market demand curve ◦ Sum - individual demand curves horizontally ◦ Total quantity demanded of a good varies  As the price of the good varies  All other factors that affect how much consumers want to buy are hold constant 20

21. 21 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall 2 21 Price of ice-cream cone Catherin e Nichola s Market $0.00 0.50 1.00 1.50 2.00 2.50 3.00 12 10 8 6 4 2 0 +76543217654321 =19 16 13 10 7 4 1 The quantity demanded in a market is the sum of the quantities demanded by all the buyers at each price. Thus, the market demand curve is found by adding horizontally the individual demand curves. At a price of $2.00, Catherine demands 4 ice-cream cones, and Nicholas demands 3 ice-cream cones. The quantity demanded in the market at this price is 7 cones.

22. 22 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall 2 22 D Catherine 0121011912345678 Quantity of Ice-Cream Cones $3.00 2.50 2.00 1.50 1.00 0.50 Price of Ice Cream Cones Catherine’s demand D Nicholas 01234567 Quantity of Ice-Cream Cones $3.00 2.50 2.00 1.50 1.00 0.50 Price of Ice Cream Cones Nicholas’s demand += D Market 018246810121416 Quantity of Ice-Cream Cones $3.00 2.50 2.00 1.50 1.00 0.50 Price of Ice Cream Cones Market demand

23. 23 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall  FIGURE 3.5 Deriving Market Demand from Individual Demand Curves Total demand in the marketplace is simply the sum of the demands of all the households shopping in a particular market. It is the sum of all the individual demand curves—that is, the sum of all the individual quantities demanded at each price.

24. 24 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall What you decide to buy today certainly depends on today’s prices and your current income and wealth. There are many examples of the ways expectations affect demand. Increasingly, economic theory has come to recognize the importance of expectations. It is important to understand that demand depends on more than just current incomes, prices, and tastes. Expectations

25. 25 of 50 © 2014 Pearson Education, Inc. Publishing as Prentice Hall