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Chapters 4 and 5 Supply and Demand © OnlineTexts.com p. 1 The Law of Demand • The law of demand holds that other things equal, as the price of a good or service rises, its quantity demanded falls. – The reverse is also true: as the price of a good or service falls, its quantity demanded increases. © OnlineTexts.com p. 2 Demand Curve The demand curve has a negative slope, consistent with the law of demand. © OnlineTexts.com p. 3 Demand © OnlineTexts.com p. 4 Demand and Marginal Utility • Marginal Utility – the extra usefulness or additional satisfaction a person gets from using one more unit of a product – As we use more and more of the product, we encounter diminishing marginal utility – satisfaction begins to decline © OnlineTexts.com p. 5 Diminishing Marginal Utility © OnlineTexts.com p. 6 Shift in the Demand Curve • A change in any variable other than price that influences quantity demanded produces a shift in the demand curve or a change in demand. • Factors that shift the demand curve include: – – – – Change in consumer incomes (Income Effect) Population change Consumer preferences (Fads) Prices of related goods: • Substitutes (Substitution Effect): goods consumed in place of one another • Complements: goods consumed jointly © OnlineTexts.com p. 7 Shift in the Demand Curve This demand curve has shifted to the right. Quantity demanded is now higher at any given price. © OnlineTexts.com p. 8 Change in Demand © OnlineTexts.com p. 9 Demand Elasticity • Demand Elasticity – how responsive consumers are to a change in price. – Elastic Demand • Highly responsive to a price change – ex. Gas stations – Inelastic Demand • Unresponsive (or very little) to a price change – ex. Insulin shots, heart transplant, salt Determinants of Demand Elasticity 1. Can the purchase be delayed? 2. Are adequate substitutes available? 3. Does it use a large portion of your income? © OnlineTexts.com p. 10 © OnlineTexts.com p. 11 Demand Elasticity © OnlineTexts.com p. 12 The Law of Supply • The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa. • Why do producers produce more output when prices rise? – They seek higher profits – They can cover higher marginal costs of production © OnlineTexts.com p. 13 Supply © OnlineTexts.com p. 14 Supply Curve The supply curve has a positive slope, consistent with the law of supply. © OnlineTexts.com p. 15 GRAPHING SUPPLY Price of Corn P Plot the Points $5 CORN P QS 4 $5 4 3 2 1 3 2 1 o 5 10 20 30 40 50 60 70 80 Quantity of Corn 60 50 35 20 5 Q © OnlineTexts.com p. 16 GRAPHING SUPPLY Price of Corn P Plot the Points $5 CORN P QS 4 $5 4 3 2 1 3 2 1 o 10 20 30 40 50 60 70 80 Quantity of Corn 60 50 35 20 5 Q © OnlineTexts.com p. 17 GRAPHING SUPPLY Price of Corn P Plot the Points $5 CORN P QS 4 $5 4 3 2 1 3 2 1 o 10 20 303540 50 60 70 80 Quantity of Corn 60 50 35 20 5 Q © OnlineTexts.com p. 18 GRAPHING SUPPLY Price of Corn P Plot the Points $5 CORN P QS 4 $5 4 3 2 1 3 2 1 o 10 20 30 40 50 60 70 80 Quantity of Corn 60 50 35 20 5 Q © OnlineTexts.com p. 19 GRAPHING SUPPLY Price of Corn P Plot the Points $5 CORN P QS 4 $5 4 3 2 1 3 2 1 o 10 20 30 40 50 60 70 80 Quantity of Corn 60 50 35 20 5 Q © OnlineTexts.com p. 20 GRAPHING SUPPLY Price of Corn P $5 Plot the Points S CORN P QS 4 3 2 1 o Connect the Points 10 20 30 40 50 60 70 80 Quantity of Corn $5 4 3 2 1 60 50 35 20 5 Q © OnlineTexts.com p. 21 GRAPHING SUPPLY Price of Corn P $5 S CORN P QS 4 $5 4 3 2 1 3 2 1 o 10 20 30 40 50 60 70 80 Quantity of Corn 60 50 35 20 5 Q © OnlineTexts.com p. 22 Shift in the Supply Curve • A change in any variable other than price that influences quantity supplied produces a shift in the supply curve or a change in supply. • Factors that shift the supply curve include: – Change in input costs – Increase in technology – Change in size of the industry – Taxes © OnlineTexts.com p. 23 Shift in the Supply Curve For an given rental price, quantity supplied is now lower than before. © OnlineTexts.com p. 24 Theory of Production • The Production Function – See page 128 – The Production Period – Total Product – Marginal Product © OnlineTexts.com p. 25 Stages of Production • Stage I – Increase Marginal Returns – Adding more workers increase output • Stage II – Decrease Marginal Returns – Total production keeps growing, but by smaller and smaller amounts (diminishing returns) • Stage III – Negative Marginal Returns – With added workers, output begins to fall © OnlineTexts.com p. 26 Diminishing Marginal Utility © OnlineTexts.com p. 27 Cost, Revenue and Profit Maximization Measures of Cost • Fixed Costs – A.k.a. Overhead – Ex. – salaries, rent payments, state and local property taxes © OnlineTexts.com p. 28 • Variable Costs – Change when the business’s rate of operation or output changes – Ex. Labor cost (hourly), raw materials, freight cost © OnlineTexts.com p. 29 Applying Cost Principles • E-Commerce – Limited overhead cost • No need to purchase building • All online accounting, catalogs, etc. • Break-Even Point – The level of production that generates just enough revenue to cover its total operating cost – Profit Maximization – marginal cost and marginal revenue are equal