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Demand, Supply and Pricing
Prices produce a rationing effect in a
market economy. If there is a shortage of
a good or service it results in higher
prices. Higher prices result in a reduction
in the quantity demanded.
How demand is influenced
• Substitute effect- when the price of a
good increases people will by less of the
good and they will look for substitutes.
• Income effect- when the price rises people
buy less because it takes a greater portion
of their income and when the price goes
down they may buy more of the good.
Changes in quantity demanded
versus shifts in demand
• A change in the quantity demanded is
movement along the demand line due to
changes in price
• A shift in demand is a whole new demand
line caused by outside circumstances
Causes of shift in demand
• Change in income
• Consumer expectations
• Population (number of buyers)
• Changes in tastes, advertising, styles
• Prices of substitutes
• Prices of complementary goods (things
that go along with the other good such as,
peanut butter and jelly
Elasticity of demand
• A good is elastic if the quantity demanded
changes due to a price change. A good is
inelastic if people buy almost the same
amount even if there is a price change.
Factors that affect elasticity
• 1. available substitutes
• 2. portion of income- relative importance
• 3. Change over time (long vs. short run)
Test for Elasticity of Demand
Total Revenue
• Supply is the amount of goods and services that
producers are willing to offer at different prices.
Often producers face higher marginal costs to
produce more of their product so they want
higher prices to cover their costs. Market entry
costs also affect the number of goods produced.
• Supply elasticity is determined by TIME. Supply
usually can not change much in the short run
but may be adjusted over the long-run.
Causes for changes in Supply
• 1.
• 2.
• 3.
• 4.
• 5.
• 6.
Change in future expectations
Changes in the number of suppliers
Changes in production costs
Changes in technology
Changes in the price of substitutes
Changes in taxes. subsidies and
Market Price or Equilibrium Price
• The intersection of the supply and
demand lines. This is the only price where
supply equals demands. At this price
there will be no surpluses or shortages.
Government’s influence on Supply
• Price floors- a price that is set higher
than the market price by the government
to help suppliers by setting minimum
prices to encourage more production
(farm price supports, minimum wage etc)
Government influence on supply
• Price ceilings- a price set below the
market clearing price to help consumers
from playing very high market prices (rent
controls for low income housing)
Advantages of Prices
• Higher price an incentive to produce more
• Prices are signal of consumer demand
• Flexibility- if there is a shift in supply or
demand prices can change quickly to meet
the change
• Price system is free- no government
control is needed. Prices adjust