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Economics Unit 2 Chapters 4-6 Time: 2.5 Weeks Materials: Unit 2 Packet and Chapter Problem Sets UCA: Banana Market 1 Economics Unit 2 Part I -Gains from TradeTopic: Unit 2 Part 1 – Specialization and Gains From Trade EQ: How does comparative and absolute advantage lead to supply and demand? CSS: 12.1.1 Scarcity/choices, 12.1.2 Marginal benefit/cost, 12.1.3 Incentives 2 • Specialization – Individuals become highly skilled in specific tasks • I teach economics and government, I don’t milk a cow why not, well b/c it is a waste of my time. – Allows for Division of Labor • Do one job and do it well • Creates trade among individuals for items they have no skill to produce • Trade – Always a voluntary exchange of: • Goods I want ______(enter what is important to you) • Services my hard work (service) provides you with the means (good grade = higher paying job) to purchase said good 3 • Trade is needed to exploit advantages – Found in economies: • Traditional: the use of coincidence of wants = barter for goods that are NEEDED • Market: the use of fiat (fake) money • Economic Interdependence – Require the removal of trade barriers to work efficiently – Found in U.S. Constitution’s “Commerce Clause” • Article I Section 8 > “Congress shall have Power…to regulate Commerce with foreign Nations, and among the several States.” • Question = why was the Constitution set up this way? 4 • Self-Sufficiency or Interdependence? – Absolute Advantage • Use fewer resources to produce same good/service • You’re just better at everything . . . Kinda’ like Kanye West. • Benefits of Comparative Advantage – Theory developed by David Ricardo in 1817 • Perform a task AT A LOWER OPPORTUNITY COST – in other words, if your OC is lower than another persons, you will perform that task because it benefits you more (profit motive) – This allows you to specialize in something and trade for something else – This theory applies to COUNTRIES as well as INDIVIDUALS 5 Opportunity Costs 6 • Specialization Benefits us in three ways: – Puts goods in the hands of those who value them • You’re only going to buy it if you value the item – Increases the quantity/variety of goods • Due to specialization of tasks/skills – Lowers costs of goods • Open trade to areas of less expensive production -> China and cheap manufactured goods • Expanding markets for goods increase the sale of goods 7 Specialization Quick Review 1. The term “specialization" A. B. C. D. describes a person who has a lower opportunity cost to create something better than someone else describes a person who has a higher opportunity cost to create something better than someone else describes has nothing to do with opportunity cost Squirrels make me laugh. 2. Trade makes us: A. B. C. D. Better off Worse off Neutral, kinda’ like Switzerland Better off if we have a lower opportunity cost for the good that we are trading for 3. Comparative advantage A. B. C. D. Puts goods in the hands of those who values them Means you have a lower opportunity cost to produce a good Lowers the costs of goods All above are correct 8 Gains from Trade Review 1. Explain why I don’t milk cows yes, that is a real question with a real answer. 2. What is absolute advantage? 3. What is comparative advantage? • • Give an example of each of the terms above. What is the difference between the two? 4. Name the three ways in which trade benefits all of us. Give an example of each. 5. Now answer the EQ with your partner (this is your summary). 9 Economics Topic: Unit 2 Part 2 -DemandEQ: Who creates demand and what causes demand for a good/service to change (shift)? MMM, Donuts 10 Indiana Jones!!! 11 MARKETS AND COMPETITION One thing is very important for the next few weeks: we are always talking about the SHORT RUN and we are only looking at the specific market conditions that I give you. • Buyers determine demand. • Demand will always, always, go down to the ground when we graph it – Think: “D”emand = “D”own 12 DEMAND • Quantity demanded is the amount of a good that buyers are willing and able to purchase. • Law of Demand – The law of demand states that, other things equal, the quantity demanded of a good falls when the price of the good rises. 13 The Demand Curve: The Relationship between Price and Quantity Demanded • Demand Schedule – The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. • Price is always on the “Y” Axis • Quantity is always on the “X” Axis Demand for a donut Price for a donut $2.50 $2.00 $1.50 $1.00 $.50 14 Basic Demand Graph Y = Price Demand Curve The demand curve (D) is a graph of the relationship between the price of a good and the quantity demanded (think QD=Price). X = Quantity 15 Variable that influence a MOVEMENT along the demand curve is called a change in the quantity demanded A TAX is the most common reason for the change of price. Think: If the price of donuts goes up, I will buy less of them b/c I will buy some other breakfast food instead . . . Thus b/c of the price I will have a change in the quantity demanded for donuts (as a consumer, I want to 16 maximize my profit). Copyright©2004 South-Western Basic Demand Graph –Class Results Period 2 Demand for a Donut 8 11 FOR DONUTS 21 26 29 Market Demand Period 3for Donuts Period 4 Price for a Donut Demand for a Donut Price of Donuts Period 5 Demand Price for for a Donut a Donut 71 7 $2.50 96 10 $2.00 14 $1.50 106 22 $1.00 25 $0.50 106, 0.5 150 f Donuts Demand for a Donut Market Market Price $2.50 12 $2.50 2 Demand for for a Donut $2.00 11 a $2.00 5 $1.50 Donut19 $1.50 17 $1.00 25 $1.00 23 29 28 $0.50 $0.50 $2.50 24 37 6, 1 Price for a Donut Price for a Donut $2.50 $2.00 $1.50 $1.00 $0.50 $2.00 $1.50 $1.00 $0.50 17 Demand Quick Review Short Answer #1 Governor Brown just passed A.B. (Assembly Bill) 1388 which decrease the taxes on gas. What is going to happen to the demand for gas? Demonstrate by using a graph. 18 Demand Quick Review Short Answer #2 The price of sugar increases due to a tax. What will happen to demand for Soda? Demonstrate by using a graph. 19 The Shifting Demand Curve • Demand Curve shifts when: – There is a change in the amount of a good demanded regardless of price – This is called a change in the amount demanded – There are five variables that cause a demand curve to shift – Shifts are based on quantity Shift in Demand for Donuts Vader Video #2 Demand Curve Shifters 20 Variables that influence a SHIFT of the whole demand curve. Remember, only a change in one is needed to cause a shift 21 Copyright©2004 South-Western Shifts in the Demand Curve • Consumer Income – As income increases the demand for a normal good will increase. LEXUS • People might even buy a superior good – As income increases the demand for an inferior good will decrease. TOYOTA SCION C O N S U M E R I N C O M E 22 Complements and Substitutes • Prices of Related Goods 23 Demand Quick Review If the government announces today that a tax increase of 50 cents per pack of cigarettes is to take place in two weeks, what would you expect to happen today to the current market for cigarettes? a. The demand for cigarettes would increase. b. The demand for cigarettes would decrease. c. The price of cigarettes would increase. d. Both a) and c) are correct. e. Both b) and c) are correct. 24 Demand Quick Review If a loaf of bread is an inferior good, then what will happen in the market for the loaf of bread as the consumer income increases? a. The market quantity will increase. b. The market quantity will decrease. c. There will be no change in market quantity demanded. d. What does inferior mean? 25 Demand Quick Review Short Answer #3 If consumers expect a new version of Nike Michael Jordan shoes to be introduced next week, how is that going to change the demand curve for the shoes THIS WEEK? Demonstrate by using a graph. 26 Demand Quick Review Short Answer #4 Mr. Maino makes the following statement in class, “you should take advantage of the college courses offered at THS, it’s good for your educational knowledge (and future income).” What is going to happen to the demand for college classes offered at THS? Demonstrate by using a graph. 27 Demand Quick Review Short Answer #5 Governor Brown just passed A.B. (Assembly Bill) 1388 which decrease the taxes on gas. What is going to happen to the demand for SUV’s? Demonstrate by using a graph. 28 Demand Quick Review Short Answer #6 The price of Coke increases. What will happen to demand for Pepsi? Demonstrate by using a graph. 29 Unit 2 Part 3 Topic: Chapter 4 Demand Elasticity EQ: Explain how demand reacts to a change in price . . . In other words, how far will your dollar stretch Think about it this way: The degree to which demand for a good or service varies with its price. That degree is “elasticity”. CSS: 12.1.1 Scarcity/choices, 12.1.2 Marginal benefit/cost, 12.1.3 Incentives 30 Gas Prices in California Why is there such a huge swing in prices? Are these prices “fair” for the consumer? 31 Determinants of Elasticity 1. Number of Substitutes Available – More substitutes means more elasticity • You will not pay a lot for something when you can get a substitute for cheaper – Less substitutes means less elasticity 2. Luxury vs. Necessity – Luxuries tend to be more elastic—you can wait – Necessities, well, you need them, hence inelastic • I must have heart medication regardless of the price 3. How Much of your Income the Good Costs – More of your pay: elastic • When you make more money, it usually goes to luxuries – Less of your pay: inelastic 32 How to tell… • Unlike demand variables, where only one is needed to shift the curve, all elasticity determinates must be looked at; then 2 out of 3 determines elasticity. *Keep in mind your determinates of elasticity: • Lets try some: • Number of Substitutes Available – Gas • Luxury vs. Necessity • How Much of your Income the – Car Good Costs – Rolex watches – Blood Pressure Medication 33 Demand & Elasticity= a married couple • The Law of Demand shows us that people buy more of a product at a lower price • Demand Elasticity: indicates the extent to which changes in price cause changes in the quantity demanded Ask yourself this question: How much more will be purchased at that lower/higher price? 34 Determining Elasticity via Math Step 1: Percentage of Change in Quantity and Price Formula: Original number (Q1 or P1) – new number (Q2 or P2) Original number (Q1 or P1) X 100 = % of change – This formula is used once to find percentage change for quantity (Q1 and Q2) – This formula is used once to find percentage change for price (P1 and P2) – These two results are then used in the next step 35 Determining Elasticity via Math Step 2: Type of Elasticity Formula: Percentage change in quantity demanded (Q) Percentage change in price (P) = type of elasticity This number will determine if the product is: – Elastic: the number is greater than one (>1) – Unitary: the number is exactly equal to one (= 1) – Inelastic: the number is less than one (<1) The slope of the demand curve is determined by the elasticity for that good 36 Step 1: Find % of change Q1 = 3 Q2 = 2 P1= 4 P2 = 3 Lets practice this idea . . . Q1-Q2 Q1 x100 P1-P2 x 100 P1 = % of change in quantity Step 2: Find elasticity % in Q % in P = % of change in price = type of elasticity 1. Use the formulas to find the demand elasticity for this product. 2. What would this look like on a graph? – Think slope 37 Elastic Demand When a relatively small change in price causes a relatively large change in the quantity demanded – Example: steaks on sale at the market. The lower the price, the more steaks will be bought. – Brain Pop: Think “E”asy slope to walk up is “E”lastic 3−9 𝑥100 = 200𝑄 3 1.00 − .75 𝑥100 = 25𝑃 1.00 200𝑄 = 𝟖 𝑬𝒍𝒂𝒔𝒕𝒊𝒄 25𝑃 38 Inelastic Demand When a relatively large change in price causes a relatively small change in quantity demanded – Example: Gas. The price of gas has a limited effect on the consumption of gas – Brain Pop: Think an “I”nclined slope is “I”nelastic 3−5 𝑥100 = 6𝑄 3 1.50 − .50 𝑥100 = 67𝑃 1.50 6𝑄 =. 𝟎𝟖 𝑰𝒏𝒆𝒍𝒂𝒔𝒕𝒊𝒄 67𝑃 39 Unitary Elastic Demand When a increase/decrease in price will be met by an equal percentage increase/decrease. Elasticity of demand is exactly 1 – Perfectly inelastic demand = you buy regardless of the price • There are no substitutes – Perfectly elastic demand = price stays the same regardless of how many you buy • There are many substitutes, but people buy this particular product This does not exist in the real world 40 Vader Video #3 Find Demand Elasticity Demand Elasticity Locate this chart in your Demand Problem Set Packet. Find Demand Elasticity using the formulas from this section of notes. Label and graph the demand curves correctly. 5. P 6. P Q 7. Q 8. P Q P 41 Q Vader Video #3 Find Demand Elasticity Demand Elasticity Locate this chart in your Demand Problem Set Packet. Find Demand Elasticity using the formulas from this section of notes. Label and graph the demand curves correctly. 60 25 20 10 P 3 (E) .33 (IE) 2 (E) .2 (IE) 20 75 10 50 6. P 7. p2 p2 p2 p2 p1 p1 p1 p1 5. q2 q1 Q q2 q1 Q 8. P q2 q1 Q P 42 q2 q1 Q Another Way to Measure Elasticity • The Total Revenue Test: makes a mathematical determination about whether a product is elastic – Price x Quantity Demanded = Total Revenue • Demand is Elastic when price goes up total revenue goes down (& vice versa) • Demand is Inelastic when price goes up total revenue goes up – This is usually used for businesses to set prices on items. 43 Class Example: Elasticity of Bottled Water How many of you would purchase ONE bottle of water at the following prices: Price in $ Quantity of water bottles demanded Total Revenue 2.00 1.75 1.50 *Keep in mind your determinates of elasticity: • Number of Substitutes Available • Luxury vs. Necessity • How Much of your Income the Good Costs Price Total Revenue 1.00 .75 Old Price ___ x Quantity ___ = OTR ___ New Price ___ x Quantity ___ = NTR ___ Type of Elasticity: ____________________ 44 Elasticity Quick Review 1. Explain why price elasticity is important to you as a consumer. Business owner? 2. What is inelastic demand? Give an example. 3. What is elastic demand? Give an example. 4. Use the correct formulas to find the Elasticity for: Q1: 9, Q2: 5 – P1: $5, P2: $4 (No TRT!!!) – Now graph it and label your demand curve 5. With your partner answer the EQ in your notes 45 Economics -Chapter 5- Topic: Unit 2 Part 4 -Supply EQ: Who creates supply and what causes supply for a good/service to change (shift)? MMM, Profit 46 SUPPLY • Quantity supplied is the amount of a good that sellers are willing and able to sell at any given price point. • Law of Supply – The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good rises. – Think: If you produce a good, you want to be paid MORE for the MORE goods you make. Vader Video #4 Quantity Supplied 47 The Supply Curve: The Relationship between Price and Quantity Supplied Supply Schedule – The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied. • Price is always on the “Y” Axis • Quantity is always on the “X” Axis 48 Basic Supply Graph Y = Price X = Quantity Supply Curve (S) The supply curve is the graph of the relationship between the price of a good and the quantity supplied. Think “S”upply goes up to the “S”ky 49 Variable that influence a Movement along the supply curve is a change in Price . . . A movement along a fixed supply curve is called a change in quantity supplied (price of the item only). A TAX is the most common reason for the change of price. Think: If there is an increase in taxes on my products, as a producer I will not pay that tax, I will pass it onto my consumers. Remember, I’m all about profit. 50 Copyright©2004 South-Western The Shifting Supply Curve • Supply Curve shifts when: – There is a change in the amount of a good supplied regardless of price – This is called a change in the amount supplied – Four variables can cause a supply curve to shift – Shifts are based on quantity Shift in Supply for Donuts 51 Variables that influence a SHIFT of the whole supply curve. Remember, only a change in one is needed to cause a shift . . . 52 Copyright©2004 South-Western Quick Review Questions M/C • Suppliers produce two goods, cheese and butter. Suppose the demand for butter increases. What do we expect to happen to the supply of cheese? A. B. C. D. E. The price will go up and the quantity will drop The price will go up and the quantity will rise. The price will go down and the quantity will drop. The price will go down and the quantity will rise. None of the above. 53 Basic Supply Graph –Class Results Period 2 Supply for a Donut Price for a Donut Period 3 for Donuts Period 4 Market Demand Supply for a Donut Price for a Donut Supply for a Donut 24 Market Supply Market Price $2.50 25 $2.50 15 for a Donut for a Donut $2.00 24 $2.00 19 27 $1.50 24 $1.00 19 9 R DONUTS 16 87, 1.5 Price of Donuts 100 Donuts 24 84 (not shown $2.5022 8 $1.00 $0.50 on graph) 2 $0.50 1 88 Period 5 $2.00 Supply for a Donut Price for a Donut 25 $2.50 64 21 $2.00 20 $1.50 14 10 $1.00 2 $0.50 87 88, 2 $1.50 Price for a Donut $2.50 $2.00 $1.50 $1.00 $0.50 $1.50 $1.00 $0.50 54 Government Influences on Supply Subsidy – A government payment that supports a business or activity • Usually seen in farming – Used to promote business growth price control • Prices decrease but supply increases 55 Government Influences on Supply Excise Tax – Tax on the production/sale of a good that increases production costs the producer/consumer pays this tax, can decrease supply leading to higher prices – Built into the price of the product – Causes the supply of an item to have price movement 56 Government Influences on Supply Regulation – Effects the price, quantity or quality of a good – Example would be regulations on emission controls on cars starting in the 1970’s. Vs. 57 Supply Quick Review 1. What is needed to create a supply schedule for a fruit smoothie shop? A. B. C. D. a supply curve and the price other shops are charging the price charged and the number of smoothies supplied the number of other shops producing smoothies all of the above 2. Which of the following will always cause a supply curve to shift to the right? A. B. C. D. advances in technology future expectations of falling prices excise taxes fewer inputs 3. New advances in technology usually A. cause input costs to drop. B. increase supply at all price levels. C. cause the supply curve to shift to the right. D. all of the above. 58 Supply Quick Review Short Answer #1 If consumers expect a new version of Nike Michael Jordan shoes to be introduced next week, how is that going to change the supply curve for the shoes THIS WEEK? Demonstrate by using a graph. 59 Supply Quick Review Short Answer #2 Mr. Maino takes a turn too quickly on his drive home. He takes out the local gas station. What will happen to the supply of gas? 60 Supply Quick Review Short Answer #3 Governor Brown just passed A.B. (Assembly Bill) 1388 which decrease the taxes on gas. What is going to happen to the supply for SUV’s? Demonstrate by using a graph. 61 Supply Quick Review Short Answer #4 The price of sugar increases. What will happen to supply for Pepsi? Demonstrate by using a graph. 62 Economics -Unit 2Topic: Unit 2 Part 5 –Demand and Supply EQ: How do demand and supply work with each other to make the consumer and producer happy? 63 MARKETS AND COMPETITION Remember: • Buyers determine demand. • Sellers determine supply Equilibrium Law of supply and demand – The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance. – It’s actually the Invisible Hand at work . . . The market is self correcting 24/7. 64 SUPPLY AND DEMAND TOGETHER Market Equilibrium (E) refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. –This is also called: • Market Price (MP) • Market Clearing Price (MCP) 65 SUPPLY AND DEMAND TOGETHER Equilibrium Price (P) – The price that balances quantity supplied and quantity demanded. – On a graph, it is the price at which the supply and demand curves intersect on the price axis. Equilibrium Quantity (Q) – The quantity supplied and the quantity demanded at the equilibrium price. – On a graph it is the quantity at which the supply and demand curves intersect on the quantity axis. Partner Q: How do we get these numbers to plot? 66 Demand and Supply Graph –Class Results All Class Schedule Where do you think Equilibrium Price Equilibrium Qty. Market Equilibrium Supply for a Donut (X) Price for a Donut (Y) Demand for a Donut (X) 84 $2.50 29 88 $2.00 37 87 $1.50 71 64 $1.00 96 14 $0.50 106 Are located? This is the range where we know our Market Equilibrium will be we must graph it to find-out exactly where E is 67 Price of Donuts Demand and Supply Graph –Class Results Donut Market 3 Supply 2.5 2 Results Market Equilibrium: 81, 1.45 Equilibrium Price: $1.45 Equilibrium Quantity: 81 1.5 P E 1 0.5 Demand 0 0 20 40 60 Quantity of Donuts 80 Q 100 120 68 When Markets Are Not in Equilibrium: Surplus • Happens when equilibrium prices are too high, supply overrides demand. • Suppliers will lower the price to increase sales, thereby moving toward equilibrium. – Fire Sales – Introductory prices • P and Q are ABOVE E • Need to get rid of supply • Hurts producers, good for consumers 69 When Markets Are Not in Equilibrium: Shortage • When equilibrium price is too low, causes a shortage of goods • There is excess demand or a shortage. • Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium. • P and Q are BELOW E • Allows suppliers to rebuild supply • Good for producers, hurts consumers 70 What roles do prices play in a modern mixed economy? Price Control Why Enacted Example Economic Result Price Floor Gov. feels producers are not receiving fair price -Min. wage -Min. price for goods/services -excess supply -leads to a surplus of product/workers Surplus Help: Producer Hurt: Consumer Price Ceiling Gov. feels consumers are paying too much for good/service -rent control -gas prices -excess demand -Leads to a shortage of product/workers Help: Consumer Hurt: Producer Shortage 71 Producer and Consumer Prices as Surplus • Producer Cost (PC) – How much does the good/service cost to make? • Consumer Utility (CU –also Surplus) – How much satisfaction does the consumer get out of the consumption of the good/service in a monetary format (how much is it “worth”) • Producer Revenue (PR –also Surplus) – How much is earned after costs are taken out? Example: PC =$10.00, PR is $15.00. Find CU with partner. 72 What roles do prices play in a modern mixed economy? Four main roles: 1. Prices convey information to consumers/producers 2. Prices create incentives to work/produce 3. Prices allow markets to respond to changing conditions 4. Prices allocate scarce resources efficiently 73 Steps to Analyzing Changes in Equilibrium 1. Decide whether the event shifts the supply or demand curve using the variables (nine of them located in your Unit 2 Packets) 2. Decide whether the curve(s) shift(s) to the left or to the right (you will also have movement on one of the curves) 3. Use the new information to redraw your supply or demand curve. 4. Label the new points correctly and accordingly. 74 Supply and Demand Together P.S. 1. 2. 3. We will complete the example curve as a class (Question #1). Complete the following three curves with your partner • Use your supply/demand determinates to help you along the way (found in Demand/Supply Problem Set packets) What you do not finish is homework • We will review these as a class 75 Unit 2 To-Do List • Make sure that you have answered all of the EQ’s in your notes! • Make sure all of your Unit packet work is complete: – Every term has its own definition and DRAWING – All questions are answered we reviewed these in class, so if you did not write down the information . . . well . . . enjoy that low grade. • Every Problem Set has your name on it • Complete the Unit 2 Review Sheet to better prep for the Unit 2 Test 76