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The Marketplace (cont.) • In a market economy, consumers collectively have a great deal of influence on prices of all goods and services. • The demand of a good or service creates supply. • A market represents the freely chosen actions between buyers and sellers. The Marketplace (cont.) demand: the amount of a good or service that consumers are able and willing to buy at various possible prices during a specified time period • A market economy is based on the principle of voluntary exchange - a transaction in which a buyer and a seller exercise their economic freedom by working out their own terms of exchange. supply: the amount of a good or service that producers are able and willing g to sell at various p prices during g a specified time period The Law of Demand The law of demand states that as price goes up, quantity demanded goes down, and vice versa. The law Th l off demand d d states t t that th t as price i goes up, quantity demanded goes down. As price g p goes down,, q quantity y demanded g goes up. The Law of Demand (cont.) • Several factors explain the inverse relation between price and quantity demanded, or how much people will buy of any item at a particular price price. • Factors include: – Real income effect – Substitution effect The Law of Demand (cont.) • Diminishing marginal utility: – Utility - the ability of any good or service to satisfyy consumer wants – Marginal utility - an additional amount of satisfaction – Law of diminishing marginal utility the additional satisfaction a consumer gets from purchasing one more unit of a product will lessen with each additional unit it purchased h d real income effect: economic rule stating that individuals cannot keep buying the same quantity of a product if its price rises while their income stays the same substitution b tit ti effect: ff t economic i rule l stating that if two items satisfy the same need and the price of one rises, people will buy more of the other Graphing the Demand Curve • Economists can show the relationship between a change in quantity demanded and a change in demand using a demand curve. Ad demand d curve is i a graph h th thatt shows h the relationship between the price of an item and the quantity demanded. Graphing the Demand Curve (cont.) • A demand schedule is a table reflecting quantities demanded at different possible prices. • A demand curve shows the quantity demanded of a good or service at each possible price price. Demand curves slope downward, clearly showing the inverse relationship. Pages 178-179 178 179 Determinates of Demand A change in the demand for a particular it item shifts hift the th entire ti demand d d curve to t the left or right. • Factors that can affect demand for a specific product or service: – Changes in population – Changes in income – Ch Changes iin people’s l ’ ttastes t and d preferences – Th The availability il bilit and d price i off substitutes b tit t – The price of complementary goods • Th The decrease d in i the th price i off one good d will ill increase the demand for its complementary. Page 180 Page 180 Page 181 Page 181 Page 182 Page 181 The Price Elasticity of Demand Elasticity of demand measures how much h the th quantity tit demanded d d d changes h when price goes up or down. The Price Elasticity of Demand (cont.) • For some goods, a rise or fall in price greatly affects the amount people are willing to buy. This economic concept is referred to as elasticity. elasticity • The measure of how much consumers respond to a given change in price is referred to as price elasticity of demand. View: Demand vs. Quantity Demanded View: Goods with… The Price Elasticity of Demand (cont.) elastic demand: situation in which a given rise or fall in a product’s price greatly affects the amount that people are willing to buy inelastic demand: situation in which a product’s product s price change has little impact on the quantity demanded by consumers View: Demand vs. Quantity Demanded View: Goods with… Page 183 Page 184 Page 185 Profits and the Law of Supply The law of supply states that as price goes up, quantity tit supplied li d goes up, and vice versa. • To understand pricing, you must look at both demand and supply supply. Profits and the Law of Supply (cont.) quantity supplied: the amount of a good or service that a producer is willing and able to supply at a specific price – The higher the price of a good, the greater the incentive is for a p g producer to produce more. pp y states that as the p price • The law of supply of a good rises, the quantity supplied also rises. As the price falls, the quantity supplied also falls falls. View: The Law of Supply The Supply Curve A supply curve is a graph that shows th relationship the l ti hi between b t price i and d quantity supplied. The law Th l off supply l states t t that th t as price i goes up, quantity supplied also goes up. As price goes down,, quantity g q y supplied pp g goes down. supplied supplied The Supply Curve (cont.) • A supply schedule is a table showing quantities supplied at different possible prices. • The supply curve is an upward-sloping line that shows in graph form the quantities producers are willing to supply at each possible price. Pages 188-189 The Determinants of Supply A change in the supply of a particular it item shifts hift the th entire ti supply l curve to t the left or right. The Determinants of Supply (cont.) • Many factors affect the supply of a specific product. Four of the major determinants are: – The price of inputs – The e number u be o of firms s in the e industry dus y – Taxes imposed or not imposed – may also be called government involvement View: If Inputs Become Cheaper View: If Number of Firms Increases View: If Taxes Increase The Determinants of Supply (cont.) – Technology • Any improvement in technology will increase supply. technology: the use of science to develop new products and new methods for producing and distrib ting goods and ser distributing services ices Page 190 Page 190 View: If Technology Improves Production Page 190 Page 191 Page 192 Page 191 The Law of Diminishing Returns When a business wants to expand, it h to has t consider id how h much h expansion i will really help the business. The Law of Diminishing Returns (cont.) • Will product output continue to increase proportionally as more workers are hired? g returns shows • The law of diminishing that as more units of a factor of production are added to the other factors of production after a certain point production, point, the extra output for each additional unit hired will begin g to decrease. View: Supply vs. Quantity Supplied View: Diminishing Returns Equilibrium Price In free markets, prices are determined by y the interaction of supply pp y and demand. • Demand and supply operate together. As the price of a good goes down, the quantity demanded rises and the quantity supplied falls (and vice versa) versa). • The point at which the quantity demanded and quantity supplied meet is called the equilibrium price. Page 193 The point Th i t att which hi h the th quantity tit d demanded d d and the quantity supplied meet is called the equilibrium q price. p Page 196 Prices as Signals Under a free-enterprise system, prices f function ti as signals i l that th t communicate i t information and coordinate the activities of producers and consumers. Prices as Signals (cont.) • Rising prices signal producers to produce more and consumers to purchase less. gp prices signal g p producers to p produce • Falling less and consumers to purchase more. • A shortage occurs when at the current price, the quantity demanded is greater than the quantity supplied. • Prices above the equilibrium price reflect a surplus to suppliers. (quantity supplied > quantity tit demanded d d d att currentt price. i Prices as Signals (cont.) • When a market economy operates without restriction, it eliminates shortages and surpluses. – When a shortage occurs, the price goes up to eliminate the shortage. – When surpluses occur, the price falls to eliminate the surplus. Price Controls Under certain circumstances, the government sometimes sets a limit on how high or low a price of a good or service can go. • A price ceiling is a government-set maximum price that may be charged for a particular good or service. – Eff Effective ti price i ceilings, ili and d resulting lti shortages, often lead to non-market ways ays o of d distributing s bu g goods a and d se services ces such as rationing and leading to the black market. Price Controls (cont.) rationing: the distribution of goods and services based on something other than price black market: “underground” or ill illegal l market k t iin which hi h goods d are traded at prices above their legal maximum prices or in which illegal goods are sold • Conversely, a price floor, is a government-set minimum price that can be charged for goods and services.