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This lesson includes Basics of Supply and Demand ◦ Movement along curve ◦ Shifts in the curve Government Interventions ◦ Subsidies, taxes, regulations, price floors and price ceilings Market Structures ◦ Monopoly, perfect competition, market, communism, oligopoly, etcs. Elasticity of Supply and Demand ◦ Sensitivity to change Unit Test When we finish up with this slide presentation, you will be ready for your first unit test Chapters 1-6 in the textbook Vocabulary Basic Economic concepts along with supply, demand, elasticity, etc. Will do a basic review Your assignment – read the chapters and find the AP questions on line – study them Barter v. Monetary Economy Barter – goods are traded directly for other goods Problems: ◦ Requires a double coincidence of wants ◦ Large number of trading ratios (high information costs) Monetary Economy has lower transaction and information costs Relative and Nominal Prices Relative Price = price of a good in terms of another good ◦ Example: If milk costs $4 per gallon and bread costs $2 per loaf, then the relative price of milk is 2 loaves of bread Nominal Price – price expressed in terms of the monetary unit Relative price is a more direct measure of opportunity cost The market forces of Supply and Demand Demand: desire, ability and willingness to buy a good or service ◦ Amount of a product that a consumer (individual) or group of consumers (market) will purchase at a given price ◦ Relationship between PRICE and QUANTITY DEMANDED in a given time period, ceteris paribus Market – group of buyers and sellers of a good or service Competitive Market – a market in which there are so many buyers and sellers that each has a negligible impact on the market price Market structures found in the world Perfect Competition ◦ Market where no participants are large enough to have the market power to set the price of a homogeneous product ◦ Goods offered for sale are exactly the same ◦ Buyers and sellers are so numerous that no one has any influence over the price (they are price takers) ◦ Examples: Wheat, Oranges, Tomatoes, Crude Oil, Stock Market Various Market Structures Monopoly ◦ When one company controls the market of a good/service and can effectively dictate prices ◦ NFL, Microsoft (until sued), China’s Pandas Monopolistic Competition ◦ Many companies selling similar products but NOT identical ◦ Jeans in the United States Oligopoly ◦ Market structure in which a few large firms dominate a market; four largest firms produce at least 70% of the output ◦ Auto industry, the beer industry, the soda industry The Law of Demand Prices are lower – consumers will buy more (prices are higher – consumers will buy less) Inverse Negative relationship between the price and the quantity demanded of a product Quantity Demanded – specific amount of the products buyers are willing and able to purchase Prices influence the quantity demanded of a product Reasons for the Law of Demand Income Effect ◦ Change in consumption resulting from a change in price ◦ You feel richer when items are cheaper Substitution Effect ◦ When consumers react to an increase in a good’s price by consuming less of one good and more of other goods $3.99 to $4.99 $3.99 Change in quantity demanded vs. change in demand Change in quantity demanded Movement along the curve Change in demand Shift the ENTIRE curve Shifts in the demand Curve Changes in Demand are reflected as a shift in the curve Shifts to the RIGHT indicate an INCREASE in demand Shifts to the LEFT indicate a DECREASE in demand Price Increase in Demand Decrease in Demand Quantity Demanded Determinants of Demand Tastes and Preferences Prices of related goods and services Income Number of Consumers Expectations of future prices and income Tastes and preferences Effect of fads Consumer tastes and advertising - changes in popularity of products or the influence of trends and advertising can affect demand Seasonal Effect News Reports Popularity Prices of related goods Substitute goods ◦ An increase in the price of one results in an increase in the demand for the other Complementary goods ◦ An increase in the price of one results in a decrease in the demand for the other Income Consumer Income – a consumer’s income affects their demand for goods and services ◦ Increase in income will cause an increase in consumption ◦ Decrease in income will cause a decrease in consumption ◦ Normal goods – income falls, demand falls ◦ Inferior goods – income falls, demand rises Number of buyers Population – an increase in the number of consumers can cause an increase/decrease in the demand for products ◦ Increase – increase ◦ Decrease - decrease Expectations A higher expected future price will INCREASE current demand A lower expected future price will DECREASE current demand A higher expected future income will INCREASE the demand for normal goods A lower expected future income will reduce the demand for all normal goods Supply (the other side of the equation) Supply: ◦ The relationship that exists between the price of a good and the quantity supplied in a given time period, ceteris paribus ◦ Amount of a good or service available in the market place ◦ The amount of a product that would be offered for sale at all possible prices that could prevail in the market ◦ Positive relationship Reason for the law of supply The law of supply is the result of the law of increasing cost ◦ As the quantity of a good produced rises, the marginal opportunity cost rises. ◦ Sellers will only produce and sell an additional unit of a good if the price rises above the marginal opportunity cost of producing the additional unit Change in supply vs. change in quantity supplied Change in supply Change in quantity supplied Determinants of Supply The price of resources Technology and productivity Expectations of the producers Number of producers (more will join if a profit is being made)and Price of related goods and services ◦ Relationship in production NOT consumption Price of resources As the price of a resource rises, profitability declines, leading to a reduction in the quantity supplied at any price. Increase in input prices will cause REDUCTION in production Decrease in input prices will cause incentive to produce and INCREASE supply Technological improvements Technological improvements (and any changes that raise the productivity of labor) lower production costs and increase profitability. Increases in ability to produce as firms invest in capital goods Decrease as a result of faulty technology or breakdowns in equipment Technology – ability to produce based on capital goods and technological knowledge Expectations and supply An increase in the expected future price of a good or service results in a reduction in current supply. Refers to the way suppliers think about the future, as it relates to production ◦ Negative expectations for the future of a market can cause suppliers to shut down production in the short term ◦ Positive speculation for the future of a market can cause suppliers to increase production and bring more suppliers to market Increase in number of sellers Number of sellers – an increase in the number of sellers can cause an increase or decrease in the supply of goods and services. Increase in sellers, increase in production Decrease in sellers, decrease in production Prices of other goods Firms produce and sell more than one commodity. Firms respond to the relative profitability of the different items that they sell. The supply decision for a particular good is affected not only by the good’s own price but also by the prices of other goods and services the firm may produce. Government Intervention Subsidies ◦ Government payment that supports a business or market ◦ Increases the ability to produce as government protect some industries ◦ Decrease as a result of government removing the subsidies Taxes ◦ Excise tax – tax on the production or sale of a domestically sold good ◦ Increases the ability to produce as government removes the taxes ◦ Decreases the ability to produce as government imposes the taxes Government Intervention Regulation ◦ Government intervention in a market that affects the price, quantity or quality of a good ◦ Increases the ability to produce as government deregulates ◦ Decreases the ability to produce as the government increases regulation Combining Supply and Demand Price – the monetary value of a product as established by supply and demand A link between the producers and the consumers Determines the WHAT, HOW and FOR WHOM to produce Defining Equilibrium Equilibrium – the point of balance where demand and supply come together at the same number QD=QS Prices are relatively stable Disequilibrium Occurs when the quantity supplied is not equal to the quantity demanded If the price exceeds the equilibrium price, a surplus occurs – force prices down If the price is below the equilibrium price, a shortage occurs – force prices up Price Controls Price ceiling - legally mandated maximum price Purpose: keep price below the market equilibrium price Examples: ◦ rent controls ◦ price controls during wartime ◦ gas price rationing in 1970s Price floor - legally mandated minimum price designed to maintain a price above the equilibrium level examples: ◦ agricultural price supports ◦ minimum wage laws Elasticity “Sensitivity to change” The Elasticity of Demand Price Elasticity of Demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. Price Elasticity of demand is the percentage change in quantity demanded given a percent change in the price Elasticity of Demand Elasticity of Demand • Elasticity shows how sensitive consumers are to a change in price. It helps answer the following questions: • What if we raise price? • Will people still buy? • What if we lower price? • How much more will they buy? Who cares about elasticity? • Used by all firms to help set prices • Used by the government to decide how to tax • Used by YOU subconsciously Inelastic Inelastic Demand INelastic = INsensitive to a change in price. •If price increases, quantity demanded will fall a little 20% •If price decreases, quantity demanded increases a little. In other words, people will continue to buy it. 5% A INELASTIC demand curve is steep! (looks like an “I”) Examples •Gasoline •Milk •Diapers •Chewing Gum •Medical Care •Toilet paper General Characteristics of INelastic Goods: • Few Substitutes • Necessities • Small portion of income • Required now, rather than later Elastic Elastic Demand Elastic = Sensitive to a change in price. •If price increases, quantity demanded will fall a lot •If price decreases, quantity demanded increases a lot. In other words, the amount people buy is very sensitive to price. An ELASTIC demand curve is flat! Examples •Soda •Boats •Beef •Real Estate •Pizza •Gold General Characteristics of Elastic Goods Necessities versus luxuries Eating at restaurants Groceries Availability of substitutes Chicken versus beef How much of our income a good takes Salt versus Nike sneakers The passage of time Remember: P – proportion of income A – availability of close substitutes I – importance of the good (luxury v. necessity) D – Delay purchase possible? Perfectly Inelastic What about the demand for insulin for diabetics? What about the demand for water for someone dying of thirst? Perfectly INELASTIC Unit Elastic (Unitary) What if % change in quantity demanded equals % change in price? Unit Elastic (45 degrees) The Total Revenue Test (AKA Total Expenditures Test) Important Observations When demand is elastic, a decrease in price will result is an increase in the revenue (sales). When demand is inelastic, a decrease in price will result is a decrease in the revenue (sales). When demand is unit-elastic, an increase (or a decrease) in price will not change the revenue (sales). Total Revenue Test Uses elasticity to show how changes in price will affect total revenue (TR). (TR = Price x Quantity) Elastic Demand• Price increase causes TR to decrease • Price decrease causes TR to increase Inelastic Demand• Price increase causes TR to increase • Price decrease causes TR to decrease Unit Elastic• Price changes and TR remains unchanged Ex: If demand for milk is INelastic, what will happen to expenditures on milk if price increases? Total Revenue Test Price and Demand Elastic Inelastic Price Increases Total Revenue Decreases Price Decreases Total Revenue Increases Price Increases Total Revenue Increases Price Decreases Total Revenue Decreases Inverse Relationship Direct relationship Other Demand Elasticities: Cross-Price Elasticity The cross-price elasticity of demand between two goods measures the effect of the change in one good’s price on the quantity demanded of the other good. It is equal to the percent change in the quantity demanded of one good divided by the percent change in the other good’s price. Cross-price elasticity of demand determines whether two goods are substitutes (positive number/relationship) or compliments (negative number/relationship). The Income Elasticity of Demand The income elasticity of demand is the percent change in the quantity of a good demanded when a consumer’s income changes divided by the percent change in the consumer’s income. By calculating the income elasticity of demand for a product you are able to determine whether it is a normal good (positive number) or an inferior good (negative number). 2. Elasticity of SUPPLY Price Elasticity of Supply Elasticity of Supply• Elasticity of supply shows how sensitive producers are to a change in price. Which supply is more elastic, electricity or pool cleaning? Elasticity of supply is based on time limitations. Some producers need a lot of time to produce more. INelastic = Insensitive to a change in price (Steep curve) • Most goods have INelastic supply in the short-run Elastic = Sensitive to a change in price (Flat curve) • Most goods have elastic supply in the long-run Perfectly Inelastic = Q doesn’t change (Vertical line) • Set quantity supplied (Ex: VanGogh Paintings) Elasticity and Excise Taxes Who ends up paying for an excise tax? EXCISE TAX ON CIGARETTES P $10 Demand- Inelastic Supply- Unitary S 8 CS 6 $2 TAX on Producers 5 4 2 D 8 10 Q EXCISE TAX ON CIGARETTES P $10 S1 S $6.50 =Pconsumers $4.50 = Pproducers 8 7 6 5 4 CS After Amount Consumers Pay $2 TAX on Producers Amount Producers Pay 2 D 9 10 Quantity Doesn’t Fall VERY Much!!! Q Elasticity on Graphs Look at the slopes of the lines Things to Remember What might impact demand? M – market size E – expected prices R – related goods I – income levels T – tastes What might impact supply? T - technology R – related goods I – input prices C - competition E – expected prices