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Laws of Demand, Supply, and Prices
The Foundation of Economics!
Remember these 3 rules!
1. Law of Demand = Consumers buy more when
prices decrease and vice versa.
2. Law of Supply = Businesses will offer more of a
good at a higher price.
3. Market equilibrium = the point where quantity
demanded and quantity supplied come
Law of Demand
• Consumers buy more when prices decrease and
they buy less when prices increase.
• How do consumers choose?
• Two important concepts help decide our choices
1. Substitution effect
• Cheaper options when prices increase
2. Income effect
• New “real” income results in new
goods/services options
Understanding demand graphs
• Demand schedule
– Lists how much 1 person will buy at a given price
• Market demand schedule
– How much all consumers in one market will buy at
different prices
• Demand curve
– Graphical representation of a demand schedule.
Shifts in Demand
• Ceteris paribus is a Latin phrase economists use
meaning “all other things held constant.”
• Several factors can lead to a change in demand:
1. Income
2. Consumer Expectations
3. Population
4. Consumer Tastes and Advertising
Impact of Related Goods
• Demand for certain goods can change the
demand for other goods.
• Complementary goods
– Goods that are bought and used together.
– Example: skis and ski boots
• Substitutes Goods
– Goods used in place of one another.
– Example: skis and snowboards
Elasticity of Demand
• Elasticity of demand is a measure of how
consumers react to a change in price.
• Inelastic demand
– Demand continues despite price increase
– Ex. Gasoline
• Elastic demand
– Demand is very sensitive to changes in price
Factors Affecting Elasticity
Availability of substitutes
Relative importance
Necessities versus Luxuries
Change over time
Elasticity and Revenue
• Why do companies need to consider demand?
– Demand determines total income
• Will increasing prices result in increased income?
– ONLY if it is an inelastic good!
– If a good becomes elastic, raising prices may
decrease a firms total income/revenue
Crash Course Economics!
• Video
Law of Supply
• Suppliers will offer more at a higher price.
• Quantity supplied = amount offered at a specific
• The promise of increased revenues when prices
are high encourages firms to produce more.
• Rising prices draw new firms into a market and add
to the quantity supplied of a good.
Supply Schedule and Curve
• Market supply schedule
– Lists how much of a good all suppliers will offer at
different prices
– Increase in profit increases production
• Market supply curve graphs the same data
Elasticity of Supply
• Elastic supply is very sensitive to price changes
• Inelastic supply is not very responsive
• What affects elasticity of supply?
• In the short run, its difficult to change output so
supply is inelastic.
• In the long run, firms are more flexible, so
supply can become more elastic.
Measuring Workers and Production
• Business owners have to consider how the number
of workers they hire will affect their total
• Marginal product of labor
– change in output from hiring one additional worker.
• Marginal revenue
– additional income from selling one more unit of a good.
• To determine the best level of output, firms
determine the output level at which marginal
revenue is equal to marginal cost.
Input Costs and Supply
• Any change in the input cost will affect supply
– Ex. raw materials, machinery, or labor
• Increase/decrease in input costs changes
– Less profit = less supply
– New technology can decrease costs
Other Factors Influencing Supply
• 3 areas of government influence
1. Subsidies
2. Excise Taxes
3. Regulation
• The global economy
• Future expectations for prices
• Number of suppliers
Balancing the Market
• The point at which quantity demanded and
quantity supplied come together is known as?
– Equilibrium!
• If the market price or quantity supplied is
anywhere but at the equilibrium price, the
market is in a state called disequilibrium.
Market Disequilibrium
• Two causes
1. Excess demand
2. Excess supply
• Interactions between buyers and sellers
pushes the market back towards equilibrium.
• Video clip
Price Ceilings
• Maximum and minimum price set by government
• Price ceiling
– Ex. Rent control
• Price floor
– Ex. Minimum wage
Shifts in Supply
• Excess supply causes businesses to do _____.
– Reduce prices
• A Fall in Supply increases _________.
– Increase demand!
• What will businesses do?
–Increase prices!
The language of pricing
Prices as an “incentive”
Signals for producers
Price System is "Free"
Efficient Resource Allocation
• Resource allocation
– What do consumers value?
• Market Problems
– Imperfect competition
– Spillover costs/externalities
– Imperfect information