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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 together. 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 1. 2. 3. 4. 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 price • 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? – TIME! • 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 production. • ACTIVITY! • 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 profitability – 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 Flexibility Price System is "Free" Efficient Resource Allocation • Resource allocation – What do consumers value? • Market Problems – Imperfect competition – Spillover costs/externalities – Imperfect information