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7 Learning Goals Chapter p 3 Supply, Demand, and the Market Process 1) Investigate and describe consumer behavior 2) Distinguish a change in demand from a change in quantity demanded 3) Investigate and describe firm behavior 4) Distinguish a change in supply from a change in quantity supplied 5) Build a market model and illustrate how equilibrium is reached 6) Demonstrate how markets respond to changes in demand and supply 7) Recognize how prices and the invisible hand principle create market order The Law of Demand: Consumer Choice and the Law of Demand We usually draw a picture of this relationship Graph: Graph: Watch content video: Micro Chapter 0303demand curve The inverse relationship between price and quantity demanded; when price rises, quantity demanded falls Quantity demanded is a number; it’s it s how many units of a good you bought Today is a great day in economic research. A study of mine, written jointly with a former colleague, has been accepted for publication in a leading scholarly journal. Both he and I are very happy about it. For a professor, getting recognition for your ideas is always very gratifying and, in my profession, publication outlets form a clear hierarchy, with this one near the top. This outlet had previously published thirteen papers by my exex-colleague, but none of mine. The marginal utility of the fourteenth paper published in that journal must be less than the marginal i l utility tilit off the th first. fi t If we are both b th rational ti l and d have the same preferences, then I should be much happier about having this study accepted for publication than he is. Q: I have had many scholarly papers published over my thirty--eight thirty eight--year career in economics, many of them in others of the very top scholarly journals in the field. What’s special about this one? 1 How do consumers react to price changes? Why is the demand curve downward sloping? Diminishing Marginal Utility – The marginal benefit you receive from an item falls as you gain more of the item – The only way to get you to buy more is to lower the price p ce Q3.1 (PMA) Consumers buy less of a good as its price increases because 1. 2. 3. 4. 5. 6. The demand curve represents your willingness to pay (your maximum price), not how much you actually paid production costs have risen. substitute goods are now relatively cheaper. substitute goods are now relatively more expensive. the income of consumers has effectively risen. the income of consumers has effectively decreased. the higher price will make the good more valuable to each consumer. 17% 17% 17% 17% 17% (1) When the price of one good falls, people substitute away from relatively more expensive goods to the relatively cheaper goods Called the substitution effect (2) When the price of one good falls, real consumer income rises so people buy more (it’s like getting a raise) Called the income effect Both of these also cause the demand curve to be downward sloping 17% 60 1 2 3 4 5 6 What if the actual price is lower than your willingness to pay? In economics, we call this difference consumer surplus (CS) Graphically, CS is the area below demand, out to quantity quantity, and down to price Graph of CS: Watch content video: Micro Chapter 0303consumer surplus 2 Q3.2 Which of the following best explains the source of consumer surplus for good A? 1. 2. 3. 4. Many consumers pay prices that are greater than the equilibrium price of good A. Many consumers would be willing to pay more than the market price for good A. Many consumers think the market price of good A is greater than its cost cost. Many consumers think the demand for good A is 25% 25% 25% 25% elastic. Changes in Demand Versus Changes in Quantityy Demanded Q 60 1 2 3 4 Watch video video:: Hudsucker Proxy Demand is the relationship between two variables: price and quantity demanded Changes: (1) When price changes, quantity demanded changes but demand does NOT change – This is movement along a demand curve (2) When something else changes, demand changes (i.e., the relationship changes) – This is movement of the entire curve Typical “something else” changes: Income Number of consumers Prices of related goods (substitutes and complements) l t ) Expectations Demographics Tastes and preferences Another way to think about the difference between demand and quantity demanded Why is the consumer buying more (or less)? If price is the reason reason, then quantity demanded changes; move along the demand curve If any variable besides price is the reason, then demand changes; shift the demand curve 3 Q3.3 When economists say the demand for a product has increased, they mean the Graphs: Graphs: Watch content video: Micro Chapter 0303shift vs move along demand 1. demand curve has shifted to the right. 2. price of the product has fallen, and consequently, consumers are buying more of it. 3. cost of producing the product has risen. 4. amount of the product that consumers are willing to purchase at various prices has decreased. 25% 25% 25% 25% 60 1 1. demand curve has shifted to the left. 2. demand curve has shifted to the right. 3. price of the product has fallen, and consequently, consumers are buying more of it. 4. price of the product has risen, and consequently, consumers are buying less of it. 25% 25% 3 4 The price for one good can be intimately tied to demand for another good Q3.4 When economists say the quantity demanded of a product has decreased, they mean the 25% 2 (1) Substitute goods goods--used in place of each other An increase (decrease) in price for the first good will increase (decrease) demand for the second good 25% 60 1 2 3 4 (1) Substitute goods Example: (A)__________, (B)__________ If the price of (A)_________ rose rose,, the (demand/quantity demanded) of (A)____________ would (rise/fall) and consumers would purchase (more/less) (A)_______________. The (demand/quantity demanded) for (B)____________ would (rise/fall), causing the demand curve to shift (right/left). Graphs: Watch content video: Micro Chapter 03 03-substitute goods 4 (2) Complement goods (2) Complement goods goods--usually consumed at the same time An increase (decrease) in price for the first good will decrease (increase) demand for the second good Graphs: Example: (A)__________, (B)__________ If the price of (A)_____________ rose rose,, the (demand/quantity demanded) of (A)_____________ would (rise/fall) and consumers would purchase (more/less) (A)________________. The (demand/quantity demanded) for (B)_____________ would (rise/fall), causing the demand curve to shift (right/left). Q3.5 If air travel and bus travel are substitutes, 1. an increase in the price of bus travel will decrease the demand for air travel. 2. a decrease in the price of bus travel will decrease the demand for air travel. 3. an increase in the price of bus travel will generally have no effect on the demand for air travel. 4. an increase in the price of bus travel will shift the demand curve for air travel to the left. Watch content video: Micro Chapter 03 03-complement goods 25% 25% 25% 25% 60 1 2 3 4 Q3.6 If coffee and cream are complements, an increase in the price of coffee will cause 1. 2. 3. 4. the demand for cream to increase. the demand for cream to fall. the demand for coffee to fall. no change g in the demand for cream;; onlyy quantity demanded would be affected. 25% 25% 25% Producer Choice and the Law of Supply pp y 25% 60 1 2 3 4 5 Goal: Explain and Predict Firm Behavior Ways to express Law of Supply: The Law of Supply: 1. 2. 3. 4. – The positive relationship between price and quantity supplied; when price rises, quantity supplied pp rises – Quantity supplied is a number; it’s how many units of a good you made Words (see notes you just wrote) Table Math equation Picture We usually draw a picture of this relationship Why is the supply curve upward sloping? Graph: Graph: Watch content video: Micro Chapter 03 03-supply curve At a higher price, a product is usually more profitable so a firm has a stronger incentive to make more. more. Q3.7 According to the law of supply, 1. producers are willing to supply larger amounts of a good as its price increases. 2. a direct relationship exists between the price of a good and the amount buyers choose to buy. 3. an inverse relationship exists between the price of a good and the amount buyers wish to buy. 4. an inverse relationship exists between the price of a good and the amount producers supply. 25% 25% 25% What if the actual price is higher than your minimum price? In economics, we call this difference producer surplus (PS) Graphically, PS is the area above supply, out to quantity, quantity and up to price 25% 60 1 2 3 4 6 Graph of PS: Watch content video: Micro Chapter 03 03-producer surplus Changes in Supply Versus Changes in Quantity Supplied Typical “something else” changes: Resource prices Technology Nature Political Taxes Watch video video:: Pretty Woman Woman-- consumer surplus Price is not the only factor that determines how much a firm makes Changes: (1) When price changes, quantity supplied changes but supply does NOT change – This is movement along a supply curve (2) When something else changes, supply changes (i.e., the relationship changes) – This is movement of the entire curve Another way to think about the difference between supply and quantity supplied Why is the firm producing more (or less)? If price is the reason, then quantity supplied changes; move along the supply curve If any variable besides price is the reason, then supply changes; shift the supply curve 7 Q3.8 When economists say the supply of a product has increased, they mean the Graphs: 1. supply curve has shifted to the right. 2. price of the product has risen, and consequently, suppliers are producing more of it. 3. supply pp y curve has shifted to the left. 4. amount of the product that consumers are willing to purchase at various prices has increased. Watch content video: Micro Chapter 03 03-shift vs move along supply 25% 25% 25% 25% 60 1 Q3.9 When economists say the quantity supplied of a product has decreased, they mean the 1. supply curve has shifted to the left. 2. supply curve has shifted to the right. 3. price of the product has risen, and consequently, suppliers pp are producing p g more of it. 4. price of the product has fallen, and consequently, suppliers are producing less of it. 25% 25% 25% 25% 60 1 2 3 25% 25% 3 4 Even gangsters’ supply curves slope upward. In his book But He Was Good to His Mother (Jerusalem: Gefen, 2000), Robert Rockaway reports that an associate of Big Jack, a New York gangster in the early twentieth century, stated to police that Big Jack had the following price list for his services: slash on the cheek with knife, $1 to $5; shot in leg, $1 to $25; shot in arm, $5 to $25; throwing a bomb, $5 to $50, murder, $10 to $100. Clearly, the prices are higher for the more difficult tasks; and the range of prices for a particular criminal act probably reflects the ease of access to the target. Perhaps a shot in the leg costs less than one in the arm because hitting a person in the leg without causing further damage is easier than hitting someone in the arm. Q: Draw a supply curve for criminal activities. Then show how it would shift if unemployment were low and there were many good legitimate jobs. Then show how the curve would shift if jobs were scarce. 4 Q3.10 How will an increase in lumber prices influence the home construction market? 1. The demand for newly constructed homes will increase. 2. The demand for newly constructed homes will decrease. 3. The supply of newly constructed homes will increase. 4. The supply of newly constructed homes will decrease. 25% 2 How Market Prices are Determined: Supply and D Demand d Interact I 25% 60 1 2 3 4 8 Graph: Watch content video: Micro Chapter 03 03-supply and demand Key points: – (1) Excess supply and excess demand are NOT unique points – (2) Equilibrium IS a unique point Q3.11 On the following graph, how much is excess supply (surplus)? 1. 2. 3. 4. 5. Q3.12 On the following graph, how much is excess demand (shortage)? 1. 2. 3. 4. 150 50 100 125 75 20% 20% 20% 20% 50 75 100 125 25% 20% 25% 25% 25% 60 1 2 3 4 5 60 1 2 3 4 This is called supply and demand analysis How Markets Respond to Ch Changes in i Supply S l and d Demand You don’t have to use graphs but it’s helpful Use this 3 step procedure: – (1) Identify Id tif the th change h – (2) Determine if Supply or Demand is affected and how – (3) Draw and read graph (or reason through the change) 9 Only allow one variable to change at a time. Graph: Example: Part of Doak Campbell Stadium is destroyed by locusts Watch content video: decrease supply – (1) Fewer seats will be available – (2) Supply is affected, affected will decrease – (3) Shift supply left and find new equilibrium There have been stories all over the Web and on television in the last few weeks about the lowlowcarbohydrate food crazecraze- people following weightweight-loss diets that involve sharp reductions in the intake of carbohydrates. One story on Yahoo said, “Food companies rush to take advantage of carbohydrate crunch.” This is a good description of behavior in a market where the demand curve has shifted to the right. The demand shift is due to people’s new belief that these diets will enable them to lose weight. weight To meet the shift in demanddemand- and seeing a chance to make additional profits-- food companies are happy to produce more lowprofits lowcarbohydrate foods. They are happy to increase the amount supplied in response to the shift in demand. Q: What does this change in consumer behavior do to the equilibrium price of lowlow-carbohydrate foods? Q3.13 If the demand for a good decreased, what would be the effect on the equilibrium price and quantity? 1. Price would decrease. 2. Price would decrease decrease. 3. Price would increase. 4. Price would increase. increase and quantity would decrease and quantity would increase and quantity would decrease and quantity would 25% 25% 25% 25% 60 1 1. supply curve for peaches to shift to the right and the price of peaches to fall. 2. supply curve for peaches to shift to the left and the price of peaches to rise. 3 d curve ffor peaches h tto shift hift tto th ft 3. d demand the lleft and the price of peaches to fall. 4. demand curve for peaches to shift to the right and the price of peaches to rise. 25% 25% 3 4 What if supply and demand shift at the same time? Q3.14 If Georgia experiences a late frost that damages the peach crop, we should expect the 25% 2 Suppose supply and demand both decrease Watch content video: Micro Chapter 03 03-supply and demand decrease 25% 60 1 2 3 4 10 Q3.15 (PMA) If there is a simultaneously an increase in demand and an increase in supply, we would expect 1. An increase in equilibrium price and an increase in equilibrium quantity 2. A decrease in equilibrium price and an increase in equilibrium quantity 3. An increase in equilibrium price and a decrease in equilibrium quantity 4. A decrease in equilibrium price and a decrease in equilibrium quantity 25% 1 25% 2 25% 25% 3 4 “Every individual is continually exerting himself to find out the most advantageous employment for whatever [income] he can command. It is his own advantage, indeed, and not that of the society which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to society…He society He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was not part of his intention. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.” Invisible Hand Principle Adam SmithSmith- An Inquiry into the Nature and Causes of the Wealth of Nations Personal selfself-interest directed by market prices is a powerful force promoting economic progress Question Answers: Q3.16 Which of the following is a major implication of the invisible hand concept? 1. 2. 3 3. 4. When directed by competitive market prices, the actions of self self--interested individuals will tend to promote overall economic prosperity. Prosperity cannot be achieved unless the selfish nature of people can be changed. C titi iis h f l tto th lth off an economy Competition harmful the h health because it results in wasteful duplication. GovernmentGovernment-operated firms tend to have higher efficiency and lower costs than private sector firms. 25% 25% 25% 25% 60 1 2 3 Class Activity: Name one good you purchased recently. Identify at least 5 different people that were involved in that product so that you could buy itit. Watch video: FriedmanFriedman-price system 4 Q3.1 = 2 & 5 Q3.2 = 2 Q3.3 = 1 Q3.4 = 4 Q3.5 = 2 Q3.6 = 2 Q3.7 = 1 Q3.8 = 1 Q3.9 = 4 Q3.10 = 4 Q3.11 = 2 Q3.12 = 4 Q3.13 = 2 Q3.14 = 2 Q3.15 = 1 & 2 Q3.16 = 1 11