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Demand, Supply and Equilibrium Price The Market Model Demand • Demand is defined as the willingness and ability for consumers to pay for goods and services • Law of Demand= As price goes up, the quantity demanded goes down As price goes down, the quantity demanded increases The Demand Curve • The demand curve slopes down • As prices fall consumers demand more products Changes in the Quantity Demanded • Price determines whether more or less of a product is demanded • Notice that a change in the quantity demanded moves along the same curve. Shifts in the Demand Curve - Levels of Demand • Non price factors can shift the demand curve up or down • These include people’s tastes, styles or desires • For example, the level of demand for bell bottom jeans declines, as people no longer believe they are “in style” Substitute and Complimentary Products • Substitute products - e.g. if the price of chicken goes up, the level of demand for hamburger will increase • Complimentary products - e.g. if the demand for burgers increases, so will the level of demand for ketchup The Income Effect • The income effect - as consumers incomes fluctuate, so does the level of demand • Increases in real wages will increase the level of demand for goods • Decreases in real wages will lower the level of demand for goods Population increases and future expectations • Population increases or decreases can lead to shifts in the level of demand • Future expectations of prices can shift the level of demand. For example, if people believe that the price of homes will rise in the future, this will increase the level of demand in the present Supply • Supply is defined as the quantity of goods that producers will supply at various prices • The Law of Supply = As price goes up, the quantity supplied will increase As price goes down, the quantity supplied will decrease • This is because of the profit motive of business The Supply Curve • The supply curve is upward sloping • This is because businesses will supply more goods if prices are higher, and fewer goods if prices are low • These price changes result in the change in quantity supplied Factors which influence supply • The price of inputs - when the cost of land, labor, and capital change in the process of production • Higher costs decreases the level of supply, while lower costs increases the level of supply • Technological improvements which make the production process more efficient increases the level of supply Changes in the number of sellers • When there is an increase in the number of sellers or businesses in a market, this tends to increase the level of supply • Conversely, if the number of sellers decreases, then the level of supply also decreases The Impact of Taxes and Tariffs • Changes in tax laws which raise or lower business taxes effect the level of supply • Higher taxes to businesses increase their costs of production and therefore, reduce the level of supply • Conversly, lower taxes to businesses decrease the costs of production, and therefore, increase the level of supply • Quotas and tariffs (taxes on imported goods) reduces the level of supply for domestic consumers Shifting Supply Curve • Increased input costs or business taxes will shift the supply curve to a lower amount (s3)left. • Decreases in input costs, increased efficiency, or lower business taxes will shift the supply curve to a higher amount (s2)right. Equilibrium Price • The point at which the supply curve and the demand curve intersect indicates the equilibrium price and quantity in a market. • This is also called the market clearing price. Shortages • Shortages occur when prices fall below the equilibrium price. For example, at $10 businesses will not supply sufficient products to meet consumer demand. Surpluses • Surpluses occur when prices rise above the equilibrium price. For example, at $16 businesses will supply more products than consumers are willing to buy. #1 The impact of increased demand • When the consumer demand curve increases, both prices and the quantity supplied of the product also increases #2 The impact of decreased demand • When consumer demand decreases, both prices and the quantity of goods falls #3 The impact of increased supply • When the supply level of a product increases, then prices fall and the quantity supplied rises #4 The impact of decreased supply • When the level of supply decreases, prices rise and the quantity supplied falls, as well. Normal Goods • Normal goods are products for which the demand increases as peoples’ income rise and the demand decreases as peoples’ incomes fall. Inferior goods • Inferior goods are those products that decrease in demand, even when peoples’ income rise. Inexpensive cars or old clunkers are examples of inferior goods. Diminishing Marginal Utility • As a person increases consumption of a product there is a decline in the marginal utility that person gets from consuming each additional product • Marginal means the last unit consumed or produced • An example is that the first candy bar gives more utility, or satisfaction than the last. Think of experiences you might have had at a buffet. Diminishing Marginal Returns • This concept occurs on the supply side when a factor of production is increased, at some point each additional unit produced will decline. • For example, adding fertilizer to a garden will increase vegetable output, but at some point more fertilizer will not have the same effect. • Also in factory situations, adding workers adds to total output, but at some point adding additional workers will decrease marginal output. This occurs as production nears 100% of capacity. Indeterminate • When both supply and demand curves move simultaneously, the movement of prices and quantities can be indeterminate. • This is because we don’t know which shift is more p owerful, or more decisive than the other. The Rationing Role of Prices • If prices are above the equilibrium price, this signals businesses to produce more of a product (law of supply) • If businesses increase supply, prices will drop • Conversely, if prices are below equilibrium price, this signals businesses to produce less of a product. A smaller supply will raise prices. • Therefore, the market rations goods and services with the price mechanism. Price Ceilings • A ceiling is a government policy which sets a legal maximum price that may be charged for a good. For example, rent controlled apartments are a price ceiling. • Classical economists say that ceilings cause a shortage of a product when it is set below the equilibrium price. Price Floors • A price floor is a government policy which sets a legal minimum price that may be charged for a particular good. For example, the government set a price floor for wheat during the Depression • When floors are set above the equilibrium price there will be a surplus of goods. The Minimum Wage • Is the minimum wage a floor or a ceiling? • Graph the minimum wage. • According to your graph, what impact does the minimum wage have on the equilibrium quantity of labor? • Should we have a minimum wage? Why or why not?