Download ECN 111 Chapter 4 Lecture Notes

ECN 111 Chapter 4 Lecture Notes
4.1 Demand
A. Markets
A market is any arrangement that brings buyers and sellers together. We study a
competitive market with so many buyers and sellers that no one can influence the price.
B. The Law of Demand
1. The quantity demanded of any good, service, or resource is the amount that people
are willing and able to buy during a specified period at a specified price. The quantity
demanded is the quantity at one price.
2. The law of demand states that other things remaining the same, if the price of a good
rises, the quantity demanded of that good decreases; and if the price of a good falls,
the quantity demanded of that good increases.
3. The law of demand exists because people have a limited budget and try to get the
best deals they can find.
C. Demand Schedule and Demand Curve
1. Demand is the relationship between the quantity demanded and the price of the good
when all other influences on buying plans remain the same. Demand is a list of
quantities at different prices.
2. The demand schedule is a list of the quantities demanded at each different price
when all the other influences on buying plans remain the same.
3. The demand curve is a graph of the relationship between the quantity demanded of a
good and its price when all the other influences on buying plans remain the same. A
demand curve is downward sloping.
D. Changes in Demand
1. When the price of the good changes, there is a change in the quantity demanded,
which is illustrated by a movement along the demand curve.
2. When any influence of buying plans other than the price of the good changes, there is
a change in demand, which is illustrated by a shift of the demand curve. Factors that
change demand are:
a. Prices of related goods. An increase in the price of a substitute (a good that can be
consumed in place of another good) increases the demand for the good. An
increase in the price of a complement (a good that is consumed with another good)
decreases the demand for the good.
b. Income. An increase in income increases demand for a normal good. An increase
in income decreases demand for an inferior good.
c. Expectations. Changes in expected future income and prices change demand.
d. Number of buyers
e. Preferences
3. When demand increases, the demand curve shifts rightward; when demand
decreases, the demand curve shifts leftward.
4.2 Supply
A. The Law of Supply
1. The quantity supplied of any good, service, or resource is the amount that people are
willing and able to sell during a specified period at a specified price. The quantity
supplied is one quantity at one price.
2. The law of supply states that other things remaining the same, if the price of a good
rises, the quantity supplied of that good increases; and if the price of a good falls, the
quantity supplied of that good decreases.
3. The law of supply exists because faced with scarce resources, suppliers have an
incentive to use their resources in the way that brings the biggest return.
B. Supply Schedule and Supply Curve
1. Supply is the relationship between the quantity supplied and the price of a good when
all the other influences on selling plans remain the same. Supply is a list of quantities at
different prices.
2. The supply schedule is a list of the quantities supplied at each price when all the
other influences on selling plans remain the same.
3. The supply curve is a graph of the relationship between the quantity supplied of a
good and its price when all the other influences on selling plans remain the same. A
supply curve is upward sloping.
C. Changes in Supply
1. When the price of the good changes, there is a change in the quantity supplied,
which is illustrated by a movement along the supply curve.
2. When any other influence on selling plans other than the price of the good changes,
there is a change in supply, which is illustrated by a shift of the supply curve. Factors
that change supply are:
a. Prices of related goods. An increase in the price of a substitute in production (a
good that can be produced in place of another good) decreases the supply of the
good. An increase in the price of a complement in production (a good that is
produced along with another good) increases the supply of the good.
b. Prices of resources and other inputs.
c. Expectations
d. Number of sellers
e. Productivity
3. When supply increases, the supply curve shifts rightward; when supply decreases, the
supply curve shifts leftward.
4.3 Market Equilibrium
A. Market Equilibrium
Market equilibrium occurs when the quantity demanded equals the quantity supplied—
buyers’ and sellers' plans are consistent.
1. The equilibrium price is the price at which the quantity demanded equals the quantity
supplied.
2. The equilibrium quantity is the quantity that is bought and sold at the equilibrium
price.
B. Price: A Market’s Automatic Regulator
1. The law of market forces states that when there is a shortage, the price rises; and
when there is a surplus the price falls.
a. If the price is above the equilibrium price, there is a surplus or excess supply—the
quantity supplied exceeds the quantity demanded—and the price falls.
b. If the price is below the equilibrium price, there is a shortage or excess demand—
the quantity demanded exceeds the quantity supplied—and the price rises.
c. At the equilibrium price, there is no tendency for the price to change.
C. Effects of Changes in Demand
1. If the demand for a good increases, the demand curve shifts rightward. The
equilibrium price rises and the equilibrium quantity increases.
2. If the demand for a good decreases, the demand curve shifts leftward. The equilibrium
price falls and the equilibrium quantity decreases.
3. When demand changes, there is no change in supply and the supply curve does not
shift.
D. Effects of Changes in Supply
1. If the supply of a good increases, the supply curve shifts rightward. The equilibrium
price falls and the equilibrium quantity increases.
2. If the supply of a good decreases, the supply curve shifts leftward. The equilibrium
price rises and the equilibrium quantity decreases.
3. When supply changes, there is no change in demand and the demand curve does not
shift.
E. Changes in Both Demand and Supply
1. When both demand for and supply of a good increase, both the demand and supply
curves shift rightward. The equilibrium quantity increases but the effect on the
equilibrium price is ambiguous.
2. When both demand for and supply of a good decrease, both the demand and supply
curves shift leftward. The equilibrium quantity decreases but the effect on the
equilibrium price is ambiguous.
3. When demand increases and supply decreases, the demand curve shifts rightward
and the supply curve shifts leftward. The equilibrium price rises but the effect on the
equilibrium quantity is ambiguous.
4. When demand decreases and supply increases, the demand curve shifts leftward and
the supply curve shifts rightward. The equilibrium price falls but the effect on the
equilibrium quantity is ambiguous.
4.4. Price Rigidities
A. Price Ceiling
A price ceiling is the highest price at which it is legal to trade a particular good, service,
or factor of production. An example of a price ceiling is a rent ceiling, a law that makes it
illegal for landlords to charge a rent that exceeds a set limit.
1. A price ceiling imposed above the equilibrium price has no effect.
2. A price ceiling set below the equilibrium price creates a shortage because at the price
ceiling the quantity demanded exceeds the quantity supplied.
B. Price Floor
A price floor is the lowest price at which it is legal to trade a particular good, service, or
factor of production. An example of a price floor is a minimum wage law, a government
regulation that makes hiring labor for less than specified wage illegal.
1. A price floor imposed below the equilibrium price has no effect.
2. A price floor set above the equilibrium price creates a surplus because at the price
floor the quantity supplied exceeds the quantity demanded.
3. In the labor market, if the minimum wage is set above the equilibrium wage,
unemployment occurs.
C. Sticky Price
Restrictions on price between buyer and seller, such as long-term contracts with labor
unions that fix wages for at least one year and often for as many as three years, can
keep the market price from reaching its equilibrium and can create surpluses or
shortages.