Download Why do prices change?

Why do prices change?
• Inflation/Deflation (times of generally
rising/declining prices) reflect the changes
• Change in market conditions for a particular
product/service
– change in factors that affect consumers’
demand for the good
– change in factors that affect producers’ supply
of the good
Consumer Demand
• Households get less satisfaction from later
units of a product/service than they get from
earlier units -- diminishing marginal
utility (declining marginal value)
– why the first run of the season down the ski
slope is more exciting than the second
– why the second donut doesn’t taste as good as
the first
• Implies that consumers are only willing to
buy more of a good if the price declines
Consumer Demand (cont.)
• Demand Curve - depicts the relationship
between the price of the product and the
quantity of the product that consumers will
purchase.
• For this class, Demand Curves will always
have a negative slope
Demand for Donuts
Price/donut
1.2
1
0.8
0.6
D1
0.4
0.2
0
1
2
6
Quantity of Donuts (in 1,000’s)
12
What affects the shape/position of
the demand curve?
• Household income
– as income rises families increase their demand for
“normal” goods and decrease their demand for
“inferior” goods
• Household preferences
– some people don’t like to eat sweet things in the
morning while others do
• The availability and price of substitutes
– e.g., bagels vs. donuts
• The availability and price of complements
– e.g., coffee and donuts
Defining Terms
• Normal Goods: a good for which
consumption increases as an individual’s
income rises.
• Inferior Goods: a good for which
consumption decreases as an individual’s
income rises
Producer Supply
• Producers’ willingness to provide a product
or service is dependent on the price they can
get for the good/service in the market…
– the higher the price, the more they are willing
to produce
• Producers’ supply is a positive function of
price
• For this class, Supply Curves will always
have a positive slope
Supply of Donuts
Price/donut
1.2
S1
1
0.8
0.6
0.4
0.2
0
1
2
6
Quantity of Donuts (in 1,000’s)
12
What affects the shape of the supply curve?
• Production technology
– e.g., must donuts be made by hand or can a machine do
it?
• Cost of inputs (a.k.a Input Costs)
– e.g., price of labor, machines, space
Supply & Demand Intersect to
Determine Market Price
Price/donut
1.2
1
P1
S1
E1
0.8
0.6
0.4
D1
0.2
0
1
2
6
Q1
Quantity of Donuts (in 1,000’s)
12
Let’s draw some curves!
• How does an income increase affect
demand for a normal good?
• How does an income decrease affect
demand for a normal good?
• How does an income increase affect
demand for an inferior good?
• How does an income decrease affect
demand for an inferior good?
Let’s draw some curves!
How does an income increase affect demand for a normal good?
Price
Supply
Curve = S
E2
E1
Original
Demand
Curve = D1
New
Demand
Curve = D2
Quantity
More Curves!
How does an income decrease affect demand for a normal good?
Price
Supply Curve
=S
E1
E2
New
Demand
Curve = D2
Original
Demand
Curve = D1
Quantity
More Curves!
How does an income increase affect demand for an inferior good?
P
S
E1
E2
D1
D2
Q
More Curves!
How does an income decrease affect demand for an inferior good?
P
S
E2
E1
D2
D1
Q
More Curves!
How does having a higher preference for a particular good
affect the demand of that good?
P
S
E2
E1
D2
D1
Q
More Curves!
How does having a lower preference for a particular good affect
the demand of that good?
P
S
E1
E2
D2
D1
Q
More Curves!
If the price of a substitute increases, how does that affect the
demand of the original good?
P
S
E2
E1
D2
D1
Q
More Curves!
If the price of a substitute decreases, how does that affect the
demand of the original good?
P
S
E1
E2
D2
D1
Q
More Curves!
If the price of a complement decreases, how does that affect the
demand of the original good?
P
S
E2
E1
D2
D1
Q
More Curves!
If the price of a complement increases, how does that affect the
demand of the original good?
P
S
E1
E2
D2
D1
Q
Supply Curves!
If technology becomes relatively cheaper, how does that affect
the supply of a good?
Original Supply
Curve = S1
P
New Supply Curve
= S2
E1
E2
Demand
Curve = D
Q
Supply Curves!
If technology becomes relatively more expensive, how does that
affect the supply of a good?
New Supply Curve
= S2
P
Original Supply
Curve = S1
E2
E1
Demand
Curve = D
Q
Supply Curves!
If input costs increase, how does that affect the supply of a
good?
S2
P
S1
E2
E1
D
Q
Supply Curves!
If input costs decrease, how does that affect the supply of a
good?
P
S1
S2
E1
E2
D
Q
Examples...
• Oprah Effect: Households become aware of the
perceived negative health consequences of eating
beef
• shifts demand to the left and the market price for
beef declines.
• ABC Factory moves it’s manufacturing plant to
Veracruz, Mexico. What will happen to the price
of ABC’s products?
• shifts supply to the right and the market price for
ABC’s products decrease.
Examples...
• California has the best strawberry crop in years.
What will happen to the price of chocolate and
whipped cream?
• May shift demand for chocolate and whipped
cream to the
– right (increasing both equilibrium quantity and
price).
• Strike of union workers may
• raise employee costs and shift supply curve to the
left (raising equilibrium price and decreasing
quantity).
Sample Test Question
Based on the following graph, which of the following answers is true?
P
B
C
A
Q
A.
B.
C.
D.
E.
A shift from curve A to B could represent an increase in the technology costs
A shift from curve B to A could represent an increase in household income (assuming normal goods)
A shift from curve C to A could represent an increase in input costs
A shift from curve A to B could represent an increase in household income (assuming normal goods)
A shift from curve A to B could represent a decrease in household income (assuming normal goods)
Implications
• Prices for particular products/services may
shift over time because of changes in factors
that affect supply and demand
• It’s possible that during a period of inflation
(deflation) that some prices may still
decline (rise).
– E.g., the CPI for fuel oil used in home heating
declined from 98.6 in 1990 and to 84.8 in 1995
while the overall CPI climbed from 130.7 to
152.4 during the same time period.
Small Group Activity – 4 people per
group
• What is changing – Supply or Demand?
– Add the appropriate labels
• Is it increasing or decreasing?
• What is happening to the price?
• Come up with a scenario that will explain your
graph
• Put your names on the paper and turn it in
• The group with the best scenario wins, and your
question will appear on the first exam