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SUPPLY AND DEMAND The Mechanism for Pricing Demand The four reasons for the law of demand: 1. 2. 3. 4. Common Sense The Income Effect The Substitution Effect Diminishing Marginal Return Demand The Determinants of Demand 1. Tastes and Preferences 2. Number of Buyers 3. Prices of related goods – Substitutes – Complements – Independent goods 4. Consumer expectations 5. Income – Normal Goods – Inferior Goods The Law of Supply The Law of Supply states the higher the price, the higher the quantity supplied. Please remember Ceteris Paribus Determinants of Supply Resource Prices Technology Taxes and Subsidies Prices of Other Goods Expectations Number of Sellers Shift vs. Slide A shift of the curve is caused by a change in one of the determinants of demand A slide on the existing curve is caused by a change in price only Will these cause a shift or a slide? In what direction? A rise in the price of ground beef…market for ground beef. A rise in the price of movies…market for popcorn at the movies. A decrease in the price of soda…market for soda. An increase in the price of golf balls…the market for golf. A decrease in the price of computers…the market for computers. Equilibrium Equilibrium exists at the point where quantity supplied equals quantity demanded Each time there is a shift or a slide there is a change in equilibrium An increase in demand will generally increase price and increase quantity An increase in supply will generally mean a decrease in price and an increase in quantity ELASTICITY How stretchy is demand? Important Questions: Does the law of demand apply equally to all products? If so, why? If not, why not? Extreme elasticities Perfectly elastic demand A situation where a small change in price will cause consumers to shift their QD from zero to all they could obtain Perfectly inelastic demand A situation where buyers will continue to purchase the same amount no matter what the change in price Perfectly Elastic Perfectly Inelastic Determinants of Price Elasticity Time The longer a period of time available to make the decision the more elastic the demand Substitutability The more substitutes a product has, the more elastic the demand Proportion of income The larger the proportion of income on a product or service, the more elastic will be the demand Luxury v. Necessity Luxury items tend to be more elastic, while necessities tend to be more inelastic Supply Elasticity How quickly can a producer respond to a change in market price In the short run it is difficult to change production, therefore most firms are somewhat inelastic in the short run The Total Revenue Test The total revenue test is another way to determine elasticity If price and total revenue move in opposite directions, demand is elastic If price and total revenue move in the same direction, demand is inelastic
