Download Chapter 3 and Chapter 5

Chapter 3 Supply and
Demand
Additional – Circular Flow
Model
What Determines a Person’s Income in the Market?
This means… what is the value of the human
being?
Determined by:
a) value of their product…. Rock singer,
athlete, Shaq, Oprah, department store clerk,
insurance salesman, teacher
b) supply and demand…. If lot of people
doing same things you are… not likely to be
paid much.(underwater welders)……. As
demand for product decreases, reduces
number of available jobs… gas station jobs!
c) if demand for product lacking- rewards
minimal and number of competing workers
is few, demand high, wages high. 20 years
ago… heart surgeons
Who Determines the value of a
product?
The value of the product is the worth
that society puts on it….
What worth does society put on
sports?
What worth does society put on
music industry?
What worth does society put on
sport cars, SUVs, large houses,
motorcycles, eating out, designer
clothes, entertainment. Etc, etc. etc.
Education?
WORKING MODEL OF THE ECOMONY
International Participants
Product Market
Payments for Goods & Services
Receive Goods & Services
Injection
Investment
Banks
BUSINESS
HOME
Land,Labour, Capital, Entrepreneurs
Factor Market
Savings
Governmen
t
Taxes
Leakage
Rent, Wages, Interest, Profit
International Participants
Leakage S + T = I + G Injection
S+T > I+G = Recession
I+G > S+T = Inflation
Circular Flow Explanation
 Flow of resources in the market
shows how the market works…
 In market system, voluntary
exchanges continually take place in
circular flow model
 System works that what is an
expense to one is ultimately an
income to the other
Two Leakages Explained
Savings and Taxes
 Savings does not help unless it is
invested back into the flow
(economy).
 Financial intermediaries: why are
they called this?

(because they take savings of one group and

make it available to another to borrow or invest)
Financial Intermediaries are: banks, savings & loan,
credit unions, stock market, insurance companies.
 If savings is greater than
investment..business expenses
mount.*****
Taxes are also a leakage.
 Government injects tax dollars back
into the economy (flow) by spending
the money that taxes take out.
 What expenditures does government
make into the flow?
 ****Money spent on redistribution of
income or transfer payments is not
“productive into the flow.”
Why?**This is where a lot of the
controversy occurs about stimulus
package.
S + T greater than I + G =
recession
G + I greater than S + T =
inflation
Supply-siders favor strong I
Demand-siders (Keynesian
economy) favor strong G ***
this is where we are now for
most of populous thinking
What if???
Banks will not loan money?
People lose their jobs?
Companies are not hiring?
People are under-employed?
Consumption decreases significantly?
Characteristics of Recession/Inflation
Recession:
Businesses not selling what it produces
Inventories accumulate
Businesses then cut down on employment
(hence unemployment/layoffs)
Inflation:
_____________________________
Government and investors spending more
Inventories begin to be depleted
Prices increase
Production increases
More workers are hired
What is a Market?
Any Place Where Goods and Services are
Voluntarily Exchanged
(brings together buyers and sellers)
Price is a primary influence in determining
allocation of resources in our free
enterprise economy.
Difference between Price, Value, Utility
Price= value of product in terms of
money
Value= has to do with relative scarcity =
exchange value
Utility = satisfaction that good or
service can provide
Law of Supply
As the price of the product increases,
the quantity that the supplier tends
to supply also increases.
****Ceteris Paribus Ceteris Paribus
Assumption
[KAY-ter-us PEAR-uh-bus]
 Nothing changes except the factor or factors
being studied.
 Other things “constant” “equal”
Economics as a Science (cont'd)
 Ceteris Paribus Assumption
[KAY-ter-us PEAR-uh-bus]
 Nothing changes except the factor or
factors being studied.
 “Other things constant”
 “Other things equal”
Law of supply
= positive relationship between the
quantity of a good supplied and
price.
PRICE IS THE INDEPENDENT
VARIABLE
Determinants of Supply
1. Technique of production (technology)
(ovens, organic farming)
2. Resource Prices (Factor Costs)– cost of
inputs
3. Taxes and Subsidies
4. Prices of Other Goods – (decline in wheat
will cause farmer to shift to corn)
5. Expectations- (farmers expect price to
rise.. Hold back production)
6. Number of sellers in market – more
sellers, greater supply….
Important Concepts
Change in Supply (shifting of curve)
Or
Change in Quantity Supplied
(movement along curve)
Ability to Respond to Price varies
Often the ability of an individual firm to
respond to an increase in price is
limited or constrained by its existing
scale of operations, or capacity, or
ability to obtain resources….. IN
SHORT RUN
Examples:
IN LONG RUN… can adjust. The greater
the amount of time producers have
to adjust, the greater their output
response.
Law of Demand
AS THE PRICE OF A GOOD DECREASES
THE QUANTITY DEMANDED TENDS
TO INCREASE….
***Ceteris Paribus
Price once again is the independent
variable!
Wishing for a new boat does not constitute
demand… one must be WILLING AND
ABLE to purchase a boat.
Generally speaking…. The higher the price
obstacle, the less of a product a
consumers will buy.
Bargain days are based on law of demand.
The greater the want satisfaction….
The greater the utility…
Marginal Utility… How much more
utility do you get adding or
subtracting units (more doughnuts…
more cars… more steak in one day)
DIMINISHING MARGINAL UTILITY.
As the number of units of a
product a consumer has
increases, the satisfying power
for each extra unit decreases.
Utility
Purpose of Utility analysis is to study
how people behave not how they
think.
Theory of consumer choice is based on
the idea that each consumer spends
his/her income in a way that yields
the greatest satisfaction.
Determinants of Demand
1.Preferences
2.Prices of Related Goods
3.Number of Buyers
4.Expectations of future price
5.Income
Determinants of Demand
1. Tastes and preferences
Taste changes throughout our lifetime.
# 2 Determinant: Prices of
Related Goods
Your preference is Coke… price skyrockets….
Affected in the market by substitute goods and
complimentary goods.
*Substitute goods… anything that can be
substituted for the product or service desired…
(Coke/Pepsi,
Millers/Coors,
potato chips/popcorn).
If price of Coke rises… and consumer doesn’t feel
strongly about brand preference… will buy Pepsi
until Coke price declines)
When two products are substitutes, the price of
one good and the demand for the other are
DIRECTLY RELATED.
*Complementary Goods… Goods
that “go along with other goods
consumer’s buy”
peanut butter/jelly, beer/pretzels,
milk/cookies, golf balls/golf tees,
When two goods are complements,
an increase in the price of one
good adversely affects the
demand for the other and
creates an inverse relationship.
Independent Goods… No connection
between price and demand
(cars/bread)
Determinants Continued
3. Number of buyers
The number of buyers will increase
demand for the product which (if
supply is fixed) will drive up the
price.)
Determinant #4
Income- RATHER OBVIOUS HERE.
Show shifts…
Superior or Normal goods=
commodities whose demand varies
DIRECTLY with money income.
INFERIOR OR “POOR MAN’S”
GOODS.
Goods whose demand varies inversely
with a change in money income.
5. Expectations…
If you are in medical school or law
school, the expectation of you
getting a larger income when you
get out of school will affect your
demand for goods… Inheriting
money, winning the lottery!
IMPORTANT CONCEPTS OF DEMAND
Change in Demand
OR
Change in Quantity Demanded
Terms to Remember
Profit:
TR-TC
Total Revenue
PxQ
Marginal Utility
To maximize utility, consumers should
choose that good which delivers the most
marginal utility per dollar. Optimal utility
is then achieved.
Optimal consumption= mix of output
that maximizes total utility for the
limited amount of income you have to
spend.
Equilibrium
 Equilibrium = market clearing price…
supply and demand are “in balance.”
 Does not occur often if ever with the
constantly changing “invisible hand”
and the consumer fickleness.
 In our U.S. economy we have
consumer sovereignty… which tends
to shift both curves or move along
the curve almost continuously.
Ceilings and Floors
Price Ceiling a legally established maximum price
that sellers may charge (rent
control)
 Direct effect of a price ceiling is a
shortage
 Secondary effect- reduction in the
quality of the good, inefficient use,
lower future supply, black markets,
Price Floors
 Price floor is a legally established
minimum price that buyers must
pay. (minimum wage)
 Direct effect= reduces employment
of low-skilled labor
 Indirect effects – reduction in
nonwage component of
compensation (perks), lesson-thejob training.
Recap Ceilings and Floors
P
P
S
S
D
D
Q
Q
Black Markets
 Markets that operate outside the
legal system
 Have a higher incidence of defective
products, higher profit rates, greater
violence (cigarettes, drugs {both
prescription and illegal}, Levis
during cold war)
Equilibrium Tutorial
Equilibrium
Supply and Demand for Cowboy
Tickets
http://www.tickco.com/schedule/dallascowboys/
http://www.tickco.com/schedule/newengland-patriots/
Kiley is my best friend… She
Supplies a lot of love! 