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Factor Markets Businesses Households Product Markets Selling Price $5 $4 $3 $2 $1 Quantity Demanded 10 15 25 40 60 Graphing: -Plot the points -Connect the dots Price $6 $5 Downsloping to right $4 $3 left Demand $2 $1 0 10 20 30 40 50 60 Quantity Selling Price Quantity Supplied $5 $4 $3 $2 $1 60 40 25 15 10 Graphing: -Plot the points -Connect the dots Price $6 $5 $4 Upsloping right to left $3 Supply $2 $1 0 10 20 30 40 50 60 Quantity Selling Price $5 $4 $3 $2 $1 Quantity Demanded Supplied 60 10 40 15 25 25 15 40 10 60 Graphing: -Plot Demand -Plot Supply Price $6 D S $5 $4 $3 $2 $1 0 D S 10 20 30 40 50 60 Quantity Movement OF the curve Caused by a Change in a Determinant Selling Price $6 $5 $4 $3 $2 $1 $0 Quantity Old New 0 1 2 3 4 5 6 Inc 1 2 3 4 5 6 7 Dec 0 1 2 3 4 5 Increase in Demand shifts Price out or to the right $6 $5 $4 $3 $2 $1 Old 0 1 2 3 4 5 6 Decrease in Demand shifts in or Quantity Why the curve shifts 1 Consumer Tastes 2 Price of Other Goods 3 Consumer Incomes 4 Number of Consumers 5 Consumer Expectations Or why the curve shifts 1 Consumer Tastes -beanie hats make a comeback Demand increases -Hula Hoops go out of style Demand decreases 2 Price of Other Goods If airlines cut ticket prices More demand for Luggage Less demand for train tickets Tickets and Luggage are compliments Compliments are consumed or used together (inverse relationship) If ticket prices decrease, demand for Luggage increases If ticket prices increase, demand for Luggage decreases Airlines and Trains are Substitutes Substitutes replace each other (direct relationship) If air tickets decrease, demand for Train tickets also decreases If air tickets increase, demand for Train tickets also increases 3 Consumer Incomes +tax cuts increase net incomes Consumers have more money to spend, demand increases -the $ depreciates against the Euro Imported goods from Europe cost more dollars, demand decreases For Normal Goods!!! For Inferior Goods +tax cuts increase net incomes Consumers switch to better goods, demand for Hot Dogs decreases -the $ depreciates against the Euro Domestic travel looks better, demand increases 4 Number of Consumers (also Demographics) -Hurricanes arrive on Labor Day weekend Fewer tourists touring, demand decreases +NAFTA North American Free Trade Agreement Canada sells to 290 million US consumers, demand for their goods increases 5 Consumer Expectations -dealers reduce car prices in August Car buyers wait, demand decreases -heavy rains have damaged coffee crop Consumers expect shortages and higher prices so they buy more now, demand increases Shifting the Demand Curve Caused by a change in a Determinant of Demand Price $6 $5 P Q P2$4 P1 decrease Current Equilibrium $3 P3 $2 increase P Q $1 0 Supply 1 Q3 2 Q1 3 Q2 Demand 4 5 6 Quantity Why the curve shifts 1 Consumer Tastes 2 Price of Other Goods 3 Consumer Incomes 4 Number of Consumers 5 Consumer Expectations Movement OF the curve Caused by a Change in a Determinant Selling Price $6 $5 $4 $3 $2 $1 Quantity Supplied Old New 6 5 4 3 2 1 Inc 7 6 5 4 3 2 Dec 5 4 3 2 1 0 Price Increase in Supply shifts out or to the right $6 $5 $4 Old $3 $2 Decrease in Supply $1 0 shifts in or to the left 1 2 3 4 5 6 Quantity Why the curve shifts 1 Resource Prices 2 Changes in Technology 3 Prices of other goods 4 Taxes and Subsidies 5 Number of Producers Or why the curve shifts 1 Resource Prices -gas is discovered under CVCC Supply increases -Minimum wage goes up Supply decreases 2 Changes in Technology + If a more powerful computer is developed Makes production easier (and cheaper) - If stronger pollution controls are required Makes production harder (and costly) 3 Elements of Nature/Prices of other goods Shift resources away from high production cost goods. Caused by natural disasters or market price of other goods 4 Taxes and Subsidies - taxes discourage production + subsidies encourage production 5 Number of Producers +more firms increase supply -fewer firms decrease supply 6 Producer Expectations about prices and resource availability -if prices are expected to increase, more production -if prices are expected to decrease, less production Why the curve shifts 1 Resource Prices 2 Changes in Technology 3 Prices of other goods 4 Taxes and Subsidies 5 Number of Producers 6 Producer Expectations Movement ALONG the curve Consumers responding to a Change in the Price of the good Caused by factors related to production of the Price good The Supply Schedule!! $6 Harder or costlier to produce, pri goes up Supply decrease $5 P $4 2 P Q P Current Price $3 1 P $2 3 $1 0 increase P Q Easier or less expensive to produce, price goes down 1 Q2 2 Q1 3 Q3 4 5 Curve What makes the Supply Curve Shift?? Demand 6 Quantity Shifting the Supply Curve Caused by a change in a Determinant of Supply Price $6 $5 decrease P $4 2 P Q P increase Current Equilibrium $3 1 P $2 3 P Q $1 0 Supply Demand 1 Q2 2 Q1 3 Q3 4 5 6 Quantity Movement ALONG the curve Response to a Change in the Price of the good Caused by factors related to consumers Price $6 $5 P2$4 P1 Current Price $3 P3 $2 Supply $1 0 1 Q2 2 Q1 3 Q3 4 5 6 Quantity Economic Examples Resource Prices, and Product Markets • A reduction in the supply of unskilled labor … pushes the wage rates of fast-food workers upward. • Higher wages cause a reduction in supply. This leads to higher hamburger prices. S2 Price (wage) Resources Market Price S2 S1 Product Market S1 $2.25 $7.50 $2.00 $6.25 DR Employment E2 E1 DP Q2 Q1 Quantity 2. Increase in the Demand for LoanableInterest Funds • At the interest rate r the quantity of loanable funds demanded by borrowers into equals quantity supplied by lenders. • An increase in demand will move D1 to D2 the interest rises to r2 and increasing borrowing to Q2 • Higher interest rates encourage additional savings, making it possible to fund more borrowing. Lending rate S r2 r1 Borrowing D1 Q1 Q2 D2 Quantity of loanable funds 3. Increase in the Demand for Foreign Exchange U.S. sales to • Begin in equilibrium, where the dollar price of the quetzal is $.10 (10 cents = 1quetzal). • An increase in American demand for Guatemalan coffee will also increase the demand for quetzals (with which American importers pay Guatemalan coffee growers). Exchange rate • Equilibrium occurs where the new demand D2 just equals the supply S 0.10 •– at $.20 per quetzal with Q2 > Q1 quetzals clearing the market. Guatemala ($ per quetzal) S 0.20 D2 U.S. purchases from Guatemala D1 Q1 Q2 Quantity of quetzal exchange Price Controls 1. Price Ceilings • Price ceiling is a legally established maximum price that sellers may charge. • It stops the price from rising to the equilibrium level. – Example: rent control • The direct effect of a price ceiling is a shortage: quantity demanded exceeds quantity supplied. The Impact of a Price Ceiling Price (rent) • In the rental housing market the price (rent) P0 would bring the quantity of rental units demanded into balance with the quantity supplied. • A price ceiling like P1sets a price below equilibrium … quantity demanded QD … exceeds quantity supplied QS … resulting in a shortage. S Rental housing market P0 Price ceiling P1 Shortage D QS QD Quantity of housing units 2. Price Floors • Price floor is a legally established minimum price that buyers must pay. • It stops the price from dropping down to equilibrium level. – Example: minimum wage • The direct effect of a price floor above the equilibrium price is a surplus: quantity supplied exceeds quantity demanded. The Impact of a Price Floor Price • A price floor like P1 imposes a price above market equilibrium … causing quantity supplied QD … P1 to exceed quantity demanded QS … results in a surplus. P0 S Surplus Price floor • Because prices are not allowed to direct the market to equilibrium, non-price elements of exchange will become more important in determining where scarce goods go. D QD QS Quantity Employment and the Minimum Wage Price (wage) Excess supply • Consider where a price (wage) of $4.00 could bring the $ 5.15 quantity of labor demanded into balance with the quantity supplied. • A minimum wage (price floor) of $5.15 would increase the earnings of those who were able to maintain employment (E1), but would reduce the employment of others. • Those who lose their job (E0 to E1) would be pushed into either the unemployment rolls or some other less preferred form of employment. S Minimum wage level $ 4.00 D E1 E0 Quantity (employment) Elastic and Inelastic Demand Curves • Elastic demand – quantity demanded is sensitive to small changes in price. – Easy to substitute away from good. • Inelastic demand – quantity demanded is not sensitive to changes in price. – Difficult to substitute away from good. Measuring Elasticity Percent change in Quantity demanded Percent change in Price > 1 : Elastic sensitive to Price changes Price Quantity (by more %) TR Price Quantity (by more %) TR < 1 : Inelastic not sensitive to Price changes Price Quantity (by less %) TR Price Quantity (by less %) TR What affects Elasticity??? 1. Available Substitutes 2. Necessity vs Luxury 3. Proportion of Income 4. Time to shop around And the Drug Problem Inelastic Demand - necessity Price Supply P1 Demand Q1 Quantity Change supply: or Price P2 eradication Q then P Q then P Supply decrease increase P1 legalization P3 Inelastic Demand Q2Q1Q3 Quantity Elastic and Inelastic Supply Curves Price Price Quantity Quantity • Elastic supply – quantity supplied is sensitive to changes in price. Inelastic demand – quantity supplied is not sensitive to changes in price. What affects Elasticity of Supply??? 1. Time a. Market Period b. Short Run c. Long Run