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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? 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).