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Chapter 3

Chapter 3- Demand and Supply

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ECON 101
Emanuel Carvalho

Chapter 3: Demand and Supply Market and Prices  Market has two sides: buyers and sellers  Markets for goods (apples), services (haircuts), resources (computer programmers), manufactured inputs (memory chips, auto parts), money (Japanese Yen), financial securities (Yahoo!)  Some can be physical (auction, broker)  Some can be through the internet, or by telephone and fax (e.g. e-commerce)  We do most of our trading in unorganized collections of buyers and sellers (basketball shoes market)  Competitive market: A market that has many buyers and many sellers, so no single buyer or seller can influence the price  Producers offer items for sale only if the price is high enough to cover their opportunity cost  Money price: The price of an object is the number of dollars that must be given up in exchange for it  The opportunity cost of an action is the highest-valued alternative forgone  Relative price: The ratio of one price to another an opportunity cost  Pick $2 coffee, gum =$1 each, ratio 1:2, opportunity cost = 2 packs of gum  Normal way of expressing a relative price is in terms of a “basket” of all goods and services  To calculate relative price: Divide the money price of a good by the money price of a “basket” of all goods (called a price index)  Results tells us the opportunity cost of the good in terms of how much of the “basket” we must give up to buy it  When predicted a price will fall, it means it relative price (average price of other goods and services), not money price Demand If you have demand for something: 1. Want it 2. Can afford it 3. Plan to buy it  Wants: Unlimited desires or wishes that people have for goods and services  Quantity demanded: Amount that consumers plan to buy during a given time period at a particular price  May not be the same as quantity bought  Sometimes the quantity demanded exceeds the amount of goods available, so the quantity bought is less than the quantity demanded  Quantity demanded is measured as an amount per unit of time  Price influence buying plans Law of Demand: Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded Two reasons: 1. Substitution effect 2. Income effect Substitution effect: When the price of a good rises, other things remaining the same, its relative price-its opportunity cost rises  Each good has substitutes-other goods that can be used in its place  As the opportunity cost of a good rises, the incentive to economize on its use and switch to a substitute becomes stronger Income effect: When a price raises, other things remaining the same, the price rises relative to income  People cannot afford to buy all the things they previously bought  They must decrease the quantities demanded of at least some goods and services Demand Curve and Demand Schedule  Demand: Refers to the entire relationship between the price of a good and the quantity demanded for the good  Illustrated by the demand curve and the demand schedule  The term quantity demanded refers to a point on a demand curve- the quantity demanded at a particular price  Demand curve: Shows the relationship between the quantity demanded of a good and its price when all other influences on consumers’ planned purchases remain the same  Demand schedule: Lists the quantities demanded at each price when all the other influences on consumers’ planned purchases remain the same Willingness and Ability to Pay  Willingness and ability to pay is a measure of marginal benefit  As the quantity available increases, the marginal benefit of each additional unit falls and the highest price that someone is willing and able to pay also falls along the demand curve A Change in Demand: When any factor that influences buying plans another than the price of the good changes  When demand increases, the demand curve shifts rightward and the quantity demanded at each price is greater Six factors bring changes in demand: 1. The prices of related goods 2. Expected future prices 3. Income 4. Expected future income and credit 5. Population 6. Preferences Price of Related Goods:  Substitute: A good that can be used in place of another good  If the price of a substitute rises, people buy less of the substitute and more of the item  Complement: A good that is used in conjunction with another good  If the price of an hour at the gym falls, people buy more gym time and more energy bars Expected Future Prices:  If the price of a good is expected to rise in the future and if the good can be stored, the opportunity cost of obtaining the good for future use is lower today than it will be when the price has increased  They buy more of the food now before its price is expected to rise so the demand for the good today increases  Same as when prices are expected to fall later, people retime their purchases Income:  When income increases, consumers buy more of most goods; and when income decreases, consumers buy less of most goods (may not apply to all goods)  Normal good: Demand increases as income increases  Inferior good: Demand decreases as income increases (e.g. long distance bus trips) Expected Future Income and Credit:  When income is expected to increase in the future, or when credit is easy to obtain, demand might increase now Population:  The larger the population, the greater is the demand for all goods and services; the smaller the population, the smaller is the demand for all goods and services  The larger the proportion of the population in a given age group, the greater is the demand for the goods and services used by that age group (e.g. number schools for kids) Preferences:  Preferences determine the value that people place on each good and service  Depend on things like weather, information, and fashion trends A Change in the Quantity Demanded Versus a Change in Demand  Same as that between a movement along the demand curve and a shift of the demand curve  A point on the demand curve shows the quantity demanded at a given price  So a movement along the demand curve shows a change in the quantity demanded  The entire demand curve shows demand, so a shift of the demand curve shows a change in demand Movement Along the Demand Curve  If the price of the good changes but no other influence on buying plans changes, the effect is a movement along the demand curve  A fall in the price of a good increases the quantity demanded of it  A rise in the price of a good decreases the quantity demanded of it A Shift of the Demand Curve  If the price of a good remains constant but some other influence on buyers’ plans changes, there is a change in demand for that good (e.g. If more people work out at the gym, co:nsumers buy more energy bars regardless of the price of a bar)  Increases shifts to the right  Decreasesshifts to the left Supply If a firm supplies a good or service, they: 1. Have the resources and technology to produce it 2. Can profit from producing it
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