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Chapter 3

ECON 101 - chapter #3 notes.doc

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Department
Economics
Course
ECON 101
Professor
Corey Van De Waal
Semester
Fall

Description
ECON 101 – Chapter #3 Markets and Prices A Market is any arrangement that enables buyers and sellers to exchange information an do business with each other In this course we will be examining a Competitive market, this is a market that has many buyers and sellers and in which no single buyer has influence over the price of goods or services. Producers offer items for sale only if the price is high enough to cover the opportunity cost. In response to change of opportunity costs’ customers go seeking cheaper alternatives. We must understand the relationship between price and opportunity cost. In everyday life when we talk about price, we are referring to the money price – the amount of dollars (or yen or pesos) that must be given up in exchange for a good or service. As we well know the opportunity cost of something is the highest-valued alternative forgone (not taken). If when you buy a chocolate bar, the highest- valued opportunity forgone is a pack of gum, then the opportunity cost of the chocolate a pack of gum. We can calculate the quantity of gum forgone from the money prices of the coffee and gum - For example: If the money price of the coffee was $2 and the money price of the gum is $1 a pack, then the opportunity cost of one cup of coffee is two packs of sum. To calculate this opportunity cost , we divide the price of a cup of coffee by the price of a pack of gum and find the ratio of one price to the other. This ratio is called relative price, and a relative price is an opportunity cost. The normal way of expressing a relative price is in terms of a “basket” of all goods and services. To calculate this relative price, we divide the money price of a good by the money price of the of a “basket” of ALL goods (this is called a price index) This in turn gives us the opportunity cost of the good in terms of hoe much of the “basket” we must give up to get it. Demand If we demand something, we: 1. Want it 2. Can afford it 3. Plan to buy it Wants are unlimited desires or wishes that people have for goods and services. Scarcity guarantees that perhaps many of our desires will never be satisfied. The quantity demanded of a good or service is the amount that consumers plan to buy during a given period of time at a particular price. QD is not necessarily the same as quantity bought. The Law of Demand The law of demand states: Other things being equal (we hold all other forces constant) the higher the price of a good, the smaller the quantity demanded; and the lower the price, the higher the quantity demanded. Why does price reduce the quantity demanded ? 1. The substitution effect – when the price of a good rises, other things remaining the same, its relative price – its opportunity cost – rises. As the relative price of a good rises, then the incentive to switch to cheaper substitutes (goods that can be used in place of the good) becomes stronger. Thus the QD of the good decreases. 2. The income effect – When a price rises, other things remaining the same, it rises relative to income (since income doesn’t rise as well by the same amount). Faced with a higher price and an unchanged income, people cant afford the product or good any longer. Thus people demand less of the product since they cant afford to buy as much as they previously bought. Thus QD decreases. Distinction between Quantity demand and Demand. The term demand refers to the entire relationship between the price of a good and the QD of that good. Demand is illustrated by the demand curve and the demand schedule. The demand curve shows the relationship between QD and price of the good. When any factor that influences buying plans other than the price of the good changes, there’s a change in demand. A change in demand obviously creates a shift in the demand curve. If demand increases then the demand curve shift rightward or outward. If demand decreases then the demand curve shifts leftward or inward. Six factors that cause changes in demand 1. Price of related goods – substitutes (a good that can be used in place of another good: coffee  tea), compliments (is a good that is used in conjunction with another good: burger  fries). When the price of a substitute goes up, OR when the price of a compliment goes down, THEN demand shift UP (out). 2. Expected future prices – If the price of a good is expected to rise in the future, then the opportunity cost of obtaining the good today is higher than the opportunity cost of obtaining it in the future. Since people know this, they retime their purchases and subsequently buy a lot of the good NOW and so demand increases, (FOR NOW). Example – If there is expected to be a natural disaster in Florida that will destroy the orange farms, you would expect a rise in price in the future, so, as a result you stock your fridge with as much orange juice as possible. 3. Income - when income increase most customers buy more of MOST goods, therefore the demand increases therefore shifting the demand curve right. A normal good is one for which demand increases as income increases. An inferior good is a good for which demand decreases as income increases. An increase in income causes an incr
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