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.
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
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
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