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Chapter 3

Chapter 3 - Demand & Supply - Textbook Notes

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York University
ECON 1000
Steven Edwards

Sept.23 , 2013 ECON 1000 Chapter 3: Demand and Supply Markets and Prices: - A market is the place where you’ll find goods and services - A market is any arrangement that enables buyers and sellers to get information and to do business with each other - A market has two sides: buyers and sellers - There are markets for goods such as apples and hiking boots, for services such as haircuts and tennis lessons, for factors of production such as computer programmers and earthmovers, and for other manufactured inputs such as memory chips and auto parts - There are also markets for money such as Japanese yen and for financial securities such as Yahoo! Stock - Some markets are physical places where buyers and sellers meet and where an auctioneer or a broker helps to determine the price (E.g. Live car auctions, wholesale fish, meant, and produce markets, etc.) - Some markets are groups of people spread around the world who never meet but are connected through the Internet or by telephone and fax (E.g. E- commerce markets, currency markets, etc.) - Most markets are unorganized collections of buyers and sellers which is where most of you do your trading (E.g. Market of basketball shoes – buyers in this $3-billion-a-year market are those 45 million Canadians and Americans who play basketball, and the sellers are the tens of thousands of retail sports equipment and footwear stores) - Each buyer can visit several stores and each seller knows that the buyer has a choice of different stores - Markets vary in the intensity of competition that buyers and sellers face Competitive Market: - Competitive market is 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 - Consumers respond to changing opportunity cost by seeking cheaper alternatives to expensive items Relationship Between Price and an Opportunity Cost: - Price of an object is the number of dollars that must be given up in exchange for it, which is referred to as the money price - The opportunity cost of an action is the highest-valued alternative forgone - E.g. Opportunity cost of a cup of coffee is the quantity of gum forgone – If the money price of coffee is $1 a cup, and the money price of gum is 50 cents a pack, then the opportunity cost of one cup of coffee is two packs of gum - The ratio of one price to another is called a relative price, and a relative price is an opportunity cost - To calculate this relative price, we divide the money price of a good by the money price of a “basket of all goods (called a price index) and the resulting relative price tells us the opportunity cost of the good in terms of how much of the “basket” we must give up to buy it - Demand and supply models determine relative prices, and the word “price” means relative price - When we predict that a price will fall, we mean that its relative price will fall – its price will fall relative to the average price of other goods and services Demand: If you demand something, then you 1) Want it, 2) Can afford it, and 3) Plan to buy it. - Wants are the unlimited desires or wishes that people have for goods and services - Scarcity guarantees that many of our wants will never be satisfied - Demand reflects a decision about which wants to satisfy - Quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price - Quantity demanded is not necessarily the same as what is bought - Sometimes, QD exceeds the amount of goods available - QD is measured as an amount per unit of time (E.g. Coffee – 1 cup per day, 7 per week, or 365 per year) - Price influences buying plans To study the relationship between price and the QD, we keep all other influences on buying plans the same and we ask: How, other things remaining the same, does the quantity demanded of a good change as its price changes? The law of demand provides the answer. The 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.” Why does a higher price reduce the quantity demanded? There are two reasons: 1) Substitution Effect a. When the price of a good rises, its relative price (opp. cost) rises b. As opportunity cost of a good rises, the incentive to substitute becomes stronger 2) Income Effect a. When a price rises, the price rises relative to income b. Faced with a higher price and unchanged income, people cannot afford to buy all the things they previously bought c. They must decrease the quantities demanded of at least some goods and services – Normally, the good whose price has increased will be one of the goods that people buy less of Demand Curve and Demand Schedule: - The term demand refers to the entire relationship between the price of a good and the quantity demanded of that good - Demand is illustrated by the demand curve and the demand schedule - QD refers to a point on a demand curve – the QD 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 - Demand schedule is graphed as a demand curve with the QD on the x-axis and the price on the y-axis - The points on the demand curve correspond to the rows of the demand schedule (Figure 3.1 on pg.58) Willingness and Ability to Pay: - Another way of looking at the demand curve is as a willingness-and-ability- to-pay curve - Willingness and ability to pay is a measure of marginal benefit - If a small quantity is available, the highest price that a person is willing and able to pay for one more unit is high - But as the quantity available increases, 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 changes, other than the price of the good, there is a change in demand - When demand increases the demand curve shifts rightward and the quantity demanded at each price is greater 6 Factors that Influence Change in Demand: 1) Prices of Related Outputs a. Quantity of energy bars that consumers plan to buy depends on substitutes for energy bars b. A substitute is a good that can be used in place of another good (E.g. Hamburgers and hotdogs, train ride and bus ride, etc.) c. If the price of a substitute rises, people buy less of the substitute and if the price of a substitute lowers, people buy more of the substitute d. Quantity of energy bars that people plan to buy also depends on the prices of complements with energy bars e. A complement is a good that is used in conjuction with another good (E.g. Hamburgers and fries, energy bars and exercise, etc.) f. If the price of a complement falls, people buy more complements and more of the good and vice versa 2) Expected Future Prices a. If the expected future price of a good rises and if the good can be stored, the opportunity cost of obtaining the good for future use is lower today that it will be gin the future when people expect the price to be higher b. People retime their purchases – substitute over time c. They buy more of the good now before its price is expected to rise so the demand for the good today increases d. E.g. If a Florida frost damages the season’s orange crop, you expect the price of orange juice to rise, so you fill your freezer with enough frozen juice to get you through the next six weeks – Current demand rises, and future demand decreases e. Similarly if the expected future price of a good falls, the opportunity cost of buying the good today is high relative to what it is expected to be in the future f. E.g. Computer prices are constantly falling and because people expect computer prices to keep falling, the current demand for computers is less (and the future demand is greater) 3) Income a. Consumers’ income influences demand b. When income increases, consumers buy more of most goods and when income decreases, consumers buy less of most goods c. Although an increase income leads to an increase in the demand for MOST goods, it does not lead to an increase in the demand for ALL goods d. A normal good is one for which demand increases as income increases e. An inferior good is one for which demand decreases as income increases f. E.g. As income increases, the demand for air travel (a normal good) increases and the demand for long-distance bus trips (an inferior good) decreases 4) Expected future Income and Credit a. When expected future income increases or credit becomes easier to get, demand for the good might increase now b. E.g. A salesperson who gets the news that she will receive a big bonus at the end of the year might go into debt and buys a new car now, rather than wait until she receives the bonus 5) Population a. Demand also depends on the size and age structure of the population b. The larger the population, the greater the demand for goods/services c. The smaller the population, the smaller the demand d. E.g. Demand for parking space in the GTA is much greater than in Thunder Bay e. 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 f. E.g. Demand for university places in 2010 was greater than in 2000 because there were more people in that age group 6) Preferences a. Demand depends on preferences b. Preferences determine the value that people place on each good and service c. Preferences depend on fashion, weather, information, etc. d. For examples, greater health and fitness awareness has shifted preferences in favour of energy bars, so the demand for energy bars has increased Table 3.1 on pg.60 – Changes in Demand A Change in the Quantity Demanded Versus a Change in Demand: - Distinguish between the QD and a change in demand is the 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 QD - The entire demand curve shows demand, so a shift of the demand curve shows a change in demand A Movement Along the Demand Curve: - If the price of the good changes and no
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