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# Thursday, September 5, 2013

## Unit II Introduction to Supply & Demand

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all products are similar lots of buyers & sellers (idea of perfect competition) buyers & sellers are price takers free to enter/leave the market (inefficiency will lower, efficiency will enter

## The Law of Demand

- Demand = quantity that a person or market is ready, willing, & able to buys - law of demand: all else being equal, quantity demand of a good rises as
price decreases

## \$ increase = QD decrease - inverse relationship

Price Quantity Demanded 2000 1000 500 100 1 1 1 3 15 29

## The Determinants of Demand

- Income (level of wealth) Normal good: rich - Income increase, QD increase - Income decrease, QD decrease inferior good: poor - Income increase, QD decrease - Income decrease, QD increase exceptions - commodities: water, food - Prices of Related Goods substitutes: instead of products - Chevy vs Toyota "1

Thursday, September 5, 2013 - PA increase = QD increase - PA decrease = QD decrease complements: together products - hotdogs and hotdog buns - PA increase = QD decrease - PA decrease = QD increase - Tastes - Taste increase = QD increase - Taste decrease = QD decrease - Expectation of change expect price to rise in future = QD increase expect price to fall in future = QD decrease - # of buyers # of buyers increase = QD increase # of buyers decrease = QD decrease
Connection to Circular Flow Model

## - individual supply & demand - business supply & demand

Why doe Law of Demand Occur

- substitution effect P increase, consumer buys decrease of that product & more of some other
product

- income effect P decrease, purchasing power increase for consumers, allowing them to
purchase more

- law of Diminishing Marginal Utility utility = satisfaction we buy goods because we get utility from them law of diminishing marginal utility states that as you consume more units
of any good, the additional satisfaction from each additional unit will eventually start to decrease

more you buy of ANY GOOD the less satisfaction you get from each new unit
Supply

- Supply: amount that firms are willing to produce & sell (now) - Law of Supply: all else being equal, quantity supplied increases as prices
increases

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## Thursday, September 5, 2013 P increase, QS increase P decrease, QS decrease

Determinants of Supply

## - Input Prices IP increase, S decrease IP decrease, S increase

willing to mow lawns. How many lawns will you mow at these prices? \$Price Quantity Mowed 1 0 5 1 20 20 50 29 100 30

cars: iron, cotton what if all iron rusts? - Technology process of training inputs -> outputs Technology increase, Supply increase Technology decrease, Supply decrease *Weather counts as technology* ex) if all cotton destroyed by bad weather, technology decreases - Expectations: Expect Prices increase, (for now) quantity decrease Expect Prices decrease, (for now) quantity increase - Taxes: Taxes increase, Supply decrease Taxes decrease, Supply increase - # of sellers: sellers increase, supply increase sellers decrease, supply decrease
Supply & Demand Together

- The market pushes down - limiting factor is supply - upward pressure: caused by supplies - downward pressure: market suppliers

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## Thursday, September 5, 2013

Price Ceilings & Price Floor

- Price ceiling Binding when Price ceiling < equilibrium point - limiting factor: supply shortage - when gov wants to help consumers Non binding - when price ceiling > equilibrium point *binding today doesnt mean its going to be
nonbonding tomorrow

- Price floor non binding when > than eq point - government anticipates changes Binding when < eq point - limiting factor: decrease demand causes surplus gov does this to help businesses businesses/consumers all pay taxes
Taxes on Producers

- producer is the one sending the check to gov gov wants to tax, so supply gov < S the vertical distance from S to S is the
tax producer pays

## - tax evidence: the manner in which the

burden of a tax is skewed Elasticity

- how sensitive quantity is to change in price - Elasticity of Demand measurement of consumers: responsiveness
to a change in price

## what will happen if price increase? how

will it affect quantity demanded

who? - used by firms to determine prices & sales - used by gov to decide how to tax "4

## Thursday, September 5, 2013

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- ratio of change is constant
example: - salt: inelastic

many substitutes! luxuries (real estate, pizza)! take up krypton of income! plenty of time to decide! elasticity coefcient >1

fewer substitutes! necessities! small portion of income! required now, rather than later! elasticity coefcient <1

## - new car: elastic - European vacation trip: elastic - insulinin: elastic

Elasticity Supply

Unit Elasticity

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## Difficult to produce (ie gas)

-when e<1, inelastic -when e=1, unit supply when e>1, elastic Income Elasticity of Demand

## Thursday, September 5, 2013

Cross Price Elasticity of Demand

- if -, complement - if +, substitute

- ex) Corn Makes you smarter Demand increase, Supply increase (Graph 8) - ex) Corn Makes you bald Demand decrease, Supply decrease (Graph 6)

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