Chapter 3 Economics Notes Section 3.

1: Market: An institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of particular goods, services, or resources. All situations that link potential buyers with potential sellers are markets.

Demand: A schedule or a curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time. Shows the quantities of a product that will be purchased at various possible prices, other things equal. - Demand is simply a statement of a buyers plans, or intentions, with respect to the purchase of a product. Demand schedules reveal the relationship between the price and quantity of an item that a particular consumer would be willing and able to purchase.

Law of Demand: All else equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls. A negative/inverse relationship between price and quantity demanded exists. When discussing price, values are always relative to other options. Causes for the inverse relationship: 1. The law of demand is consistent with common sense. People ordinarily do buy more of a product at a low price than a high price. 2. The Law of Diminishing Marginal Utility: Each buyer of a product will derive less satisfaction from each successive unit of the product consumed. 3. Income Effect: A lower priced good increases the purchasing power of a buyers money income, enabling the buyer to purchase more of the product than she or he could buy before. 4. Substitution Effect: Suggests that at lower prices buyers have the incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive.

The Demand Curve:

By convention the quantity demanded is measured on the x-axis and the prices on the y-axis. The downward slope reflects the law of demand.

Market Demand: Market Demand is derived from the sum of all Individual Demands. At each price the Ind. Demand = the total quantity demanded at that price. The price and the total quantity demand are then plotted as one point on the Market Demand curve. Price is the most important influence on the amount of a product purchased. Other factors also affect purchases however the Determinants of Demand (demand/curve shifters). Consumer preferences: Through new products, or other change in tastes, a product becomes more desirable. Number of consumers: Example Increases in life expectancy has increased the demand for medical care, retirement communities, and nursing homes. Consumer incomes: For most products, a rise in income causes an increase in demand. Consumers buy more steaks, furniture and computers as their income increases. Normal Goods (Superior Goods): Products whose demand varies directly with money income. For some products, as income rises, demand decreases (i.e. used clothes, retread tires, etc.) Inferior Goods: Goods whose demand varies inversely with money income. Price of related goods: - Substitute Good: Goods that can be used in place of other goods. Two substitute goods move in the same direction in terms of ones demand and the others prices. - Complementary Good: Good that is used together with another good. When two products are complements, the price of one good and the demand for the other good move in opposite directions. - Independent Goods: A change in the price of one good doesnt affect the demand for the other. Consumer expectations: A new customer expectation that either prices or income will be higher in the future.

Changes in Demand: A shift of the entire demand curve to the right or left. It occurs because the consumers state of mind about purchasing the product has been altered in response to a change in one or more of the determinants of demand. Change in Quantity Demanded: A movement from one point to another point (one pricequantity combination to another) on a fixed demand schedule or curve. The cause of such a change is an increase or decrease in the price of the product under consideration. Section 3.2: Supply: A schedule or curve showing the amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specific period. Law of Supply: As price rises, the quantity supplied rises; as price falls, the quantity supplied falls. To a supplier, price represents revenue, which serves as an incentive to produce and sell the product. To the consumer, price is an obstacle; the higher the price, the less the consumer will buy.

Supply Curve: The market Supply Curve is obtained by horizontally adding the supply curves of the individual producers.

Determinants of Supply: A change in supply, meaning the entire supply curve will shift. 1. Resource Prices: Higher resource prices raise production costs, squeeze profits and then lowers supply output. Lower resource prices reduce production costs and increase profits, allowing for firms to supply greater output.

2. Technology: Improvements in technology enable firms to produce units of output with fewer resources. Because resources are costly, using fewer of them lowers production costs and increases supply. 3. Taxes and Subsidies: An increase in sales or property taxes will increase production costs and reduce supply. Subsidies are the opposite of taxes (government grants). 4. Prices of other goods: Firms that produce more than 1 product might substitute the production of one good for another to increase profits. Thus there is an increase in the supply of the product replacing the original. 5. Price Expectations: Changes in expectations about the future price of a product may affect the producers current willingness to supply that product. 6. The # of Sellers in the market: Other things equal, the larger the number of suppliers, the greater the market supply. As more firms enter an industry, the supply curve shifts to the right. Changes in Supply: A shift of the entire supply curve to the right or left. It occurs because the consumers state of mind about purchasing the product has been altered in response to a change in one or more of the determinants of supply. Change in Quantity Demanded: A movement from one point to another point (one pricequantity combination to another) on a fixed supply schedule or curve. The cause of such a change is an increase or decrease in the price of the product under consideration. Section 3.3: Surpluses: Instance where a price encourages the production of lots of goods, but discourages most consumers from buying it; Excess supply. A very large surplus of a good would prompt competing sellers to lower the price to encourage buyers to take the surplus of their hands. surplus cannot persist over a period of time, only temporarily. Shortages: Occurs when a price discourages the devotion of resources to production and encourages consumer to buy more than is available. Excess demand. Because many consumers will not be able to get some of the product, they will be willing to spend more for the available output. Competition among these buyers will drive the price to something greater. Equilibrium Price and Quantity: Only at the equilibrium point is the producers quantity that he is willing to produce and supply = to the quantity that consumers are willing and able to buy. The price at this point is called the market-clearing or equilibrium price. The point where the quantity supplied and the quantity demanded (equilibrium point) are in balance is the equilibrium quantity. ** Graphically, the intersection of the supply curve and the demand curve for a product indicates the market equilibrium. Any price below the equilibrium creates shortage, above creates surplus.

Rationing Function of Prices: The ability of the competitive forces of supply and demand to establish a price at which selling and buying decisions are consistent. It is the combination of freely made individual decisions that sets the marketclearing price.

Changes in Supply, Demand, and Equilibrium: What effects will changes in supply and demand have on the equilibrium price and quantity? Changes in Demand: Supply is constant and demand increases - An increase in demand raises both the equilibrium price and quantity (and vice versa). Changes in Supply: Demand is constant but supply increases An increase in supply reduces the equilibrium price but increases equilibrium quantity (and vice versa). Complex Cases: When both supply and demand change, the effect is a combination of the individual effects: Change in Supply Change in Effect on Effect on Demand Equilibrium Price Equilibrium Quantity 1. Increase Decrease Decrease Indeterminate 2. Decrease Increase Increase Indeterminate 3. Increase Increase Indeterminate Increase 4. Decrease Decrease Indeterminate Decrease Other Special Cases: When a decrease in demand and a decrease in supply, or an increase in demand and an increase in supply, exactly cancel out. In both cases, the net effect on equilibrium price will be 0; price will not change.

A Reminder: Other things equal: It is important to remember that specific demand and supply curves show relationships between prices and quantities demanded and supplied, other things equal. If you forget the ceteris paribus assumption, you can encounter situations that seem to be in conflict with basic economic principles.