Introduction to Economics 3

Demand and Supply

Markets and Prices

There are markets for:

· Goods

· Services

· Resources

· Manufactured inputs

· Money

· Some markets are physical; others are places where people never meet.

· Most markets are unorganized collections of buyers and sellers.

A Competitive Market

· A competitive market has many buyers and sellers, so no single buyer or seller can influence the price.

· Producers offer items for sale only if the price is high enough for them to cover their opportunity cost.

· Consumers respond to changing opportunity cost by seeking cheaper alternative.

· Economists refer to price as the money price.

· To calculate the opportunity cost, we divide the money price of our chosen item by the money price of the item forgone and find the ratio of one price to another.

· The ratio of one price to another 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.

· To calculate the relative price, we divide the money price of a good by the money price of a basket of all goods (called price index).

· 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

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 – perhaps most – of our wants will never be satisfied.

· The quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price.

· The quantity demanded is not necessarily the same as quantity actually bought.

The Law of Demand:

Other things remain 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 demand? 2 reasons:

· Substitution Effect

o When the price of a good rises, it relative price- opportunity cost rises. Although each good is unique, it has substitutes. As the opportunity cost rises, people buy less of that good and more of its substitutes.

· Income Effect

o When the price of a good rises, its price rises relative to income.

o Faces with higher prices, people cannot afford to buy all the things they previously bought.

o They must decrease the quantity demanded of at least some goods and services.

o Normally the good whose price increased will be one of the good that is bought less.

Demand curve and Demand Schedule

· The term demand refers to the entire relationship between the price of the good and the quantity demanded of the good. Demand is illustrated by the demand curve and demand schedule.

· The term quantity demanded refers to a point on the demand curve – the quantity demanded at a specific price.

· A demand schedule illustrates the quantity demanded at specific price intervals.

Willingness and Ability to pay

· Demand curve = Willingness-and-ability-to-pay curve.

· Willingness and ability to pay is a measure of marginal benefit.

A Change in Demand

When any factor influences buying plans other than the price of goods changes, there is a change in demand.

There are six main factors that bring a change in demand. There are:

· Income.

o A normal good is one for which demand increases as income increases. An inferior good is one for which demand decreases as income increases.

· Price of related goods.

o Substitutes

o Complement

· Expected future income.

o When expected future income increases, demand might increase

· Expected future prices.

o If the price of a good is expected to rise in the future, opportunity cost will be higher, so people buy now.

· Population.

o Demand depends on the size and age of structure of population.

· Preferences.

o Preferences depend on such things as weather, information and fashion.

A Change in the Quantity Demanded versus a Change in Demand.

I get this….

Supply

If a firms supplies a good or a service, the firm:

· Has the resource and technology to produce it.

· Can profit from producing it, and Plans to produce it and sell it.

· Supply reflects a decision about which technologically feasible item to produce.

· The quantity supplied of a good or service is the amount that producers plan to sell durable a specific time period at a specific price.

The Law of Supply

Other things remain the same, the higher the price of a good, the greater is the quantity supplied, and the lower the price of a good, the smaller is the quantity supplied.

Supply Curve and Supply Schedule

· The term supply refers to the entire relationship between the quantity supplied and the price of a good.

· The term quantity supplied refers to a point on the supply curve, the quantity supplied at a specific price.

· A supply curve show the relationship between the quantities supplied of a good and its price when all other factors stay the same.

· A supply schedule shows the lists the quantities supplied at each price when all the other factors on the producers planned sales remain the same.

Minimum Supply Price

· Supply curve = minimum-supply-price curve.

· The greater the price, the more supplied.

A Change in Supply

When any factor that influences selling plans other than the price of the good change, there is a change is supply.

Five main factors bring changes in supply. They are:

· Prices of factors of production

o If a price of a factor of production increases, the lowest price a producer is willing to accept rises, so supply decreases.

· Prices of related goods produced

o EG; if the price of soft-drinks rises, the supply of energy drinks decreases.

o Energy drinks and soft drinks are substitutes in production. Goods that can be produced using the same resources.

o EG; IF the price of beef rises, the supply of leather decreases.

o Beef and leather are compliments in production – goods that must be produced together.

· Expected future prices

o If the price of a good is expected to rise in the future, the return from selling the good in future is higher than it is today.

o So supply decrease today and increases in the future.

· Number of suppliers

o The more firms in an industry, the greater the demand, the less firms in an industry, the less the demand.

· Technology

o A positive technology change is when a new method of production is discovered that lowers the cost of producing a good.

o A negative technology change occurs when an event such as extreme weather or natural disaster increases the cost of producing a good.

Market Equilibrium

· The equilibrium price is the price at which the quantity demanded equals the quantity supplied.

· The equilibrium price is the quantity bought and sold at the equilibrium price.

A market moves towards its equilibrium because:

· Price regulates buying and selling plans

· Price adjusts when plans don’t match.

Price as a regulator:

The price of a good regulates the quantities supplied and demanded.

If the price is too high, the quantity supplied exceeds the quantity demanded. If the price is too low, the quantity demanded exceeds the quantity supplied.

Price Adjustments

· A shortage forces the price up

· A surplus forces the prices down

· Price equilibrium is the best deal for both buyers and sellers.

Predicting Changes in Price and Quantity

We can make the first 2 predictions: (demand)

· When the demand increases, both the price and the quantity increase.

· When the demand decreases, both the price and the quantity decrease.

We can now make two more predictions: (supply)

· When the supply increases, the quantity increases and the price falls.

· When the supply decreases, the quantity decreases and the price rises.

All possible changes in demand and supply:

1. Change in demand with no change in supply.

2. Change in supply with no change in demand.

3. Increase in both demand and supply.

4. Decrease in both demand and supply.

5. Decrease in demand and increase in supply.

Study figure 3.10 pg 73

Summary

Key Points

Markets and Prices (P. 58)

· A competitive market is one that has so many buyers and sellers that no one can influence the price.

· Opportunity is a relative price

· Demand and supply determine relative prices.

Demand (P. 59-53)

· Demand is the relationship between the quantity demanded of a good and its price when all other influences on buying plans remain the same.

· The higher the price of a good, other things remaining the same, the smaller is the quantity demanded – the law of demand.

· Demand depends of income, the prices of substitutes and complements, expected future income, expected future prices and population.

Supply (P. 64 - 67)

· Supply is the relationship between the quantity supplied of a good and its price when all other influences on selling plans remain the same.

· The higher the price of a good, other things remaining the same, the greater is the quantity supplied – the law of supply.

· Supply depends on the prices of factors of production used to produce a good, the prices of related goods produced, expected future prices, the number of suppliers and technology.

Market Equilibrium (pp. 68 - 69)

· At the equilibrium price, the quantity demanded equals the quantity supplied.

· At the prices above equilibrium, there is a surplus and the price falls.

· At prices below equilibrium, there is a shortage and prices rise.

Predicting Changes in Price and Quantity (pp. 70 - 73)

· An increase in demand brings a rise in the price and an increase in the quantity supplied.

· A decrease in demand brings a fall in the price and a decrease in the quantity supplied.

· An increase in supply brings a fall in the price and an increase in the quantity demanded. A decrease in supply brings a rise in price and a decrease in the quantity demanded.

· An increase in demand and an increase in supply bring an increase in quantity but an uncertain price change. An increase in demand and a decrease in supply bring a higher price but an uncertain change in quantity.

Key figures:

3.1, The demand curve, 60; 3.3, A change in the quantity demanded versus a change in demand, 63; 3.4 The supply curve, 65; 3.6 A Change in Quantity Supplied versus a Change in supply, 67; 3.7 Equilibrium, 68; 3.10 The effects of all possible changes in demand and supply.

Key Terms:

Change in demand, 60; Change in supply, 65; change in quantity demanded,63; Change in quantity supplied, 67; Competitive market, 58; Complement, 61; Demand 59; Demand Curve, 60; Equilibrium price, 68; Equilibrium quantity, 68; Inferior good, 61; Law of demand, 59; Law of supply, 64; Money price, 58; Normal good, 61; Quantity demanded, 59; Quantity supplied, 64; Relative price, 58; Substitute, 61; Supply, 64; Supply curve, 64;