Post on 10-Feb-2016
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Topic 3: Demand, Supply, & Pricing
Warm-Up:1)What is your most important
consideration when you consider buying something?
2)What are five things that you couldn’t live without? Would you still buy these items if they doubles or tripled in price?
Buyers demand goods, sellers supply those goods, and the interactions between the two groups lead to an agreement on the price and
the quantity traded.
Rules To RememberDWAP: desire, willingness, ability to
purchaseDemand dipsLaw of Demand inverse Price(P) &
Quantity(Q)Demand = Quantity Demanded (D =
Qd)Price only changes quantity demanded5 shift factors of the demand curve that
are not related to price
Law of DemandThe law of demand holds that
other things equal, as the price of a good or service rises, its quantity demanded falls.◦ Inverse relationship: as the price of a good
or service falls, its quantity demanded increases.
Demand is important because it shows how people are willing to allocate resources
ExamplePizza:
If a slice of pizza costs $1, would you buy it?
How many slices would you buy?
If a slice of pizza cost $3, would you buy it?
How many slices would you now buy?
This shows us the law of demand…as price increases you will buy less
Demand Schedule: A demand schedule is a table that lists the quantity of a
good that an individual in a market will buy at each different price.
A market demand schedule is a table that lists the quantity of a good all consumers in a market will buy at each different price.
Demand CurveShows how much consumers will
demand at given prices in graph form
Change in quantity demanded (Qd) refers to movement along the curve; a
change in quantity based on price
Consider This:What might happen to sales of a particular type of car if its producer announced that its new engine emitted no pollution, was more powerful than previous engines, had better gas mileage than ALL other vehicles, and would cost the same?
Shifts in Demand
A willingness to buy different amounts at the same prices
Shift in the Quantity Demanded A willingness to buy different amounts at the same prices
The following five things cause a shift in the demand curve (SPITE):◦Substitution: complimentary goods used to
replace or with a good or service◦Population: population increases, demand
tends to increase◦Income: more $, more willing to pay more or
buy more quantity◦Tastes & Preferences: trends, values/ beliefs◦Expectations: what they expect
How the Demand Curve Changes
When we have an INCREASE in demand the curve will shift to the RIGHT because at the SAME price we are demanding more
When we have a DECREASE in demand the curve will shift to the left because at the SAME price we are demanded less
Demand Elasticity
•Give 3 examples of goods that can affect demand for another good because of price change.
Warm-Up:
Demand ElasticitySmall change in price = great (large) change in quantity demanded
The extent in which changes in price cause changes in the quantity demanded
It is the way consumers respond to price changes
Elasticity of a good varies at every price level
Consider This:
What is essential to me? What goods must I have even if the price rises greatly?
Elastic DemandConsumers care about changes in
the price of products with elastic demand
Example:◦ The current price of a donut is $.75. Dunkin
Donuts hold a promotion for their coffee, and in the meantime lower the price of a donut to $.50.
◦ What is the effect on quantity demanded?◦ How is this related to elasticity?
Determinants of Demand Elasticity
Urgency of need (Necessity v. Luxury)◦if it is not a necessity it is elastic◦if it is a need, it is inelastic
Relative Importance◦Ex. Clothing: if you currently spend
½ of your budget on clothing, an increase in the cost of clothing will cause a large reduction in the quantity you purchase.- Elastic
◦Ex. Shoelaces: if the price doubled, would you cut back? Probably not because you may not even notice the difference b/c it is only a small part of your budget-Inelastic
Determinants of Demand Elasticity (Continued)
Substitution availability◦If substitutions are available- elastic
Ex. Butter/ margarineChange over time
◦Can’t react quickly to price increase so it takes time to find substitutes; so demand is inelastic for a short time until they find substitutes
Income portion to buy◦If goods/services are expensive-
elastic
Inelastic DemandA small change in price causes a very little change in quantity demanded
A demand for a good you keep buying despite a price increase◦Examples:
Gas Milk at the grocery store costs $3.79 per
gallon. Price Chopper has a weekly sale and lowers the price to $3.39 per gallon. What is the effect on quantity demanded? How is this related to inelasticity?
Supply
Warm-Up:
Rules of Supply (Producer)
S = Supply (Think about what’s already on the store shelves available for purchase and not what the manufacturing potential is).
Supply to the sky (Curve)Law of Supply- direct relationship (P
Q )Price = change in Quantity Supplied8 factors that shift supply
Law of Supplyholds that other things equal, as
the price of a good rises, its quantity supplied will rise, and vice versa.P Q OR P Q
Direct Relationship
•Producers produce more output when prices rise so they can cover higher marginal costs of production
What is a Supply Schedule?
Shows the relationship between price & quantity supplied
What is a Supply Curve?
A graphical representation of the supply scheduleHorizontal axis measures the quantity of good
suppliedProducer's supply curve shows the quantity of an
item that producers will supply for given prices.
Equilibrium occurs at a price of $3 and a quantity of 30 units.
EquilibriumIn economics, an equilibrium is a situation in which:
• there is no inherent tendency to change, • quantity demanded equals quantity supplied
Shifts in Supply A change in any variable other than price that influences quantity supplied produces a shift in the supply curve or a change in supply (GETSTIPS).Government RegulationExpectationsTechnologySubsidiesTaxesInput (Cost Of)ProductivitySellers (number of)
Elasticity of Supply◦Measure of the way suppliers respond to a change in price
◦If supply is ELASTIC it means that changes in price will have a large impact on Quantity supplied
◦If supply is INELASTIC, it means price does little to change Quantity Supplied
What Affects Elasticity of Supply?
TimeIn the long run, firms are more flexible, so supply can become more elastic.
• In the short run, a firm cannot easily change its output level, so supply is inelastic.
Supply Elasticity vs. Demand Elasticity
If quantities are being purchased, the concept is demand elasticity
If quantities are being sold, concept is supply inelasticity
Government Influences on Supply
SubsidiesA subsidy is a government payment that supports a business or market. Subsidies cause the supply of a good to increase.
TaxesThe government can reduce the supply of some goods by placing an excise tax on them. An excise tax is a tax on the production or sale of a good.
RegulationRegulation occurs when the government steps into a market to affect the price, quantity, or quality of a good. Regulation usually raises costs.
Costs
Fixed Costs Variable Costs
Total Cost
Costs that don’t change with output
Costs that change withOutput
Ex. Wage workers, Raw materials,
electricity
Sum of fixed & Variable costs
DefinitionsMarginal Costs:Costs incurred by making one more unit
Marginal Product:Extra output made by adding one more unit of input
Theory of Production:Deals w/ relationship between Factors of Production
and output; it looks at how output changes when input changes
Law of Variable Proportions: output will change as one input is changed
Stages of ProductionStage #1 Increasing
ReturnsEach input contributes more to total output(ex. Labor)
Stage # 2 Diminishing Returns
Output increases with each input, but at a slower rate
Stage # 3 Negative Returns
Each added input makes total output decrease
Pricing & Decision Making
Pricing As Signals: The role of prices is to act as signals for buyers and sellers in the market.
Measure of ValueSignal
Flexible
Cost
Choice of g/s
Efficient
• Standard form of measure for g/s
• for excess or shortage: suppliers inc/dec production for profit; consumers inc/dec spending• can decrease price to get rid of a surplus•Can increase price to alleviate shortage problem
• no administrative cost b/c supply and demand determine price
• variety of prices for each g/s
• FOPS adjust based on demand• Easily understood (universal language)
Allocation without Prices:Rationing:
◦Government decides everyone’s fair share Ex. WWII/ OPEC 1973 Oil Embargo
Problems with Rationing◦Fairness: small shares for everyone◦Diminished incentives: no motivation to work
◦Can lead to BLACK MARKET
How Prices are Determined?
The Economic Model◦Analyzes behaviors ◦Predicts outcomes
When Quantity Demanded = Quantity Supplied, we have a market equilibrium
Surplus
When Qs>QdEffects:
◦cause Price to decrease
◦ Qd to increase
◦Qs to decrease
Shortage
Shortage◦ Qs < Qd
EFFECTS of a Shortage (how to return to Eq):
1. Increase price2. Quantity
Supplied increase
What happens when prices are fixed?
Price Ceilings◦Maximum legal price charged b/c the gov’t thinks price is too high
◦Effect: SHORTAGE◦Example: rent control
Price Floors◦Minimum legal price charged b/c the gov’t thinks it is too low
◦Effect: SURPLUS◦Example: minimum wage
$2.00
$1.00
$.50
Price Ceiling
$2.00
$1.00
$.50Price Floor