Buyers DON’T Compete With Buyers DON’T Compete With SellersSellers

Buyers Compete with Other Buyers Compete with Other BuyersBuyers

Sellers Compete with Other Sellers Compete with Other SellersSellers

Market Competition: Win-WinMarket Competition: Win-Win

Both buyers and sellers value what they received more than what they voluntarily gave up.

How are prices set?How are prices set?

By the Market!By the Market!

Supply and

Demand!

1. DEMAND1. DEMAND

Japanese gamers await Playstation 3 going on sale.

What Is the Law of Demand?What Is the Law of Demand?

The law of demand states that consumers buy more of a good when its price decreases and less when its price increases.

                                                                         

What influences What influences demand?demand?

((Demand ShiftersDemand Shifters)) Taste and preference (advertising Taste and preference (advertising

helps)helps) SubstitutesSubstitutes Income Income PopulationPopulation

The The substitution substitution effect effect occurs when occurs when consumers react to an consumers react to an increase in a good’s increase in a good’s price by consuming less price by consuming less of that good and more of that good and more of other goods. of other goods.

The The income effectincome effect happens when a person happens when a person changes his or her changes his or her consumption of goods consumption of goods and services as a result and services as a result of a change in real of a change in real income. income.

The Substitution Effect The Income Effect

A A demand curvedemand curve is a graphical is a graphical representation of representation of a demand a demand schedule, schedule, representing price representing price and quantityand quantity

Market Demand Curve

3.00

2.50

2.00

1.50

1.00

.50

00 50 100 150 200 250 300 350

Slices of pizza per day

Pric

e pe

r slic

e (in

dol

lars

)

Demand

ComplementsComplements are two are two goods that are bought goods that are bought and used together. and used together. Example: skis and ski Example: skis and ski boots boots

SubstitutesSubstitutes are goods are goods used in place of one used in place of one another. Example: skis another. Example: skis and snowboards and snowboards

The demand curve for one good can be affected by a change in the demand for

another good.

Demand for a good that Demand for a good that consumers will continue consumers will continue to buy despite a price to buy despite a price increase is increase is inelastic.inelastic.

Elasticity of demand is a measure of how consumers react to a change in price.

Demand for a good that Demand for a good that is very sensitive to is very sensitive to changes in price is changes in price is elastic.elastic.

Elastic DemandElastic Demand

If demand is elastic, a small change in price leads to a relatively large change in the quantity demanded. Follow this demand curve from left to right.

Pric

e

Quantity

$7

$6

$5

$4

$3

$2

$1

Elastic and Inelastic Demand

0 5 10 15 20 25 30

Demand

The price decreases from $4 to $3, a decrease of 25 percent.

$4 – $3

$4x 100 = 25

The quantity demanded increases from 10 to 20. This is an increase of 100 percent.

10 – 20

10x 100 = 100

Elasticity of demand is equal to 4.0. Elasticity is greater than 1, so demand is elastic. In this example, a small decrease in price caused a large increase in the quantity demanded.

100%

25%= 4.0

Pric

e

Quantity

$7

$6

$5

$4

$3

$2

$1

0 5 10 15 20 25 30

Demand

Hamburgers

ID card processing fee

Factors Affecting ElasticityFactors Affecting Elasticity

1. Availability of Substitutes

If there are few substitutes for a good, then demand will not likely decrease as price increases. The

opposite is also usually true.

2. Relative Importance

Another factor determining elasticity of demand is how much of your budget you spend on the good.

3. Necessities versus Luxuries

Whether a person considers a good to be a necessity or a luxury has a

great impact on the good’s elasticity of demand for that person.

4. Change over Time

Demand sometimes becomes more elastic over time because people can eventually find substitutes.

DEMAND: REVIEW DEMAND: REVIEW 1.1. Describe the law of demand.Describe the law of demand.2.2. What is the substitution effect?What is the substitution effect?3.3. What is the income effect?What is the income effect?4.4. Give an example of a complement (one we Give an example of a complement (one we

haven’t used).haven’t used).5.5. Give an example of a substitute (one we haven’t Give an example of a substitute (one we haven’t

used).used).6.6. What is elasticity?What is elasticity?7.7. Give an example of an elastic good.Give an example of an elastic good.8.8. Give an example of an inelastic good.Give an example of an inelastic good.9.9. What is the demand dance?What is the demand dance?

2. SUPPLY2. SUPPLY

.McDonald’s looks to increase revenues, by increasingMcDonald’s looks to increase revenues, by increasing the supply of the ever popular coffee products.the supply of the ever popular coffee products.

According to the law of supply, suppliers will offer more of a good at a higher price.

Law of Supply

PriceAs price

increases…

SupplyQuantity supplied

increases

PriceAs price falls…

SupplyQuantity supplied

fallsMath Term:

DIRECT RELATIONSHI

P

How Does the Law of Supply Work?How Does the Law of Supply Work?

Economists use the term Economists use the term quantity suppliedquantity supplied to to describe how much of a describe how much of a good is offered for sale at good is offered for sale at a specific price.a specific price.

The promise of increased The promise of increased revenues when prices are revenues when prices are high encourages firms to high encourages firms to produce more.produce more.

Rising prices draw new Rising prices draw new firms into a market and firms into a market and add to the quantity add to the quantity supplied of a good. supplied of a good.

Supply CurveSupply Curve

$.50 1,000

Price per slice of pizza Slices supplied per day

Market Supply Schedule

A A market supply schedulemarket supply schedule is a chart that lists how is a chart that lists how much of a good all suppliers will offer at different much of a good all suppliers will offer at different

prices. prices.

$1.00 1,500

$1.50 2,000$2.00 2,500

$2.50 3,000

$3.00 3,500

Supply shiftersSupply shifters costs of productioncosts of production

resource availability changesresource availability changes technology changestechnology changes policies change (taxes, for policies change (taxes, for

example)example) numbers of suppliers: (zune + numbers of suppliers: (zune +

ipod= more mp3s)ipod= more mp3s)

Price

Quantity

S

S

S

D

E

E

E

APPLE’S GROWTHAPPLE’S GROWTHTHINKING ABOUT SUPPLY:THINKING ABOUT SUPPLY:

HOW DID APPLE INCREASE HOW DID APPLE INCREASE ITS REVENUE FROM 5 ITS REVENUE FROM 5 BILLION to 43 BILLION in 8 BILLION to 43 BILLION in 8 YEARS?YEARS?

Supply CurvesSupply Curves

A A market supply market supply curvecurve is a graph is a graph of the quantity of the quantity supplied of a supplied of a good by all good by all suppliers at suppliers at different prices.different prices.

Chapter 5, Section 1Chapter 5, Section 1

Market Supply Curve

Pric

e (in

dol

lars

)

Output (slices per day)

3.00

2.50

2.00

1.50

1.00

.50

0

0 500 1000 1500 2000 2500 3000 3500

Supply

If supply is not very If supply is not very responsive to changes responsive to changes in price, it is in price, it is considered inelastic.considered inelastic.

An elastic supply is An elastic supply is very sensitive to very sensitive to changes in price. changes in price.

Elasticity of supply is a measure of the way quantity supplied reacts to a change in price.

What Affects Elasticity of Supply?What Affects Elasticity of Supply?Time.Time.

In the long run, firms are In the long run, firms are more flexible, so supply more flexible, so supply can become more can become more elastic. elastic.

In the short run, a firm In the short run, a firm cannot easily change its cannot easily change its output level, so supply is output level, so supply is inelastic.inelastic.

Government Influences on SupplyGovernment Influences on SupplyBy raising or lowering the cost of producing goods, the

government can encourage or discourage an entrepreneur or industry.

Subsidies: $ from gov.

Regulation: rules from gov.

Taxes: $ to gov.

Other Factors Influencing SupplyOther Factors Influencing Supply1.1. The Global EconomyThe Global Economy

• The supply of imported goods and services has an impact on the The supply of imported goods and services has an impact on the supply of the same goods and services here.supply of the same goods and services here.

• Government import restrictions will cause a decrease in the Government import restrictions will cause a decrease in the supply of restricted goods. supply of restricted goods.

2.2. Future Expectations of PricesFuture Expectations of Prices• Expectations of higher prices will reduce supply now and Expectations of higher prices will reduce supply now and

increase supply later. Expectations of lower prices will have the increase supply later. Expectations of lower prices will have the opposite effect. opposite effect.

3.3. Number of SuppliersNumber of Suppliers • If more firms enter a market, the market supply of the good will If more firms enter a market, the market supply of the good will

rise. If firms leave the market, supply will decrease. rise. If firms leave the market, supply will decrease.

STARTER: SUPPLY REVIEW STARTER: SUPPLY REVIEW 1.1. Describe the law of supply.Describe the law of supply.2.2. Once prices goes _____, Once prices goes _____,

the quantity supplies goes the quantity supplies goes _____. _____.

3.3. What is the elasticity of What is the elasticity of supply?supply?

4.4. Give an example of a good Give an example of a good with an inelastic supply.with an inelastic supply.

5.5. Give an example of a good Give an example of a good with an elastic supply.with an elastic supply.

YOU ARE THE CEO OF:YOU ARE THE CEO OF:

INGREDIENTS: MILK CHOCOLATE (SUGAR, COCOA BUTTER, CHOCOLATE, SKIM MILK, LACTOSE, MILKFAT, SOY LECITHIN, ART. FLAVOR), PEANUTS, CORN SYRUP, SUGAR, MILKFAT, SKIM MILK, PARTIALLY HYDROGENATED SOYBEAN OIL, LACTOSE, SALT, EGG WHITES, CHOCOLATE, ARTIFICIAL FLAVOR.

3. PRICES3. PRICES

Pric

e pe

r slic

e

Equilibrium Point

Finding Equilibrium

Price of a slice

of pizza

Quantity demanded

Quantity supplied Result

Combined Supply and Demand Schedule

$ .50 300 100

$3.50

$3.00

$2.50

$2.00

$1.50

$1.00

$.50

Slices of pizza per day

050 100 150 200 250 300 350

Supply Demand

Balancing the MarketBalancing the Market The point at which quantity demanded and quantity The point at which quantity demanded and quantity supplied come together is known as supplied come together is known as priceprice equilibriumequilibrium..

$2.00

$2.50

$3.00

150

100

50

250

300

350

Surplus from excess supply

$1.50 200 200 Equilibrium

Equilibrium Price

a

Equ

ilibr

ium

Q

uant

ity

$1.00 250 150

Shortage from excess demand

Market DisequilibriumMarket DisequilibriumIf the market price or quantity supplied is anywhere but at the equilibrium price, the market is in a state called disequilibrium. There are two causes for disequilibrium:

A A price ceiling price ceiling is a is a maximum price that maximum price that can be legally can be legally charged for a good charged for a good (ex. rent control)(ex. rent control)

In some cases the government steps in to control prices. These interventions appear as

price ceilings and price floors.

Rent Control Apartments in NY

Price FloorsPrice Floors

A A price floorprice floor is a is a minimum price, set minimum price, set by the by the government, that government, that must be paid for a must be paid for a good or service.good or service.

One well-known price floor is One well-known price floor is the the minimum wage,minimum wage, which which sets a minimum price that sets a minimum price that an employer can pay a an employer can pay a worker for an hour of labor.worker for an hour of labor.

$800

$600

$400

$200

0

Pric

e

Output (in millions)

Graph A: A Change in Supply

1 2 3 4 5

Analyzing Shifts in Supply and DemandAnalyzing Shifts in Supply and Demand

Graph A shows how the market finds a new Graph A shows how the market finds a new equilibrium when there is an increase in supply. equilibrium when there is an increase in supply.

Graph B shows how the market finds a new Graph B shows how the market finds a new equilibrium when there is an increase in equilibrium when there is an increase in demand.demand.

Original supply

Demand

a

New supply

b

c

Graph B: A Change in Demand

Output (in thousands)

$60

$50

$40

$30

$20

$10

0900800700600500400300200100

Pric

e

Supply

Original demand

a

New demand

c

b

Advantages of Prices:Advantages of Prices:

1. Prices as an Incentive Prices communicate to both buyers

and sellers whether goods or services are scarce or easily

available. Prices can encourage or discourage production.

2. Signals Think of prices as a traffic light. A relatively high price is a green light telling producers to make more. A

relatively low price is a red light telling producers to make less.

3. Flexibility In many markets, prices are much

more flexible than production levels. They can be easily increased or decreased to solve problems of

excess supply or excess demand.

4. Price System is "Free" Unlike central planning, a distribution

system based on prices costs nothing to administer.

Prices provide a language for buyers and sellers.

Defining MonopolyDefining Monopoly A A monopoly monopoly is a market is a market

dominated by a single seller.dominated by a single seller. Monopolies form when barriers Monopolies form when barriers

prevent firms from entering a prevent firms from entering a market that has a single supplier. market that has a single supplier.

Monopolies can take advantage Monopolies can take advantage of their monopoly power and of their monopoly power and charge high prices.charge high prices.

Under Anti-Trust laws, most Under Anti-Trust laws, most monopolies are illegal in USmonopolies are illegal in US