CHAPTER 7 DEMAND AND SUPPLY. demand: the amount of a good or service that consumers are able and...
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Transcript of CHAPTER 7 DEMAND AND SUPPLY. demand: the amount of a good or service that consumers are able and...
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CHAPTER 7
DEMAND AND S
UPPLY
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demand: the amount of a good or service that consumers are able and willing to buy at various possible prices during a specified time period
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supply: the amount of a good or service that producers are able and willing to sell at various prices during a specified time period
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market: the process of freely exchanging goods and services between buyers and sellers
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SECTION 1The Marketplace (cont.)
• In a market economy, consumers collectively have a great deal of influence on prices of all goods and services.
• The demand of a good or service creates supply.
• A market represents the freely chosen actions between buyers and sellers.
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SECTION 1The Marketplace (cont.)
• In a market economy, individuals decide for themselves the answers to:
– What?
– How?
– For Whom?
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SECTION 1The Marketplace (cont.)
• A market economy is based on the principle of voluntary exchange.
– Supply and demand analysis is a model of how buyers and sellers operate in the marketplace.
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voluntary exchange: a transaction in which a buyer and a seller exercise their economic freedom by working out their own terms of exchange
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SECTION 1The Law of Demand
The law of demand states that as price goes up, quantity demanded goes down, and vice versa.
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The law of demand states that as price goes up, quantity demanded goes down. As price goes down, quantity demanded goes up.
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The law of supply states that as price goes up, quantity supplied also goes up. As price goes down, quantity supplied goes down.
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SECTION 1The Law of Demand (cont.)
• The law of demand explains consumer reactions to changing prices in terms of the quantities demanded of a good or service. There is an inverse or opposite relationship between quantity demanded and price.
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SECTION 1The Law of Demand (cont.)
• Several factors explain the inverse relation between price and quantity demanded, or how much people will buy of any item at a particular price.
– Real income effect
– Substitution effect
• Factors include:
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real income effect: economic rule stating that individuals cannot keep buying the same quantity of a product if its price rises while their income stays the same
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substitution effect: economic rule stating that if two items satisfy the same need and the price of one rises, people will buy more of the other
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SECTION 1The Law of Demand (cont.)
• Diminishing marginal utility:
– Utility
– Marginal utility
– Law of diminishing marginal utility
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VOCAB11
law of diminishing marginal utility: rule stating that the additional satisfaction a consumer gets from purchasing one more unit of a product will lessen with each additional unit purchased
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real income effect: economic rule stating that individuals cannot keep buying the same quantity of a product if its price rises while their income stays the same
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substitution effect: economic rule stating that if two items satisfy the same need and the price of one rises, people will buy more of the other
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SECTION 2
• A demand curve shows the quantitydemanded of a good or service at each possible price. Demand curves slope downward, clearly showing the inverse relationship.
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SECTION 2Determinates of Demand (cont.)
• Factors that can affect demand for a specific product or service:
– Changes in population
– Changes in income
– Changes in people’s tastes and preferences
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SECTION 2Determinates of Demand (cont.)
– The availability and price of substitutes
– The price of complementary goods
• The decrease in the price of one good will increase the demand for its complementary.
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FIGURE 3
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FIGURE 4
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FIGURE 5
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SECTION 2The Price Elasticity of Demand
Elasticity of demand measures how much the quantity demanded changes when price goes up or down.
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price elasticity of demand: economic concept that deals with how much demand varies according to changes in price
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elastic demand: situation in which a given rise or fall in a product’s price greatly affects the amount that people are willing to buy
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inelastic demand: situation in which a product’s price change has little impact on the quantity demanded by consumers
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FIGURE 9
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SECTION 2The Price Elasticity of Demand (cont.)
• Three factors determine the price elasticity of demand for an item:
– The existence of substitutes
– The percentage of a person’s total budget devoted to the purchase of that good
– The time consumers are given to adjust to a change in price
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FIGURE 11
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law of supply: economic rule stating that price and quantity supplied move in the same direction
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ROLE OF PROFIT
One of the most important factors that motivates people in a market economy
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supply curve: upward-sloping line that shows in graph form the quantities supplied at each possible price
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SECTION 3Profits and the Law of Supply (cont.)
• To understand pricing, you must look at both demand and supply.
– The higher the price of a good, the greater the incentive is for a producer to produce more.
• The law of supply states that as the price of a good rises, the quantity supplied also rises. As the price falls, the quantity supplied also falls.
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SECTION 3The Determinants of Supply (cont.)
• Many factors affect the supply of a specific product. Four of the major determinants are:
– The price of inputs
– The number of firms in the industry
– Taxes imposed or not imposed
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SECTION 3The Determinants of Supply (cont.)
– Technology
• Any improvement in technology will increase supply.
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LAW OF DIMINISHING RETURNS
Adding units of one factor of production to all the
other factors of production increases total
output.
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SECTION 4Equilibrium Price
In free markets, prices are determined by the interaction of supply and demand.
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SECTION 4Equilibrium Price (cont.)
• Demand and supply operate together. As the price of a good goes down, the quantity demanded rises and the quantity supplied falls (and vice versa).
• The point at which the quantity demanded and quantity supplied meet is called the equilibrium price.
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SECTION 4Prices as Signals
Under a free-enterprise system, prices function as signals that communicate information and coordinate the activities of producers and consumers.
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SECTION 4Prices as Signals (cont.)
• Rising prices signal producers to produce more and consumers to purchase less.
• Falling prices signal producers to produce less and consumers to purchase more.
• A shortage occurs when at the current price, the quantity demanded is greater than the quantity supplied.
• Prices above the equilibrium price reflect a surplus to suppliers.
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SECTION 4Prices as Signals (cont.)
• When a market economy operates without restriction, it eliminates shortages and surpluses.
– When a shortage occurs, the price goes up to eliminate the shortage.
– When surpluses occur, the price falls to eliminate the surplus.
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SECTION 4Price Controls
Under certain circumstances, the government sometimes sets a limit on how high or low a price of a good or service can go.
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SECTION 4Price Controls (cont.)
• The government sometimes gets involved in setting prices if it believes such measures are needed to protect consumers and suppliers.
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SECTION 4Price Controls (cont.)
– Effective price ceilings, and resulting shortages, often lead to non-market ways of distributing goods and services such as rationing and leading to the black market.
• A price ceiling is a government-set maximum price that may be charged for a particular good or service.
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SECTION 4Price Controls (cont.)
• Conversely, a price floor, is a government-set minimum price that can be charged for goods and services.