Domain 3

MICROECONOMICS

Georgia Standards of ExcellenceMICRO CONCEPT CLUSTER

SSEMI1

SSEMI1 Describe how households and businesses are interdependent and interact through flows of goods, services, resources, and money.

a. Illustrate a circular flow diagram that includes the product market, the resource (factor) market, households, and firms.

b. Explain the real flow of goods, services, resources, and money between and among households and firms.

PRODUCCRPRODUCTMARKET

FACTORMARKET

HOUSEHOLDS BUSINESSES

Payments

Mo

ney

Money

Paym

en

ts

Serv

ice

&

GoodsServices &

Go

od

s

Factors o

f

Production Factors of

Pro

du

ctio

nIn

com

e &

Wages

Wag

es

Income &

Own all of the factors of

production.

BUY in the Product

Market & SELL in the Factor

Market.

BUY in the Factor

Market & SELL in

the Product Market.

PRODUCCRPRODUCTMARKET

FACTORMARKET

HOUSEHOLDS BUSINESSES

Payments

Mo

ney

Money

Paym

en

ts

Serv

ice

&

GoodsServices &

Go

od

s

Factors o

f

Production Factors of

Pro

du

ctio

nIn

com

e &

Wages

Wag

es

Income &

Own all of the factors of

production.

BUY in the Product

Market & SELL in the Factor

Market.

BUY in the Factor

Market & SELL in

the Product Market.

GOVERNMENTTaxes

Taxes

Mo

ney

Paym

en

ts Fact

ors

of

Pro

du

ctio

n

Mo

ney

Pay

me

nts

Go

od

s &

Serv

ice

s

Public Goods &Services

Public Goods &Services

PRODUCCRPRODUCTMARKET

FACTORMARKET

HOUSEHOLDS BUSINESSES

Payments

Mo

ney

Money

Paym

en

ts

Serv

ice

&

GoodsServices &

Go

od

s

Factors o

f

Production Factors of

Pro

du

ctio

nIn

com

e &

Wages

Wag

es

Income &

Own all of the factors of

production.

BUY in the Product

Market & SELL in the Factor

Market.

BUY in the Factor

Market & SELL in

the Product Market.

GOVERNMENTTaxes

Taxes

Mo

ney

Paym

en

ts Fact

ors

of

Pro

du

ctio

n

Mo

ney

Pay

me

nts

Go

od

s &

Serv

ice

s

Public Goods &Services

Public Goods &Services

The Three Types of Business Organizations

https://youtu.be/rdG0x8uDEGc

Business Organizations• Sole Proprietorship

• One owner• Tend to be small with no employees

•Partnership• Two or more owners• Tend to be small with few, if any, employees

•Corporation• Legal entity that is similar to an individual in the

eyes of the law• May be large or small, with few or many employees

Sole Proprietorships

• What role do sole proprietorships play in our economy?

• What are the advantages of a sole proprietorship?

• What are the disadvantages of a sole proprietorship?

A sole proprietorship is a business owned and managed by a

single individual.

The Role of Sole Proprietorships

• A business organization is an establishment formed to carry on commercial enterprise. Sole proprietorships are the most common form of business organization and make up 72% of all U.S. firms.

• Most sole proprietorships are small. All together, sole proprietorships generate only about 6 percent of all United States sales.

Characteristics of Proprietorships

• Most sole proprietorships earn modest incomes.

• Many proprietors run their businesses part-time.

Advantages of Sole Proprietorships

Ease of Start-Up

• With a small amount of paperwork and legalexpenses, just about anyone can start a sole proprietorship.

Relatively Few Regulations

• A proprietorship is the least-regulated form of business organization.

Sole Receiver of Profit

• After paying taxes, the owner of sole proprietorship keeps all the profits.

Full Control

• Owners of sole proprietorships can run their businesses as they wish.

Easy to Discontinue

• Besides paying off legal obligations, such as taxes and debt, no other legal obligations needed to be met to stop doing business.

Sole proprietorships offer their owners many advantages:

The biggest disadvantage of sole proprietorships is unlimited personal liability. Liability is the

legally bound obligation to pay debts.

Disadvantages of Sole Proprietorships

• Sole proprietorships have limitedaccess to resources, such as physical capital. Human capital can also be limited, because no one knows everything.

• Sole proprietorships also lack permanence. Whenever an owner closes shop due to illness, retirement, or any other reason, the business ceases to exist.

Section 1 Assessment

1. Any establishment formed to carry on commercial enterprises is a

(a) partnership.

(b) business organization.

(c) sole proprietorship.

(d) corporation.

2. Sole proprietorships

(a) are complicated to establish.

(b) make up about 6 percent of all businesses.

(c) are the most common form of business in the United States.

(d) offer owners little control over operations.

Section 1 Assessment

1. Any establishment formed to carry on commercial enterprises is a

(a) partnership.

(b) business organization.

(c) sole proprietorship.

(d) corporation.

2. Sole proprietorships

(a) are complicated to establish.

(b) make up about 6 percent of all businesses.

(c) are the most common form of business in the United States.

(d) offer owners little control over operations.

Types of Partnerships

Partnerships fall into three categories:

• General Partnership• In a general partnership, partners share equally in both

responsibility and liability.

• Limited Partnership• In a limited partnership, only one partner is required to be a

general partner, or to have unlimited personal liability for the firm.

• Limited Liability Partnership• A newer type of partnership is the limited liability partnership. In

this form, all partners are limited partners.

Advantages of Partnerships•Partnerships offer entrepreneurs many benefits.

1. Ease of Start-UpPartnerships are easy to establish. There is no required partnership agreement, but it is recommended that partners develop articles of partnership.

2. Shared Decision Making and SpecializationIn a successful partnership, each partner brings different strengths and skillsto the business.

3. Larger Pool of CapitalEach partner's assets, or money and other valuables, improve the firm's ability to borrow funds for operations or expansion.

4. TaxationIndividual partners are subject to taxes, but the business itself does not have to pay taxes.

Disadvantages of Partnerships

• Unless the partnership is a limited liability partnership, at least one partner has unlimited liability.

• General partners are bound by each other’s actions.

• Partnerships also have the potential for conflict. Partners need to ensure that they agree about work habits, goals, management styles, ethics, and general business philosophies.

Corporations• Legal entity that is held responsible for its decisions•Ownership is separate and apart from the

owner/shareholders•Managed by a board of directors•Owners/shareholders have “limited liability”• Can be easier to get start-up and expansion

financing• Considered an “individual” and pays its own taxes at

corporate tax rates

Publicly vs Privately-held Corporations• Publicly-held

• Shares sold over stock exchange to members of the general public. • Stocks, or shares, represent a stockholder’s portion of ownership of a

corporation.

• Required to file quarterly report with SEC

• Information shared with shareholders and general public

• Privately-held

• Shares not traded over stock exchange; often owned by founder, family members, management or private investors

• No reports required

• Information not shared with general public

Liability• Definition: a company's legal financial debts or other

obligations resulting from its daily business operations

• Unlimited Liability: Sole Proprietor and General Partnership• Individuals are held responsible for all business activities and

must pay any debts or obligations of the business• Individuals can be sued and possibly lose personal assets to

cover those debts

• Limited Liability: Corporation• The corporation itself is held responsible for all business

activities and any debts or obligations.• Individual shareholders loss is limited to the amount of

money invested in the corporation

Financing•Definition: Ability to borrow money to start or expand

a business

• Limited Options: Sole Proprietor and Partnership• Relies more on individual/personal assets•Often financed using credit cards, personal loans or

personal savings

•More Options: Corporation• Can sell more stock to raise funds if needed• Can borrow money based on its own assets, not

those of the owners

Tax Issues• Taxes: Tax rates and deductions vary for personal income

tax and corporate/business income tax at both the state and federal levels

• Sole Proprietor and Partnership• Income/profits taxed as personal income• Limited deductions for business expenses

• Corporations• Income/profits taxes as corporate/business income• Increased options for deducting business expenses,

including employee benefits

In summary…• Each type of business organization has benefits and

costs

• While most businesses in the U.S. would be classified a “sole proprietorship”, they tend to be small, homebased businesses with limited services and sales

• The vast majority of business sales and business activity is produced by corporations

• Corporations may be publicly or privately-held

• Liability, financing and taxes are key factors in deciding which business organization is best

Competition and Market Structures

Competition and Market Structure

• Essential Question:

• How do varying market structures impact prices in a market economy?

What Are Markets?

A market is where buyers and sellers:meet to exchange goods and services.are affected by some level of competition.

Market Structure

Characterized by the degree of competition among business in the same industry

• Types of Competition:•Pure (Perfect) Competition•Monopolistic Competition•Oligopoly•Monopoly

Pure (Perfect) Competition

When a large number of buyers and sellers exchange identical products under five conditions

1. There should be a large number of buyers and sellers2. The products should be identical 3. Buyers and sellers should act independently

Pure (Perfect) Competition (cont)

4. Buyers and sellers should be well-informed 5. Buyers and sellers should be free to enter, conduct, or get out of business

Pure (Perfect) Competition (cont)

Under a Pure Competition • Supply and demand set the equilibrium price • Each firms sets a level of output that will

maximize its profits at that price

Imperfect Competition •Refers to market structures that lack one or

more of the five conditions

Monopolistic Competition

•Meets all conditions of perfect competition except for identical products

•Use product differentiation • Real or imagined differences between competing

products in the same industry

•Use non-price competition • Advertising, giveaways, promotional campaigns,

product differentiation

• Sell within a narrow price range to try to raise the price = profit maximization

Examples of Monopolistic Competition

Firms sell slightly differentiated products

❖Differentiation may be color, packaging, store location, store design, store decorations, delivery, service….. anything to make it stand out!

With your neighbor…Think about a monopolistically competitive company from which you have made a recent purchase.

• What are the substitutes’ prices?

• Why can there be a range of prices?

• Why did you purchase the one you did?

Oligopoly

• A few large businesses dominate an industry

• When one business makes a move, the others usually follow

• Ex: a price war…cuts in airline ticket

• Sometimes results in collusion or price-fixing which is illegal

• Collusion: formal agreement to set prices

• Price-Fixing: charge the same

Monopoly

One seller of a product that has no close substitutes

• Natural Monopoly

• Geographic Monopoly

• Technological Monopoly

• Government Monopoly

Natural Monopoly

Natural Monopoly – an industry in which economies of scale are so important that only one firm can survive.

In other words, it is more efficient for there to be one firm in the industry.

Example: Gas companies (we wouldn’t want multiple gas lines underground

Geographic Monopoly

No other business chooses to compete in that area

• Ex: small town drugstore

Technological Monopoly

• Results from new discoveries and inventions.

• The government grants these monopolies through the issue of patents and copyrights

• Patents: inventions

• Copyrights: publish

Government Monopoly

• Involves products people need that private industry might not adequately provide

Characteristics of Market Structures

Market

Structure

# of

Sellers

Types of

Products

Barriers to

Entry

Control

Over Price

Examples

Perfect

Competitionmany identical Low or

none

Price

takers

Monopoly 1 Unique Extremely

high

Price

searchers

Monopolistic

CompetitionMany Slightly

differentiatedEasy

entry

Price

searchers

Oligopoly Few

sellers

Identical or

slightly

differentiated

Difficult

entry

Price

Searchers

Perfect Competition

• What conditions must exist for perfect competition?

• What are barriers to entry and how do they affect the marketplace?

• What are prices and output like in a perfectly competitive market?

Section 1 Assessment

1. Which of the following is NOT a condition for perfect competition?

(a) many buyers and sellers participate

(b) identical products are offered

(c) market barriers are in place

(d) buyers and sellers are well-informed about goods and services

2. How does a perfect market influence output?

(a) Each firm adjusts its output so that it just covers all of its costs.

(b) Each firm makes its output as large as possible even though some goods are not sold.

(c) Different firms make different amounts of goods, but some make a profit and others do not.

(d) Different firms each strive to make more goods to capture more of the market.

Section 1 Assessment

1. Which of the following is NOT a condition for perfect competition?

(a) many buyers and sellers participate

(b) identical products are offered

(c) market barriers are in place

(d) buyers and sellers are well-informed about goods and services

2. How does a perfect market influence output?

(a) Each firm adjusts its output so that it just covers all of its costs.

(b) Each firm makes its output as large as possible even though some goods are not sold.

(c) Different firms make different amounts of goods, but some make a profit and others do not.

(d) Different firms each strive to make more goods to capture more of the market.

Section 1 Assessment

1. Which of the following is NOT a condition for perfect competition?

(a) many buyers and sellers participate

(b) identical products are offered

(c) market barriers are in place

(d) buyers and sellers are well-informed about goods and services

2. How does a perfect market influence output?

(a) Each firm adjusts its output so that it just covers all of its costs.

(b) Each firm makes its output as large as possible even though some goods are not sold.

(c) Different firms make different amounts of goods, but some make a profit and others do not.

(d) Different firms each strive to make more goods to capture more of the market.

Price discrimination is the division of customers into groups based on how much they will pay for a good.

Price Discrimination

• Although price discrimination is a feature of monopoly, it can be practiced by any company with market power. Market power is the ability to control prices and total market output.

• Targeted discounts, like student discounts and manufacturers’ rebate offers, are one form of price discrimination.

• Price discrimination requires some marketpower, distinct customergroups, and difficult resale.

A monopolist sets output at a point where marginal revenue is

equal to marginal cost.

Setting a Price in a Monopoly

Market Price $11

$3

Pri

ce

9,000Output

(in doses)

Marginal Cost

Demand

Marginal Revenue

B

C

A

Output Decisions

• Even a monopolist faces a limitedchoice – it can choose to set either output or price, but not both.

• Monopolists will try to maximizeprofits; therefore, compared with a perfectly competitive market, the monopolist produces fewer goods at a higher price.

Nonprice competition is a way to attract customers through style, service, or location, but not a lower price.

Nonprice Competition

1. Characteristics of Goods

The simplest way for a firm to

distinguish its products is to

offer a new size, color,

shape, texture, or taste.

2. Location of Sale

A convenience store in the

middle of the desert

differentiates its product

simply by selling it hundreds

of miles away from the

nearest competitor.

3. Service Level

Some sellers can charge higher

prices because they offer

customers a higher level of

service.

4. Advertising Image

Firms also use advertising to

create apparent differences

between their own offerings and

other products in the

marketplace.

Prices, Profits, and Output

• Prices

• Prices will be higher than they would be in perfect competition, because firms have a small amount of power to raise prices.

• Profits

• While monopolistically competitive firms can earn profits in the short run, they have to work hard to keep their product distinctenough to stay ahead of their rivals.

• Costs and Variety

• Monopolistically competitive firms cannot produce at the lowestaverage price due to the number of firms in the market. They do, however, offer a wide array of goods and services to consumers.

Regulation and Deregulation

• How do firms use market power?

• What market practices does the government regulate or ban to protect competition?

• What is deregulation?

Market power is the ability of a company to control prices and output.

Market Power

• Markets dominated by a few large firms tend to have higher prices and lower output than markets with manysellers.

• To control prices and output like a monopoly, firms sometimes use predatory pricing. Predatory pricing sets the market price below cost levels for the short termto drive out competitors.

Government policies keep firms from controlling the prices and supply of important goods. Antitrust laws are laws that encourage competition in the

marketplace.

Government and Competition

1. Regulating Business

Practices

The government has the

power to regulate business

practices if these practices

give too much power to a

company that already has

few competitors.

2. Breaking Up Monopolies

The government has used

anti-trust legislation to break

up existing monopolies, such

as the Standard Oil Trust and

AT&T.

3. Blocking Mergers

A merger is a combination of

two or more companies into a

single firm. The government

can block mergers that would

decrease competition.

4. Preserving Incentives

In 1997, new guidelines were

introduced for proposed

mergers, giving companies an

opportunity to show that their

merging benefits consumers.

Deregulation is the removal of some government controls over a market.

Deregulation

• Deregulation is used to promote competition.

• Many new competitors enter a market that has been deregulated. This is followed by an economically healthyweeding out of some firms from that market, which can be hard on workers in the short term.

Section 4 Assessment

1. Antitrust laws allow the U.S. government to do all of the following EXCEPT

(a) regulate business practices

(b) stop firms from forming monopolies

(c) prevent firms from selling new experimental products

(d) break up existing monopolies

2. The purpose of both deregulation and antitrust laws is to

(a) promote competition

(b) promote government control

(c) promote inefficient commerce

(d) prevent monopolies

Section 4 Assessment

1. Antitrust laws allow the U.S. government to do all of the following EXCEPT

(a) regulate business practices

(b) stop firms from forming monopolies

(c) prevent firms from selling new experimental products

(d) break up existing monopolies

2. The purpose of both deregulation and antitrust laws is to

(a) promote competition

(b) promote government control

(c) promote inefficient commerce

(d) prevent monopolies

What are your questions?

Georgia Standards of ExcellenceMICRO CONCEPT CLUSTER

SSEMI2

Explain how the law of demand, the law of supply and prices work to determine production and distribution in a market economy.

• Law of demand

• Law of supply

• Prices

• Profit

• Production

• Distribution

• Equilibrium

• Incentives

Indiana Jones – Demand and Supply

https://youtu.be/RP0j3Lnlazs

Understanding Demand

• What is the law of demand?

• How do the substitution effect and income effect influence decisions?

• What is a demand schedule?

• What is a demand curve?

The law of demand states that consumers buy more

of a good when its price decreases and less

when its price increases.

What Is the Law of Demand?

• The law of demand is the result of two separate behavior patterns that overlap, the substitution effect and the income effect.

• These two effects describe different ways that a consumer can change his or her spending patterns for other goods.

The Substitution Effect and Income Effect

The Substitution Effect

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

The Income Effect

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

Demand Schedules

Individual Demand Schedule

Price of a

slice of pizza

Quantity demanded

per day

Market Demand Schedule

Price of a

slice of pizza

Quantity demanded

per day

$.50

$1.00

$1.50

$2.00

$2.50

$3.00

5

4

3

2

1

0

$.50

$1.00

$1.50

$2.00

$2.50

$3.00

300

250

200

150

100

50

The Demand Schedule• A demand schedule is a table that lists

the quantity of a good a person 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.

Market Demand Curve

3.00

2.50

2.00

1.50

1.00

.50

0

0 50 100 150 200 250 300 350

Slices of pizza per day

Pri

ce

pe

r s

lic

e (

in d

oll

ars

)

Demand

The Demand Curve• A demand curve is a

graphical representation of a demand schedule.

• When reading a demand curve, assume all outside factors, such as income, are held constant.

Law of Demand Section Assessment1. The law of demand states that

(a) consumers will buy more when a price increases.

(b) price will not influence demand.

(c) consumers will buy less when a price decreases.

(d) consumers will buy more when a price decreases.

2. If the price of a good rises and income stays the same, what is the effect on demand?

(a) the prices of other goods drop

(b) fewer goods are bought

(c) more goods are bought

(d) demand stays the same

1. The law of demand states that

(a) consumers will buy more when a price increases.

(b) price will not influence demand.

(c) consumers will buy less when a price decreases.

(d) consumers will buy more when a price decreases.

2. If the price of a good rises and income stays the same, what is the effect on demand?

(a) the prices of other goods drop

(b) fewer goods are bought

(c) more goods are bought

(d) demand stays the same

Law of Demand Section Assessment

Price

As price increases…

Supply

Quantity supplied increases

Price

As price falls…

Supply

Quantity supplied falls

The Law of Supply

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

How Does the Law of Supply Work?

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

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

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

$.50 1,000

Price per slice of pizza Slices supplied per day

Market Supply Schedule

$1.00 1,500

$1.50 2,000

$2.00 2,500

$2.50 3,000

Supply Schedules

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

Market Supply Curve

Pri

ce (

in d

olla

rs)

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

Supply Curves

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

Law of Supply Section Assessment1. What is the law of supply?

(a) the lower the price, the larger the quantity supplied

(b) the higher the price, the larger the quantity supplied

(c) the higher the price, the smaller the quantity supplied

(d) the lower the price, the more manufacturers will produce the good

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

(a) less goods.

(b) more goods.

(c) the same quantity of goods.

(d) different types of goods.

1. What is the law of supply?

(a) the lower the price, the larger the quantity supplied

(b) the higher the price, the larger the quantity supplied

(c) the higher the price, the smaller the quantity supplied

(d) the lower the price, the more manufacturers will produce the good

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

(a) less goods.

(b) more goods.

(c) the same quantity of goods.

(d) different types of goods.

Law of Supply Section Assessment

Demand & Supply Curves

Inverse Relationship Positive Relationship

https://youtu.be/g9aDizJpd_s?list=PL8dPuuaLjXtPNZwz5_o_5uirJ8gQXnhEO

Combining Supply and Demand

• How do supply and demand create balance in the marketplace?

• What are differences between a market in equilibrium and a market in disequilibrium?

• What are the effects of price ceilings and price floors?

Pri

ce

pe

r s

lic

e

Equilibrium Point

Finding Equilibrium

Price of

a slice

of pizza

Quantity

demanded

Quantity

suppliedResult

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

SupplyDemand

The point at which quantity demanded and quantity supplied come together is known as equilibrium.

$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

ilibriu

m

Qu

an

tity

$1.00 250 150

Shortage from

excess demand

Balancing the Market

If 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:

Interactions between buyers and sellers will

always push the market back towards

equilibrium.

Market Disequilibrium

Excess Demand

• Excess demand occurs when quantity demanded is more than quantity supplied.

Excess Supply

• Excess supply occurs when quantity supplied exceeds quantity demanded.

In some cases the government steps in to control prices.

These interventions appear as price ceilings and price floors.

Price Ceilings

• A price ceiling is a maximum price that can be legally charged for a good.

• An example of a price ceiling is rent control, a situation where a government sets a maximum amount that can be charged for rent in an area.

• Price Ceilings result in a SHORTAGE.

Price Floors• A price floor is a minimum price, set

by the government, that must be paid for a good or service.

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

• Price Floors result in a SURPLUS

Minimum Wage Laws in the Stateshttps://w

ww.dol.gov/whd/minwage/america.htm

Equilibrium Section Assessment

1. Equilibrium in a market means which of the following?

(a) the point at which quantity supplied and quantity demanded are the same

(b) the point at which unsold goods begin to pile up

(c) the point at which suppliers begin to reduce prices

(d) the point at which prices fall below the cost of production

2. The government’s price floor on low wages is called the

(a) market equilibrium

(b) base wage rate

(c) minimum wage

(d) employment guarantee

1. Equilibrium in a market means which of the following?

(a) the point at which quantity supplied and quantity demanded are the same

(b) the point at which unsold goods begin to pile up

(c) the point at which suppliers begin to reduce prices

(d) the point at which prices fall below the cost of production

2. The government’s price floor on low wages is called the

(a) market equilibrium

(b) base wage rate

(c) minimum wage

(d) employment guarantee

Equilibrium Section Assessment

Shifts of the Demand Curve

• What is the difference between a change in quantity demanded and a shift in the demand curve?

• What factors can cause shifts in the demand curve?

• How does the change in the price of one good affect the demand for a related good?

Shifts in Demand

• Ceteris paribus is a Latin phrase economists use meaning “all other things held constant.”

• A demand curve is accurate only as long as the ceteris paribus assumption is true.

• When the ceteris paribus assumption is dropped, movement no longer occurs along the demand curve. Rather, the entire demand curve shifts.

1. Income

Changes in consumers incomes affect demand. A normal good is a good that

consumers demand more of when their incomes increase. An inferior good is

a good that consumers demand less of when their income increases.

2. Consumer Expectations

Whether or not we expect a good to increase or decrease in price in the future

greatly affects our demand for that good today.

3. Population

Changes in the size of the population also affects the demand for most

products.

4. Consumer Tastes and Advertising

Advertising plays an important role in many trends and therefore influences

demand.

What Causes a Shift in Demand?• Several factors can lead to a change in demand:

Shift in Demand

• Change in Demand due to one of the Determinants of Demand (absent of a price change)

• Demand is the whole curve. Quantity Demanded is one point on the curve at a particular Price.

The demand curve for one good can be affected

by a change in the demand for another good.

Prices of Related Goods

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

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

Shifts in Demand Section Assessment

1. Which of the following does not cause a shift of an entire demand curve?

(a) a change in price

(b) a change in income

(c) a change in consumer expectations

(d) a change in the size of the population

2. Which of the following statements is accurate?

(a) When two goods are complementary, increased demand for one will cause decreased demand for the other.

(b) When two goods are complementary, increased demand for one will cause increased demand for the other.

(c) If two goods are substitutes, increased demand for one will cause increased demand for the other.

(d) A drop in the price of one good will cause increased demand for its substitute.

1. Which of the following does not cause a shift of an entire demand curve?

(a) a change in price

(b) a change in income

(c) a change in consumer expectations

(d) a change in the size of the population

2. Which of the following statements is accurate?

(a) When two goods are complementary, increased demand for one will cause decreased demand for the other.

(b) When two goods are complementary, increased demand for one will cause increased demand for the other.

(c) If two goods are substitutes, increased demand for one will cause increased demand for the other.

(d) A drop in the price of one good will cause increased demand for its substitute.

Shifts in Demand Section Assessment

Changes in Supply

• How do input costs affect supply?

• How can the government affect the supply of a good?

• What other factors can influence supply?

Input Costs and Supply

• Any change in the cost of an input such as the raw materials, machinery, or labor used to produce a good, will affect supply.

• As input costs increase, the firm’s marginal costs also increase, decreasing profitability and supply.

• Input costs can also decrease. New technology can greatly decrease costs and increase supply.

Government Influences on Supply• By raising or lowering the cost of producing goods, the government can encourage or

discourage an entrepreneur or industry.

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.

Other Factors Influencing Supply

• The Global Economy

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

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

• Future Expectations of Prices

• Expectations of higher prices will reduce supply now and increase supply later. Expectations of lower prices will have the opposite effect.

• Number of Suppliers

• If more firms enter a market, the market supply of the good will rise. If firms leave the market, supply will decrease.

Influences on Supply Section Assessment

1. What affect does a rise in the cost of raw materials have on the cost of a good?

(a) A rise in the cost of raw materials lowers the overall cost of production.

(b) The good becomes cheaper to produce.

(c) The good becomes more expensive to produce.

(d) This does not have any affect on the eventual price of a good.

2. When government actions cause the supply of a good to increase, what happens to the supply curve for that good?

(a) It shifts to the left.

(b) It shifts to the right.

(c) It reverses direction.

(d) The supply curve is unaffected.

1. What affect does a rise in the cost of raw materials have on the cost of a good?

(a) A rise in the cost of raw materials lowers the overall cost of production.

(b) The good becomes cheaper to produce.

(c) The good becomes more expensive to produce.

(d) This does not have any affect on the eventual price of a good.

2. When government actions cause the supply of a good to increase, what happens to the supply curve for that good?

(a) It shifts to the left.

(b) It shifts to the right.

(c) It reverses direction.

(d) The supply curve is unaffected.

Influences on Supply Section Assessment

Changes in Market Equilibrium

• How do shifts in supply affect market equilibrium?

• How do shifts in demand affect market equilibrium?

• How can we use supply and demand curves to analyze changes in market equilibrium?

Shifts in Supply

• Understanding a Shift

• Since markets tend toward equilibrium, a change in supply will set market forces in motion that lead the market to a new equilibrium price and quantity sold.

• Excess Supply

• A surplus is a situation in which quantity supplied is greater than quantity demanded. If a surplus occurs, producers reduce prices to sell their products. This creates a new market equilibrium.

• A Fall in Supply

• The exact opposite will occur when supply is decreased. As supply decreases, producers will raise prices and demand will decrease.

Shifts in Demand

• Excess Demand

• A shortage is a situation in which quantity demanded is greater than quantity supplied.

• Search Costs

• Search costs are the financial and opportunity costs consumers pay when searching for a good or service.

• A Fall in Demand

• When demand falls, suppliers respond by cutting prices, and a new market equilibrium is found.

$800

$600

$400

$200

0

Pri

ce

Output (in millions)

Graph A: A Change in Supply

1 2 3 4 5

Analyzing Shifts in Supply and Demand

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

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

Original

supply

Demand

a

New

supply

b

c

Graph B: A Change in Demand

Output (in thousands)

$60

$50

$40

$30

$20

$10

0

900800700600500400300200100

Pri

ce

Supply

Original

demand

a

New

demand

c

b

Shifts in Supply & Demand Section Assessment

1. When a new equilibrium is reached after a fall in demand, the new equilibrium has a

(a) lower market price and a higher quantity sold.

(b) higher market price and a higher quantity sold.

(c) lower market price and a lower quantity sold.

(d) higher market price and a lower quantity sold.

2. What happens when any market is in disequilibrium and prices are flexible?

(a) market forces push toward equilibrium

(b) sellers waste their resources

(c) excess demand is created

(d) unsold perishable goods are thrown out

1. When a new equilibrium is reached after a fall in demand, the new equilibrium has a

(a) lower market price and a higher quantity sold.

(b) higher market price and a higher quantity sold.

(c) lower market price and a lower quantity sold.

(d) higher market price and a lower quantity sold.

2. What happens when any market is in disequilibrium and prices are flexible?

(a) market forces push toward equilibrium

(b) sellers waste their resources

(c) excess demand is created

(d) unsold perishable goods are thrown out

Shifts in Supply & Demand Section Assessment

The Role of Prices

• What role do prices play in a free market system?

• What advantages do prices offer?

• How do prices allow for efficient resource allocation?

The Role of Prices in a Free Market

• Prices serve a vital role in a free market economy.

• Prices help move land, labor, and capital into the hands of producers, and finished goods in to the hands of buyers.

• Prices create efficient resource allocation for producers and a language that both consumers and producers can use.

Prices provide a language for buyers and sellers.

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.

Advantages of Prices

Efficient Resource Allocation

• Resource Allocation

• A market system, with its fully changing prices, ensures that resources go to the uses that consumers value most highly.

• Market Problems

• Imperfect competition between firms in a market can affect prices and consumer decisions.

• Spillover costs, or externalities, are costs of production, such as air and water pollution, that “spill over” onto people who have no control over how much of a good is produced.

• If buyers and sellers have imperfect information on a product, they may not make the best purchasing or selling decision.

Price Section Assessment

1. What prompts efficient resource allocation in a well-functioning market system?

(a) businesses working to earn a profit

(b) government regulation

(c) the need for fair allocation of resources

(d) the need to buy goods regardless of price

2. How do price changes affect equilibrium?

(a) Price changes assist the centrally planned economy.

(b) Price changes serve as a tool for distributing goods and services.

(c) Price changes limit all markets to people who have the most money.

(d) Price changes prevent inflation or deflation from affecting the supply of goods.

1. What prompts efficient resource allocation in a well-functioning market system?

(a) businesses working to earn a profit

(b) government regulation

(c) the need for fair allocation of resources

(d) the need to buy goods regardless of price

2. How do price changes affect equilibrium?

(a) Price changes assist the centrally planned economy.

(b) Price changes serve as a tool for distributing goods and services.

(c) Price changes limit all markets to people who have the most money.

(d) Price changes prevent inflation or deflation from affecting the supply of goods.

Price Section Assessment

https://youtu.be/01lKDkYSFDg

Costs of Production

• How do firms decide how much labor to hire?

• What are production costs?

• How do firms decide how much to produce?

Marginal Product of Labor

Labor (number of workers)

Output (beanbags per

hour)

Marginal product of

labor

0 0 —

1 4 4

2 10 6

3 17 7

4 23 6

5 28 5

6 31 3

7 32 1

8 31 –1

A Firm’s Labor Decisions• Business owners

have to consider how the number of workers they hire will affect their total production.

• The marginal product of labor is the change in output from hiring one additional unit of labor, or worker.

Increasing, Diminishing, and Negative Marginal Returns

Labor

(number of workers)

Mar

gin

al P

rod

uct

of

lab

or

(be

anb

ags

per

ho

ur)

8

7

6

5

4

3

2

1

0

–1

–2

–3

Diminishing marginal returns occur when marginal production levels decrease with new investment.

4 5 6 7

Diminishing marginal returns

Negative marginal returns occur when the marginal product of labor becomes negative.

8 9

Negative marginal returns

Marginal Returns

1 2 3

Increasing marginal returns

Increasing marginal returnsoccur when marginal production levels increase with new investment.

Production Costs

• A fixed cost is a cost that does not change, regardless of how much of a good is produced. Examples: rent and salaries

• Variable costs are costs that rise or fall depending on how much is produced. Examples: costs of raw materials, some labor costs.

• The total cost equals fixed costs plus variable costs.

• The marginal cost is the cost of producing one more unit of a good.

Production Costs

Total revenue

Profit(total revenue –

total cost)

Marginal revenue (market

price)

Marginal cost

Total cost (fixed cost + variable

cost)

Variable cost

Fixed costBeanbags (per hour)

$ –36

–20

0

21

40

0

1

2

3

4

$0

24

48

72

96

$24

24

24

24

24

—

$8

4

3

5

$36

44

48

51

56

$0

8

12

15

20

$36

36

36

36

36

57

72

84

93

5

6

7

8

120

144

168

192

24

24

24

24

7

9

12

15

63

72

84

99

27

36

48

63

36

36

36

36

98

98

92

79

216

240

264

288

24

24

24

24

19

24

30

37

36

36

36

36

9

10

11

12

82

106

136

173

118

142

172

209

Setting Output• Marginal revenue is the additional income from selling one more unit of a good. It is

usually equal to price.

• To determine the best level of output, firms determine the output level at which marginal revenue is equal to marginal cost.

Production Section Assessment

1. What are diminishing marginal returns of labor?

(a) some workers increase output but others have the opposite effect

(b) additional workers increase total output but at a decreasing rate

(c) only a few workers will have to wait their turn to be productive

(d) additional workers will be more productive

2. How does a firm set its total output to maximize profit?

(a) set production so that total revenue plus costs is greatest

(b) set production at the point where marginal revenue is smallest

(c) determine the largest gap between total revenue and total cost

(d) determine where marginal revenue and profit are the same

1. What are diminishing marginal returns of labor?

(a) some workers increase output but others have the opposite effect

(b) additional workers increase total output but at a decreasing rate

(c) only a few workers will have to wait their turn to be productive

(d) additional workers will be more productive

2. How does a firm set its total output to maximize profit?

(a) set production so that total revenue plus costs is greatest

(b) set production at the point where marginal revenue is smallest

(c) determine the largest gap between total revenue and total cost

(d) determine where marginal revenue and profit are the same

Production Section Assessment