Economics Unit 2 How the Market Works!

1. Economics Unit 2How the Market Works! Chapter 4: Demand Chapter 5: Supply Chapter 6: Prices

2. Understanding Demand • Demand • the desire to own something and the ability to pay for it • Law of Demand • consumers buy more of a good when its price decreases and less when its price increases.

3. Effects on Demand • Substitution effect • when consumers react to an increase in a goods price by consuming less of that good and more of other goods • hybrid cars • Income Effect • the change in consumption resulting from a change in real income • lottery winner

4. Demand Curve

5. What Can Change Your Demand? • Change in Income • Normal Good- a good that consumers demand more of when incomes increase • More steak, less hamburger • Inferior Good- a good that consumers demand less of when their incomes increase • Less Ramen Noodles, more progressive soup

6. What will shift the demand curve? • Income • Consumer expectations • Consumer tastes and advertising • Price of related goods

7. What will shift the demand curve? • Income • What % of your income will you spend on something? • Consumer expectations • Will the price rise today, or tomorrow? • Will the price fall today, or tomorrow? • Consumer tastes and advertising • What is popular today? • Price of related goods • What is the price of gas? • What is the price of cable for your television?

8. What Can Change Your Demand? • Price of Related Goods • Complements-two goods are bought and used together • Ski’s • Boots • Poles • Bindings • Substitutes-goods used in place of one another • Ski’s and snowboards

9. Supply • Supply • the amount of available goods • law of supply • tendency of suppliers to offer more of a good at a higher price

10. Cost of Production • Marginal Product of labor • Marginal Product of Labor (5.6) is the change in output from hiring one more worker (increases, decreases).

11. Marginal Product of Labor Labor (# of workers) Marginal Product Output 1 4 4 2 10 6 3 17 7 4 23 6 5 28 5 6 31 3 7 32 1 8 31 -1

12. Cost of Production • Increasing Marginal Return • is the level of production in which the marginal product of labor increases as the number of workers increase. • Diminishing Marginal Return • is the level of production in which the marginal production of labor decreases as the number of workers increases. • Capital MUST EQUAL Labor • Negative Marginal Returns • reverses the productivity of the operation (workers in each others way).

13. Cost of Production • Fixed Cost • a cost that does not change, no matter how much of a good is produced • Rent • Machinery repairs • Property taxes • Salaried workers • Manager • Desks • Chairs

14. Cost of Production • Variable Cost • a cost that rises and falls depending on how much is produced • Electricity • Heat bills • Capital to produce the goods • Office supplies • Paper • Pens and pencils • Hourly workers

15. Cost of Production • Total Cost – fixed cost plus variable cost • The amount of money required to run the firm • Marginal Cost – the cost of producing one more unit of a good (5.9) • With beanbags – lower with specialties of the 1st and 3rd, then increases • More workers --- fixed production Facility

16. Setting Output • How many employees to hire? • Remember, goal is to maximize profits! • Highest profit? Total Revenue /vs/ Total Costs

17. Setting Output • Marginal Revenue and Marginal Cost • Marginal Revenue • is an additional income from selling one more unit of a good; sometimes equal to the price. ***The ideal level of output is when marginal revenue equals marginal cost.

18. The Shut Down Decision • When do you shut down an operation facility? • variable costs – costs when the facility is up and running. • fixed costs – owner pays whether the factory is open or closed. • Stay open if the benefit of operating (total revenue) is greater than the variable costs!!! • Total Revenue > Variable Costs

19. Chapter 6 Prices • Section 1 Objective: • to identify the nature of prices in regards to supply/demand • Section 2 Objective: • to identify how change in the market affects equilibrium • Section 3 Objective: • to identify the role of prices.

20. Combining Supply and Demand • Balancing the Market Buyers and Sellers= Equilibrium (market clearing) Demand and Supply

21. Defining Equilibrium • Equilibrium -the point at which quantity demanded and quantity supplied are equal. • At equilibrium, the market for a good is stable • Disequilibrium – occurs when the quantity supplied is not equal to quantity demanded. • every price that is not at equilibrium is at disequilibrium!

22. Disequilibrium • Excess Demand – is when the quantity demanded is more than the quantity supplied. • low prices encourage excess demand • as long as there is excess demand, suppliers will keep raising the price until the market cannot handle it.

23. Disequilibrium • Excess Supply – is when the quantity supplied is more than the quantity demanded. • sellers do not like to waste their resources on excess supply, especially when the excess cannot be stored.

24. Changes in Market Equilibrium • Changes in Price • market wants equilibrium price and quantity • Excess demand leads to higher prices. • Higher prices lead to rising supply and quantity demanded to fall. • Excess supply will cause price cuts and quantity demand to rise

25. Changes in Market Equilibrium • Shifts in the supply curve • advances in technology • new government taxes/subsidies • changes in the prices of raw materials and labor • a shift in the supply curve will create a new equilibrium

26. Changes in Market Equilibrium • Understanding a shift in supply • Early 1980s – CD player cost $1000 • In 1987 – CD player cost $300 • Today – CD player costs ??? • Machines today have more feature and are better than the machines of the early 1980s • Also, the price to produce and manufacture has gone down, so this passes on the savings to us. • Demand is also not as high, either.

27. Changes in Market Equilibrium • Finding a New Equilibrium • Surplus – situation in which quantity supplied is greater than quantity demanded; also, known as excess supply • Excess supply will lead to decreased prices, which will lead to an increase in demand. • Changing Equilibrium • Equilibrium changes as the market conditions change (demand/supply). • Sales, Rebates, Price Changes

28. Changes in Market Equilibrium • Problem of Excess Demand • Ipod’s or PS3’s • Shortage • situation in which quantity demanded is greater than quantity supplied. • Search Costs • the financial and opportunity costs consumers pay when searching for a good or service.

29. The Role of Prices • Prices in the Free Market • gives the consumer choices (bartering) • The Advantages of Prices • Price as an incentive can cause consumers to buy more, which can cause producers to make more. • Prices as Signals • At low prices, people buy………at high prices, people tend not to buy. • Low prices tend to slow production, whereas high prices increase production

30. The Role of Prices • Flexibility • Prices are more flexible than output levels. (Short/Long Run) • Supply Shock – is a sudden shortage of a good (excess demand). • Rationing – is dividing up goods or services using criteria other than price. *this can be expensive and time consuming

31. The Role of Prices • Price System is “Free” • The market can control prices without the use of government • Rationing and Shortages • Former Soviet Union /vs/ The United States • Communism /vs/ Wartime • Black Market – is a market in which goods are sold illegally • Ex: Stealing TV's and Selling them • Importing Illegal OR Prescribed Drugs and selling them