Unit 2 Review

1. Unit 2 Review Chapter 3, 4, 5, and 6

2. Demand • Demand/Quantity is the amount of a good or service that a consumer is willing AND able to buy at various possible prices during a given time period • Consumers must not only want the product, but have means to pay for it • Factors that change over time can affect demand for a product

3. Law of Demand • An increase in a good or service’s price will cause a decrease in demand, and vice versa. • In a free-enterprise system, price is the main variable affecting demand • Consumers will be less willing and/or able to buy goods at higher prices in most cases.

4. 3 factors Affecting Demand 1. Income effect = a change in price affects consumers’ purchasing power  the amount of $ available to spend on g/s. • Increased price = less purchasing power = decreased demand

5. Factors Affecting Demand (Con’t) 2. Substitution effect = tendency of consumers to substitute similar, lower priced items for relatively higher priced ones • Price increase in Mountain Dew will lead many to switch to Moon Mist  demand for Mountain Dew will decrease. • Milk may be substituted for Orange Juice if the price of OJ suddenly increases  demand for OJ will decrease

6. Demand Curve • Shows a graphic representation of the quantity demanded and the price of a g/s during a given time period • Price is always listed on the vertical axis • Quantity demanded is always listed on the horizontal axis Note: As price increases, quantity demanded decreases  downward slope

7. Determinants of Demand • Factors that cause a shift of the entire demand curve – a different quantity demanded at each and every price: • A shift to the right represents an increase in quantity demanded at each price • A shift to the left represents a decrease in the quantity demanded at each price

8. Determinants of Demand • Consumer tastes/preferences  fashion and music tastes are most susceptible • Ex???

9. Determinants of Demand (Cont”) 2. Market Size  an increase or decrease in the number of consumers in a market can have the same effect on some demand curves. 3. Income/Consumer expectations of income  an increase in income will make consumers more willing and able to buy g/s at every price – shift to the right. --less income results in less quantity demanded at each price- shift to the left --If consumers are expecting an increase or decrease in income, that can have the same effects on the demand curve.

10. Determinants of Demand (Con’t) • Price of related goods: • Substitute Goods: • If the price of hamburger increased, the demand for hamburgers would decrease. More people would then buy substitutes, such as hot dogs. The demand curve for hot dogs would shift to the right.

11. Determinants of Demand (Con’t) • Price of Related Goods (Con’t): • Complementary Goods: • Ex: peanut butter and jelly, toothbrush and toothpaste, shampoo and conditioner, hot dogs and buns • If the price of hamburger decreased, people would buy more hamburger and thus, more hamburger buns.

12. Elasticity of Demand • Elastic demand = a small change in price results in major change in quantity demanded: • not a necessity • have readily available substitutes • cost represents large portion of consumer’s income. Ex: art, designer clothes, eating out Note: The curve is almost horizontal  small price change = large demand change

13. Elasticity of Demand (Con’t) • Inelastic Demand = when a price change has little or no effect on quantity demanded • Necessity • Few or no substitutes • Small portion of consumer’s income EX: gasoline, salt, electricity Note: The curve is vertical or near vertical  price has little or no effect on demand

14. Elasticity of Demand • Elastic demand = a small change in price results in major change in quantity demanded: • not a necessity • have readily available substitutes • cost represents large portion of consumer’s income. Ex: art, designer clothes, eating out Note: The curve is almost horizontal  small price change = large demand change

15. Elasticity of Demand (Con’t) • Inelastic Demand = when a price change has little or no effect on quantity demanded • Necessity • Few or no substitutes • Small portion of consumer’s income EX: gasoline, salt, electricity Note: The curve is vertical or near vertical  price has little or no effect on demand

16. Law of Supply • Quantity Supplied is the amount of goods and services that producers are willing to sell at each price in a given time period. • Law of supply states that producers supply more goods and services when they can sell them at a higher price and fewer goods when they must sell them at lower prices • Primary motive is profit = price – production costs • Profit motive directs use of resources and signals for other companies to enter or leave a market

17. Supply Curve • As price increases, quantity supplied increases  upward slope

18. Elasticity of Supply • Elastic supply exists when a small change in price causes a major change in quantity supplied • Note: The curve is nearly horizontal • Products can be made quickly, cheaply, and use few resources. • Ex: shoe laces, pencils, printed materials, T-Shirts

19. Elasticity of Supply (Con’t) • Inelastic Supply exists when a change in a good’s price has little impact on the quantity supplied • Production requires time, money, and resources • Ex: Gold/Diamonds, electronics, medications • Note: The curve is nearly vertical

20. Elasticity of Supply (Con’t) • Perfectly inelastic supply exists when producers cannot supply any more of a product, regardless of price.

21. Determinants of Supply • Non-price factors that shift the supply curve, instead of simply changing the quantity supplied along the original curve. • Prices of Resources: When the price of a resource increase, it adds to the costs of production and lowers profits  supply curve shifts to the left (less supply)

22. Determinants of Supply 2. Government Tools: Taxes, Subsidies, and Regulations. • Taxes: payments made to the government to fund public services  increase production costs  shifts supply curve left • Subsidies: payments made by government to private businesses  lower costs  shifts supply curve right • Regulations: government rules about how companies conduct business  increase costs  shifts supply curve left

23. Determinants of Supply 3. Technology – new technology makes production more efficient  cuts costs  increase supply (shift right) 4. Competition – more competition leads to increased supply as producers enter the market to get a share of the market’s demand. Supply decreases as demand drops and producers leave the market

24. Determinants of Supply 5. Prices of Related Goods: Substitute Goods and Complementary Goods - Price changes have the same effect on a good’s complements – the supply curve will shift in the same direction (price increase = supply increase for comp) - Price changes have opposite effect on a good’s substitutes – if the price of a good falls, it’s substitute will see an increase in supply. (price decrease = supply increase for sub)

25. Determinants of Supply 6. Producer Expectations – When producers expect the price of a good to increase or decrease, they may take proactive steps to increase or decrease supply of a product. - Halloween USA is only open for 2 months of the year  the rest of the year they store their product (decrease supply), and wait for the price/demand for their product to increase before releasing the product back on the market.

26. LAW OF DIMINISHING RETURNS • Describes the effect that varying the level of an input has on total and marginal product • 3 stages of production that can be predicted by the law of diminishing return are • Increasing marginal returns • Diminishing marginal returns • Negative marginal returns

27. 5 Benefits of the Price System Information Incentives Choice Efficiency Flexibility

28. 3 Limitations of the Price System Externalities---Side effects for people not directly connected with production of g/s. Public Goods Instability

29. EQUILIBRIUM Market Equilibrium • Quantity supplied and quantity demanded for a product are equal at the same price • At this point, producers & consumers have communicated effectively.

30. S1 Equilibrium Point (E) D1 QS is EQUAL to QD at $60

31. Quantity supplied exceeds the quantity demanded at the price offered. Need to re-examine costs to see if price can be lowered and still make a profit. Any price above equilibrium will create a surplus S1 SURPLUS B A E D1 SURPLUSES

32. Exists when quantity demanded exceeds the quantity supplied at the price offered. May producers that they are charging too little for the shoes. Any price below equilibrium S1 SURPLUS A B E C D SHORTAGE D1 SHORTAGES

33. S1 D1 S1 S2 E2 E1 E1 D2 E2 D1

34. RATIONING • System in which a government or other institution decides how to distribute a product. • Products are distributed on the basis of policy decisions rather than on the basis of prices determined by supply & demand.

35. CONSEQUENCES OF RATIONING • UNFAIR • Goods & services not distributed fairly. • EXPENSIVE • Costs are high for programs that determine rationing. • CREATES BLACK MARKETS • Goods are exchanged illegally. • Prices are higher than officially established.

36. PERFECT COMPETITION An ideal market structure in which buyers (consumers) and sellers (producers) compete directly under the laws of supply & demand. Examples: tomatoes, corn, milk, beef Perfect competition exists when 4 conditions are met: MANY BUYERS AND SELLERS IDENTICAL PRODUCTS INFORMED BUYERS EASY MARKET ENTRY AND EXIT

37. Sellers offer different, rather than identical, products. Companies strive for unique products. Product variation is more common. Monopolistic competition is more common than perfect competition. Example: Jeans, cars, shoes Product Differentiation Nonprice Competition Profits MONOPOLISTIC COMPETITION

38. Imperfectly Competitive Markets: OLIGOPOLIES A market structure in which a few large sellers control most of the production of a good or service. Example: Gas stations, soda companies Exist when 3 conditions are present: There are only a few large sellers. Sellers offer identical or similar products. Other sellers cannot enter the market easily.

39. OLIGOPOLIES AT WORK NONPRICE COMPETITION • Control prices through nonprice competition. • Advertising • Brand name loyalty. INTERDEPENDENT PRICING • Maintain control by being responsive to the pricing actions of competitors.

40. OLIGOPOLIES AT WORK COLLUSION • Sellers secretly agree to set production levels or prices for their products. • Illegal • Carries penalties and even prison sentences. CARTELS • Companies openly organize a system of price setting & market sharing. • Illegal in U.S. • Unstable & short-lived.

41. Imperfectly Competitive Markets: MONOPOLIES • A market structure characterized by a single seller of a unique product with no close substitutes. Example: cable TV • Monopolies exist when three conditions are met: • There is a single seller. • No close substitute goods are available • Other sellers cannot enter the market easily.

42. TYPES OF MONOPOLIES • Natural Monopolies • Geographical Monopolies • Technological Monopolies • Government Monopolies

43. EARLY ANTITRUST LEGISLATION • Antitrust Legislation • Interstate Commerce Act - 1887 • Sherman Antitrust Act - 1890 • Clayton Antitrust Act - 1914 • Federal Trade Commission Act - 1914 • The Robinson-Patman Act – 1936 *Primary goal is to encourage competition. Secondary goal is to protect consumers against predatory pricing policies.