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Supply and Demand Interactions

Supply and Demand Interactions. The interaction of supply and demand. The primary function of the market is to bring buyers and sellers together in order to establish a price and to make an exchange.

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Supply and Demand Interactions

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  1. Supply and Demand Interactions

  2. The interaction of supply and demand • The primary function of the market is to bring buyers and sellers together in order to establish a price and to make an exchange.

  3. Suppliers would find that as they lower the price for sandwiches they would be able to sell more sandwiches. • At $3.30 there would be a surplus of sandwiches because suppliers would be producing 500, but consumers would be purchasing only 300. • If the suppliers decided to sell their sandwiches for $3.30, consumers would be willing to purchase 300 per week.

  4. Similarly if suppliers charge a price that is too low they will be faced with a shortage of sandwiches, they will then continue to increase the price until an equilibrium price is reached. • Suppliers will continue to reduce prices until they reach a price at which the quantity demanded is equal to the quantity supplied, the equilibrium price.

  5. The equilibrium price changes if changes take place in the factors that affect the demand or supply sides of the market.

  6. What effect does an increase in the price of hamburgers (competition)have on the equilibrium price of sandwiches?

  7. How will an increase in the price of butter used in the production of sandwiches, affect the equilibrium price of sandwiches?

  8. Operation of a Free market system • Choosing how to best handle scarce resources is a challenge for many markets. Decisions have to be made: • What products and services are these resources going to produce? • Who will receive these products and services when they are available? • These questions can be answered by the price system technique.

  9. The price system is the technique by which scarce resources are allocated to the production of those products and services that provide the greatest return to the resource owner. • In this way, the system of prices, rents, wages, and interest organizes economic activity.

  10. The price system has two distinct advantages in allocating resources: • It is efficient in allowing thousands of individuals to cooperate in making economic decisions, and • It transmits information to buyers and sellers which assists consumers in allocating their limited income to various purchases and encourages sellers to adopt the least costly and most efficient means of production.

  11. The free-market system and its establishment of prices through the interaction of demand and supply provides insight into the concept of value. • What is the value of a diamond ring? • a new car? • a glass of water?

  12. elasticity • The law of downward-sloping demand states that, all other factors remaining constant, the quantity demanded of a product increases as the price falls. • Price elasticity of demand measures the extent to which the quantity of a product demanded responds to a change in price. • Price Elasticity of Demand Coefficient =

  13. Elastic demand is one in which a price change brings about a greater than proportional change in the quantity that consumers demand. • %ΔQs > % ΔP thus Es > 1 • Ex. A small increase in the price of chocolate bars will likely have a large impact in the number of bars sold.

  14. If a supplier is not able to adjust supply readily when the price changes, the supply is referred to as inelastic. %ΔQs < % ΔP thus Es < 1 • Milk has an inelastic demand curve as price changes have little impact on the amount of milk sold.

  15. Unitary elastic supply is one in which a price change brings about a proportional change in the quantity supplied. • %ΔQs = % ΔP thus Es = 1

  16. Demand for elastic products (chocolate bars) often have flatter demand curves. Inelastic demand curves are often steeper.

  17. Characteristics that affect elasticity • Luxury or necessity • The number if close substitutes • Percentage of budget spent on the product • Length of time since price change

  18. Total revenue approach to price elasticity of demand • The total amount of money that people spend on a product is referred to as Total Revenue. • TR = P x Qd • If the demand for a product is elastic, any decrease in price will increase total revenue; conversely any increase in price will decrease total revenue. when P TR P TR

  19. If the demand for a product is inelastic, any decrease in price will decrease total revenue; conversely any increase in price will increase total revenue. when When the elasticity of demand is unitary, any change in price leaves total revenue unchanged. P TR P TR

  20. Special cases of Price Elasticity of demand • There are two special cases of a demand curve where the price and quantity demanded are not inversely related. • The first is where the price is set and the quantity demanded is unlimited, a perfectly elastic demand (Ed = ∞). • An example of a perfectly elastic demand curve is when U.S. citizens were required to sell all their gold to the government at a price of $35 an ounce.

  21. The second is where a certain quantity is demanded and any price will be paid to acquire that amount, a perfectly inelastic demand (Ed = 0). • This curve may reflect the demand for a necessary drug in which individuals will pay any price to acquire it.

  22. Price Elasticity of supply • The law of upward-sloping supply states that, all other factors remaining constant, the quantity supplied of a product increases as the price increases. • Price elasticity of supply measures the extent to which the quantity of a product supplied responds to a change in price. • Price Elasticity of Supply Coefficient =

  23. If the coefficient is greater than one, supply is elastic, if it is less than one it is inelastic and if the coefficient is equal to one the supply is unitary elastic. • Three major characteristics help determine price elasticity of supply: • Time • Ability to store product • Ability to substitute during production

  24. Other types of elasticity • Income elasticity measures the responsiveness of the change in quantity demanded to changing income levels. • Products with negative income elasticity are inferior goods. • Products with positive income elasticity are normal goods.

  25. Cross-elasticity of demand measures the impact that changes in the price of one product have on the quantity demanded of another product. It is measured as the percentage change in demand for the first good that occurs in response to a percentage change in price of the second good. • Products with negative cross-elasticity are complementary. • Products with positive cross-elasticity are substitutes.

  26. Chapter Review Questions (pg 77) • 1, 2, 4, 7, 8, 9, 11, 14, 15, 18, 20,22

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