Chapter 3 Supply and Demand

Chapter 3 Supply and Demand

What Determines a Person’s Income in the Market? This means… what is the value of the human being? Determined by: a) value of their product…. Rock singer, athlete, Shaq, Oprah, department store clerk, insurance salesman, teacher b) supply and demand…. If lot of people doing same things you are… not likely to be paid much.(underwater welders)……. As demand for product decreases, reduces number of available jobs… gas station jobs! c) if demand for product lacking- rewards minimal and number of competing workers is few, demand high, wages high. 20 years ago… heart surgeons

Who Determines the value of a product? The value of the product is the worth that society puts on it…. What worth does society put on sports? What worth does society put on music industry? What about ---- sport cars, SUVs, large houses, motorcycles, eating out, designer clothes, entertainment. Etc, etc. etc. Education?

What if??? Will this be a recession? • Banks will not loan money? • People lose their jobs? • Companies are not hiring? • People are under-employed? • Consumption decreases significantly?

Characteristics of Recession/Inflation Recession: Businesses not selling what it produces Inventories accumulate Businesses then cut down on employment (hence unemployment/layoffs) Inflation: _____________________________ Government and investors spending more Inventories begin to be depleted Prices increase Production increases More workers are hired

What is a Market? Any Place Where Goods and Services are VoluntarilyExchanged (brings together buyers and sellers) Priceis a primary influence in determining allocation of resources in our free enterprise economy. Difference between Price, Value, Utility Price= value of product in terms of money Value= has to do with relative scarcity = exchange value Utility = satisfaction that good or service can provide

Law of Supply As the price of the product increases, the quantity that the supplier tends to supply also increases. ****Ceteris Paribus Ceteris Paribus Assumption[KAY-ter-us PEAR-uh-bus] • Nothing changes except the factor or factors being studied. • Other things “constant” “equal”

Economics as a Science (cont'd) • Ceteris Paribus Assumption[KAY-ter-us PEAR-uh-bus] • Nothing changes except the factor or factors being studied. • “Other things constant” • “Other things equal”

Law of supply = positive relationship between the quantity of a good supplied and price. PRICE IS THE INDEPENDENT VARIABLE Price moves first = causeQuantity follows = effect

Determinants of Supply • Technique of production (technology) (ovens, organic farming) • Resource Prices (Factor Costs)– cost of inputs • Taxes and Subsidies • Prices of Other Goods – (decline in wheat will cause farmer to shift to corn) • Expectations- (farmers expect price to rise.. Hold back production) • Number of sellers in market – more sellers, greater supply….

Important Concepts Change in Supply (shifting of curve) Or Change in Quantity Supplied (movement along curve)

Ability to Respond to Price varies Often the ability of an individual firm to respond to an increase in price is limited or constrained by its existing scale of operations, or capacity, or ability to obtain resources….. IN SHORT RUN Examples: IN LONG RUN… can adjust. The greater the amount of time producers have to adjust, the greater their output response.

Law of Demand AS THE PRICE OF A GOOD DECREASES THE QUANTITY DEMANDED TENDS TO INCREASE…. ***Ceteris Paribus Price once again is the independent variable!

Wishing for a new boat does not constitute demand… one must be WILLING ANDABLE to purchase a boat. Generally speaking…. The higher the price obstacle, the less of a product a consumers will buy. Bargain days are based on law of demand.

The greater the want satisfaction…. The greater the utility… Marginal Utility… How much more utility do you get adding or subtracting units (more doughnuts… more cars… more steak in one day) DIMINISHING MARGINAL UTILITY. As the number of units of a product a consumer has increases, the satisfying power for each extra unit decreases.

Utility Purpose of Utility analysis is to study howpeople behave not how they think. Theory of consumer choice is based on the idea that each consumer spends his/her income in a way that yields the greatest satisfaction.

Determinants of Demand 1.Preferences 2.Prices of Related Goods 3.Number of Buyers 4.Expectations of future price 5.Income

Determinants of Demand • Tastes and preferences Taste changes throughout our lifetime.

# 2 Determinant: Prices of Related Goods Your preference is Coke… price skyrockets…. Affected in the market by substitute goods and complimentary goods. *Substitute goods… anything that can be substituted for the product or service desired… (Coke/Pepsi, Millers/Coors, potato chips/popcorn). If price of Coke rises… and consumer doesn’t feel strongly about brand preference… will buy Pepsi until Coke price declines) When two products are substitutes, the price of one good and the demand for the other are DIRECTLY RELATED.

*Complementary Goods… Goods that “go along with other goods consumer’s buy” peanut butter/jelly, beer/pretzels, milk/cookies, golf balls/golf tees, When two goods are complements, an increase in the price of one good adversely affects the demand for the other and creates an inverse relationship.

Independent Goods… No connection between price and demand (cars/bread)

Determinants Continued 3. Number of buyers The number of buyers will increase demand for the product which (if supply is fixed) will drive up the price.)

Determinant #4 Income-RATHER OBVIOUS HERE. Show shifts… Superior or Normal goods= commodities whose demand varies DIRECTLY with money income. INFERIOR OR “POOR MAN’S” GOODS. Goods whose demand varies inversely with a change in money income.

5. Expectations… If you are in medical school or law school, the expectation of you getting a larger income when you get out of school will affect your demand for goods… Inheriting money, winning the lottery!

IMPORTANT CONCEPTS OF DEMAND Change in Demand OR Change in Quantity Demanded

Terms to Remember Profit: TR-TC Total Revenue P x Q Marginal Utility To maximize utility, consumers should choose that good which delivers the most marginal utility per dollar. Optimal utility is then achieved. Optimal consumption= mix of output that maximizes total utility for the limited amount of income you have to spend.

Equilibrium • Equilibrium = market clearing price… supply and demand are “in balance.” • Does not occur often if ever with the constantly changing “invisible hand” and the consumer fickleness. • In our U.S. economy we have consumer sovereignty… which tends to shift both curves or move along the curve almost continuously.

Ceilings and Floors Price Ceiling- • a legally established maximum price that sellers may charge (rent control) • Direct effect of a price ceiling is a shortage • Secondary effect- reduction in the quality of the good, inefficient use, lower future supply, black markets,

Price Floors • Price floor is a legally established minimum price that buyers must pay. (minimum wage) • Direct effect= reduces employment of low-skilled labor • Indirect effects – reduction in nonwage component of compensation (perks), lesson-the-job training.

Recap Ceilings and Floors P S P S D D Q Q

Black Markets • Markets that operate outside the legal system • Have a higher incidence of defective products, higher profit rates, greater violence (cigarettes, drugs {both prescription and illegal}, Levis during cold war)

Equilibrium Tutorial Equilibrium

Quiz questions about supply and demand • Question: A survey indicated that chocolate is Americans’ favorite ice cream flavor. For each of the following, indicate the possible effects on demand, supply, or both as well as equilibrium price and quantity of chocolate ice cream. • a. A severe drought in the Midwest causes dairy farmers to reduce the number of milk-producing cattle in their herds by a third. These dairy farmers supply cream that is used to manufacture chocolate ice cream.

b. A new report by the American Medical Association reveals that chocolate does, in fact, have significant health benefits significant health benefits. What happens to Demand for chocolate?

C. The discovery of cheaper synthetic vanilla flavoring lowers the price of vanilla ice cream.*What happens to supply curve for ice cream? • d. New technology for mixing and freezing ice cream lowers manufacturers’ costs of producing chocolate ice cream. *What happens to supply curve for ice cream

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Chapter 3 Supply and Demand