Markets I: Supply and Demand Basics
Markets I: Supply and Demand Basics ECON 201
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This 11 page Bundle was uploaded by Chip Brothers on Wednesday September 21, 2016. The Bundle belongs to ECON 201 at University of Tennessee - Knoxville taught by Dr. Ken Baker in Fall 2016. Since its upload, it has received 5 views. For similar materials see Intro to Economics in Economics at University of Tennessee - Knoxville.
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Date Created: 09/21/16
Markets I: Supply and Demand Basics Creating “The Market” • ‘The Market’ determines the price • The Market (more or less) sets the price for all items • As consumers, we choose whether to buy and how much to buy • As businesses, we choose whether to produce and how much • When the two sides come together (interact), the determine the price • Economists try to capture this with the model of Supply and Demand • Economists create the model of supply and demand by representing two sides of the market • On one side – Demand: The BUYERS • They value the item/product/service and would like to buy/use it • On the other side – Supply: The SELLERS/PRODUCERS • They would like to make the item and sell it as a profit • We try to ‘capture’ (model) their behavior • What makes buyers behave the way they do? • What makes sellers behave the way they do? Demand All those willing and able to buy the good/service make up the demand side of the market All those interested or even potentially interested: 1. Households: buy final goods/services (groceries, phones, clothes, etc.) 2. Businesses: buy inputs and resources (labor, raw materials, etc.) 3. Government: buy services (senators) and goods (warships) Back to our basic question: • What to produce? How much of a good to produce? How much do buyers want? Part of the answer lies with buyers – how much do they really want? • What affects buyer behavior? • Why do you buy the things you do? • What could change in your life to induce you to buy more or less of a good/service than you do right now? • How many times a year do you go to the movies? • What could change that would induce you to go more or less often? Price, different movies being shown, convenience of location, quality of experience, etc… • There are MANY factors that influence your decision to buy or not buy something • Some of the factors considered more important: • Price of the good itself • Income of consumers • Prices of related goods (popcorn, netflix) • Price expectations by consumers (if you think prices will rise in future, you might buy more today) • Consumer preference • Anything else Price of the Good/Service Itself Quantity Demanded (Q ): TDe amount of a good or service that people are willing and able to buy at various prices, ceteris paribus • Ceteris Paribus means holding all factors (2 - 6) constant • Very simply, Quantity Demanded is your number • I want to go to the movies (x=quantity demanded) times per year • I usually buy x cups of coffee per week Law of Demand: Price and quantity demanded are negatively related, ceteris paribus • As price rises, quantity demanded falls • people wish to buy less of the good as it becomes more expensive • As price falls, quantity demanded rises • people wish to buy more of the good as it becomes cheaper Price and Quantity Demanded There are 3 ways to show the negative relationship between price (P) and quantity demanded (Q ) D 1. Demand Function: a mathematical representation of the relationship between price and quantity demanded 2. Demand Schedule: a table showing the relationship between P and Q D 3. Demand Curve: a graphical representation of the relationship between P and Q D *All three show the exact same thing, just in different formats Demand Function: Example Demand Function: A mathematical formula that shows the relationship between the price of the good/service (P) and the amount demanded (Q )D Suppose fictional person named K demands “do-dads” • We can write K’s demand for do-dads as a function • A mathematical representation of K’s behavior • This shows the relationship between the price of do-dads (P) and the amount he wishes to buy per month (quantity demanded) P = $18 – 3Q D Demand Schedule: Example Demand Schedule: A table that shows the relationship between the price of the good and the amount demanded We can fill in the schedule by plugging numbers into the function P = $18 – 3Q D Example – K’s demand for do-dads Q (do-dads/month) ALL OTHER FACTORS THAT AFFECT THE QUANTITIES OF GOODS BUYERS ARE PREPARED TO BUY ARE HELD CONSTANT WHEN THEY CHANGE, THEY SHIFT THE DEMAND CURVE Demand Shifters: Income Normal Goods: have a positive relationship between income and quantity demanded • As your income ↑, so does the amount you demand (quantity demanded) • As K’s income increases, K purchases more do-dads per month, even if the price stays the same, • Graphically, this shifts each point to the right • Opposite also true – as income ↓, so does the amount of the good buyers demand, shifting each point to the left • Inferior Goods: the exception to the rule; as income ↑, people demand less of the good • Examples? (lottery tickets, natty light) Demand Shifters: Income Demand Shifters: Prices of Related Goods When 2 goods are related, it means that when the price of Good A changes, consumers respond by changing the amount they buy of Good B Complement Goods: When goods A & B are consumed together • Examples? Shampoo and conditioner • How are they related? When you buy one, you generally buy the other What happens to the amount of Good A purchased when the price of Good B rises? • Amount of A purchased falls • Demand for A shifts to the left Substitute Goods: When goods A & B are consumed in place of one another • Examples? Pepsi and Coke • How are they related? One can be consumed just as likely as the next What happens to the amount of Good A purchased when the price of Good B rises? • Amount of A purchased rises • Demand for A shifts to the right *A change in the price of one of these will graphically shift the demand curve of the other (related) good Demand Shifters: Tastes/Preferences • Preferences/tastes change over time • Some goods become more popular, some become less popular • When there is a change in the general preference for a product, we show that graphically as a shift in its demand curve • More popular – shift outward (right) • Less popular – shift inward (left) Demand Shifters: Price Expectations Buyers sometimes expect the price of the good to change in the future; This may affect how much of the good they want to buy now Q. If buyers think the price of the good will rise in the near future, will they want to buy more or less today? A. More before the price of the good will increase • Graphically, this causes a rightward shift in the curve • Opposite is also true *Anything, other than a change in the price of the good itself, that makes buyers wish to buy more or less of the good will shift the demand curve Individual and Market Demand Market Demand: the summation of each individual’s quantity demanded at every price • As an example, simplify our world to 3 people who demand do- dads – K, L, and M: Market Demand Shifters Increase in Market Demand • Increase in consumer incomes • Decrease in price of complement good • Increase in price of substitute good • More popular • Belief that price will rise in near future • Increase in number of buyers • Any change (Other than the price of the good itself) that would cause consumers to buy more of the good/service Decrease in Market Demand • Decrease in consumer incomes • Increase in price of complement good • Decrease in price of substitute good • Less popular • Belief that price will fall in near future • Decrease in number of buyers • Any change (OTHER THAN THE PRICE OF THE GOOD ITSELF) that would cause consumers to buy less of the good/service Demand vs. Quantity Demanded A change in the price of the good itself will cause a movement along the demand curve and is called a change in quantity demanded Supply The other ½ of the market: All those willing and able to produce/sell/supply the good/service make up supply • All those interested or even potentially interested • Could be households, firms, or governments Back to our basic questions: • What to produce? (How much of a good to produce?) • How many gallons of milk to produce? • How many barrels of oil to extract and process? • How many pairs of shoes? Pounds of coffee, etc. How many do sellers want to make? Part of the answer lies with buyers – but the other part of the answer lies with the sellers: How many are they willing to produce? What affects how many they want to make? 1. Price of the good/service itself 2. Price of inputs used in production 3. Expected price 4. Change in technology of production Price of the Good/Service Itself Quantity Supplied (Q ): She amount of a good or service that sellers are willing and able to supply at various prices, ceteris paribus • Again, holding all factors (except price) constant • Very simply, Q is the supplier’s preferred number • As a producer of blue jeans, I want to produce Q S blue jeans per day • As a producer of tee-shirts, I want to produce/sell Q S tee-shirts per day Law of Supply: Price and quantity supplied are positively related, ceteris paribus • As price rises, quantity supplied rises • When the price rises, firms wish to supply more of the good/service • As price falls, quantity supplied falls • When the price falls, firms wish to supply less of a good/service Price and Quantity Supplied Like demand, there are 3 ways to show this relationship between price (P) and quantity supplied (Qs) 1. Supply Function: mathematical representation of the relationship between P and Quantity supplied 2. Supply Schedule: table that shows the relationship between P and Qs 3. Supply Curve: graphical representation of the relationship between P and Qs Supply Function and Schedule: Example Suppose that there is a fictional producer of do-dads: Mr. Bud ALL OTHER FACTORS THAT AFFECT THE QUANTITIES OF GOODS SELLERS ARE PREPARED TO SUPPLY ARE SHIFT FACTORS, MEANING THEY SHIFT THE SUPPLY CURVE Supply Shifters: Price of Inputs To produce any good or service, firms have to buy inputs • Firms buy labor, capital, fuel, electricity, transportation, raw materials, etc. • They turn these inputs into output • What happens to the amount of output a firm can/desires to produce if the price of its inputs rises, (holding the price of the output good it sells the same)? • It becomes more expensive to produce, so the firm will produce less • Graphically, this shifts the supply curve left at every price • Opposite also true Supply Shifters: Price Expectations Sellers sometimes expect the price of the good to change in the future, and this may affect how much of the good they want to produce and sell today • If sellers think the price of the good will fall in the future… • they might supply more today (while the price is still high) • Graphically, this would shift the supply curve to the right • Opposite also true • If sellers believe the price will rise in the future, they might reduce the supply now • Graphically, this would shift the supply curve to the left Supply Shifters: Advance in Technology A change in technology increases the productivity of the firm and its workers, meaning the firm can produce more output with the same amount of resources/inputs An advance in technology of production always increases productivity *Anything, other than a change in the price of the good itself, that makes sellers wish to supply more or less of the good will shift the supply curve Examples: weather (agriculture), Government regulations Individual Market and Supply Market Supply: the summation of each firm’s quantity supplied at every price Market Supply Shifters Increase in Market Supply • Decrease in price of inputs • Advancement in production technology • Belief that price will fall in the near future • Increase in the number of sellers • Any change (Other than the price of the good itself) that would cause producers to sell more of the good/service Decrease in Market Supply • Increase in price of inputs • Belief that price will rise in the near future • Decrease in the number of sellers • Any change (OTHER THAN THE PRICE OF THE GOOD ITSELF) that would cause producers to sell less of the good/service Supply vs. Quantity Supplied A change in the price of the good itself will cause a movement along the supply curve and is called a change in quantity supplied
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