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UR / Economics / ECO 108 / What is the law of demand?

# What is the law of demand? Description

##### Description: -Demand and demand curves -Supply and supply curves -Taxation and supply/demand -Marginal value -Producer/Consumer surplus and Social Gain -Deadweight loss -Subsidization and deadweight loss -Price Ceiling
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Midterm

## What is the law of demand?

-February 27 (Weds)

-Dewey 1-101 if last name is A-G

-Hubbell Auditorium if last name is H-Z

*previous exams are on the webpage: eco108.landsburg.com

Topics

-Demand and demand curves

-Supply and supply curves

-Taxation and supply/demand

-Marginal value

-Producer/Consumer surplus and Social Gain

-Price Ceiling

Demand and demand curves

1. The Law of Demand

a. When the price goes up, the quantity demanded goes down

b. If the price of a commodity (i.e. carrots) goes up, people want less carrots c. There are no exceptions to this Law, possible exceptions occur when other factors beyond price change

## Why you should believe the law of demand?

i. Ex: high demand for super expensive cars

1. This is extremely rare

2. The price does increase with demand, but so does the consumer

perception of the car, thus it is affected by factors beyond the

scope of the Law

d. Why you should believe the Law of Demand

i. Logically, if something increases in price you are incentivized to not buying it

2. Graph of the Law of Demand

a.

## What is the “law” of supply?

b. The line “D” is called the “demand curve” We also discuss several other topics like How do microbes uptake nutrients?

i. Demand curve is a function

ii. Demand curve slopes down

iii. Keep in mind that the curve is not always straight, can be curved c. Curve can be steeper or shallower

i. The steepness or shallowness demonstrates the commodity’s sensitivity to price

1. The more steep means the less sensitive, the more shallow

means the more sensitive

ii. Steep curves usually represent consumer insensitivity to price, the opposite with shallow curves

iii. 3. Change in Demand

a. When something other than price changes, demand as a function changes and the curve moves

i. We also discuss several other topics like Epistemology is the study of what?

b. A change in price can simply be accounted for by looking at the given curve c. Ex

d. Movement

i. Movement to the right is an increase

ii. Movement to the left is a decrease

e. We also discuss several other topics like What is the act of obtaining a desired object by offering something in return?

Supply and supply curves

1. The “Law” of Supply

a. When the price goes up, the quantity supplied goes up

b. Quotes are around “law” because there are significant exceptions

i. Ex 1: coffee shop

1. You want to sell 100 cups of coffee a day and make \$200 a day If you want to learn more check out Most mayan instruments are gendered musical performance is for what gender?

(\$2 per cup)

2. When the price raises to \$3 per cup, you are incentivized to sell

more at \$3 per cup (say 150 cups)

3. But, you are also incentivized to sell LESS because you can sell less cups at the \$3 rate to reach your goal

ii. If you are a profit maximizing firm, the “law” of supply holds true 1. The coffee shop example is the exception because you as an We also discuss several other topics like What are the developmental stages in gender identity?

individual are not always seeking to maximize profit

c. For this class, just assume that the law always holds true

2. Graph of the supply curve

a. We also discuss several other topics like How can you tell if a protein has been extruded into a microsome from an mrna encoding secretory protein?

3. If something other than price increases, the curve shifts

a. Fall in supply is a leftward shift, increase in supply is a rightward shift b.

4. But the intersection of the supply and demand curves is where the price is

a.

b. In this example, the quantity bought has to equal the quantity sold i. If supply surpasses demand, consumers don’t want to buy more ii. If demand surpasses supply, there isn’t enough to satiate demand 5. Determining price practically

a. b. Don’t think in terms of price, think in terms of supply and demand i. Just thinking in terms of price creates a logical loop

ii. When feed price goes up, farms raise less pigs and pork chops increase in price, but then price decreases as to meet the lower demand, but then price increases so farmers can sell more, but then price is lowered…. Etc etc

c. Thinking in terms of supply and demand

i.

ii. The supply curve falls to the left

iii. Demand doesn’t change, people don’t care about the price

iv. To solve the question of if demand changes

1. Imagine you are at a store and buying pork chops, do you ask the

manager how much it costs to feed the pigs?

2. If you say no, then demand does not change

3. The demand curve only moves if the information is relevant after

the price of the commodity is known

a. It might be relevant before, but it does not matter

v. Thus, price goes up and quantity goes down

d. In the end, you always end up at equilibrium

i. Using the graph quickens the process of determining price

ii. The story of competition and incentives leading to equilibrium when the supply and demand is too high or low is skipped with this graphing

process

Taxation and Supply/Demand

1. Sales tax on coffee, 10 cents per cup

a. Treat the sales tax as the buyer’s money going to the government

i. The seller taking the money and giving to the government as a middle man is irrelevant

b. With tax, what is the price (if coffee is 50 cents)?

i. Is it 50 cents (original)

ii. Is it 60 cents (original + tax)

c. For now, the price will not include tax, price NEVER includes sales tax i. So 50 cents

d. This is a change in something other than price, thus the demand curve moves i. But this could be perceived as a change in price (if you think tax is part of the price), thus demand curve wouldn’t move

e. i. The D curve shifts and the new point is denoted by the black point 2. What does tax do to the D curve

a. b. How much coffee will people buy if the price is 60 (60+10) cents on tuesday? i. 600 cups

ii. The black point (600, 60 cents) is a point on the new demand curve which results from the tax

c. What if the price is 50 cents (50+10) on tuesday?

i. 800 cups

ii. The black point (800, 50 cents) is a point on the new demand curve which results from the tax

d. Thus we have a new demand curve (denoted by the dotted line labeled D sub-Tuesday)

e.

i. The curve shifts 10 cents down (vertical shift)

ii. DO NOT denote the curve by any shift other than vertical, you can only denote a change in price in accordance to the price axis (in this case the y-axis)

3. What does tax do to the price?

a. b. The supply curve does not shift

c. New price is at the new equilibrium

d. Cannot specifically state the new price as there is not enough information i. But can give a range between 75 cents (original price) and 65 cents (observe the location of the new equilibrium in relation to the downward shift of the old equilibrium to understand the 75 to 65 range)

4. Since you know the new and old D curves are 10 cents apart, you can make certain assertions based on that

a.

c. Shortcut

i. ii. Find the point where the vertical distance between the S and D curves is equal to the tax

d. Sellers care about the new price, buyers care about the new price + tax i. Sellers want to sell at a higher price

5. Effect of excise tax on supply and demand

a. Tax paid by the seller to the government each time they sell a product b. i. The supply curve shifts up

c. General movement

i.

d. What does the tax do to price

i.

e. Since you know the new and old S curves are 10 cents apart, you can make certain assertions based on that

i.

ii. Shortcut

1.

Marginal Value

1.

Apples

Marginal value

1

\$12

2

\$10

3

\$7

4

\$5

5

\$2

6

\$1

a. Marginal value refers to how much you would pay for the next apple given the price of the previous apple

b. Marginal value decreases in this example, this is true of most real-world commodities

c. Logically, this makes sense since you are less willing to pay more for an item you already have

2. Graph of marginal value

a.

3. Demand curve of the marginal value

a.

4. Notice how both curves are identical

a. Marginal value is a function that takes Quantity as an input and puts out Price as an output

b. Demand curve is a function that takes Price as an input and puts out Quantity as an output

5. Graphing price and marginal value

a.

b. i. Keep in mind that this is an estimation (the triangles are not accounted for), it can be made more accurate by taking the area along smaller

intervals

6. Total value is the area under the demand curve out to the area of the quantity purchased a.

Producer/Consumer Surplus and Social Gain

1. Producer surplus = total revenue - variable cost (PS = TR - VC)

a.

Q

MC (\$)

1

3

2

7

3

9

4

10

5

12

b.

2. Social gain is the total benefit to society from producing or consuming a service a. SG = CS + PS

b.

3. The value of this gain is not altered by price

4. Social gain is not always directly enjoying the commodity

a. You could gain from the production of cookies by enjoying the smell of the cookie factory

1. The reduction in social gain due to tax

2. SG (no tax) - SG (tax)

a. In the example: (A+B+C+D+E+F) - (A+B+D+F) = C+E

b.

a. Reduction in social gain

b. Gains to winners are less than losses to losers

c. Piece of pie that got discarded

d. A loss to someone that is not offset by a gain to anyone else

i. Phone example

1. If you lose your phone and someone takes it, it is not a

a. You lose, but someone else gains

2. If you lose your phone and it’s destroyed beyond repair, then it is a

a. You lose, and no one gains

e. “Missing rectangles”

i. ii. Missed the chance to create additional social gain due to the tax

1. A subsidy is a sum of money granted by the government to assist an industry or

business so the price of the commodity or service can remain low

2. Graph

a.

i. A subsidy functions like a negative tax (it moves the demand curve up)

b. You actually don’t have to draw the new demand curve to find the new price, like tax, just find the point right of the original equilibrium where the distance between

the S and D curves are equal to the subsidy

3.

a.

4.

No subsidy

Subsidy

CS

A+B

A+B+E+F

PS

E+G

B+C+E+G

Taxpayers

-(B+C+D+E+F)

SG (total it up)

A+B+E+G

A+B+E+G-D

DW

D

a. The shaded area shows social loss due to subsidization

Price Ceiling

1. A price ceiling is a government imposed limit on how high a price is charged for a product

2. Graph

a. i. The difference (\$20 and \$5) means that even though the item costs \$5, you spend \$15 waiting to get the item

ii.

No ceiling

Ceiling

CS

A+B+C

A

PS

D+E+F

F

SG

A+B+C+D+E+F

A+F

DWL

B+C+D+E

b.

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