ECON Notes Chapter 3
ECON Notes Chapter 3 ECON 200
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This 6 page Class Notes was uploaded by Lucy Notetaker on Monday September 5, 2016. The Class Notes belongs to ECON 200 at University of Maryland taught by Dr. Robert Schwab in Fall 2016. Since its upload, it has received 217 views. For similar materials see Principles of Economics: Microeconomics in Economics at University of Maryland.
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Date Created: 09/05/16
ECON 200: Chapter 3- Markets Markets Market Economy: An economy in which private individuals, rather than a centralized planning authority make the decisions Market: buyers and sellers who trade a particular good or service - It’s the people, not the place (considering we think of a market as a store to get fresh produce or antique goods) Competitive Market: a market in which fully informed, price-taking buyers and sellers easily trade a standardized good or service. - Basically to be competitive, a market must compete for customers Four Characteristics of a Competitive Market 1. Standardized Good: a good for which any two units have the same features and are interchangeable 2. One must have full information about what they are buying (price and features) 3. No transaction costs: the costs incurred by buyers and sellers in agreeing to and executing a sale of a good or service 4. Price Taker: a buyer or seller who cannot affect the market price (so there is no bartering, the price is the price) - So that’s a lot of definitions…let’s try and put this into perspective a bit with an example. Let’s look at the mechanical pencil market. You have BIC, Papermate and Pentel. They all line the Staples shelf and in this competitive market you get to choose whatever pencil you like the most. 1) It is standardized, because you can use any of the pencils on printer paper. They are all compatible with printer paper. 2) The price is on a little sticker on the back of a pack, so you know. There is also information like “infinite lead” or “comfort grip”. You are well aware of what every pencil is offering you. 3) You don’t have to pay someone to allow you to buy a pencil pack. 4) If Papermate decided to hike up the price of a three pack to 20 dollars no one would buy their pencils. Therefore they do not control the market. - There is no truly perfect competition Demand Demand: How much of something people are willing to buy under certain circumstances - This depends on price and that is an individual decision, collectively what people are willing to pay is the market demand Quantity Demanded: the amount of a particular good that buyers will purchase at a given price during a specified period - The cheaper it is the higher the quantity demanded - Example: when Staples has their penny sales where you can buy notebooks and markers for a penny the demand is extremely high Law of Demand: a fundamental characteristic of demand which states that all else equal, quantity demanded rises as price falls - It’s the fancy law that is basically saying price and demand are an inverse relationship - But…keep in mind all else must be the same (ceteris paribus). This does not hold true if a cheaper car falls apart in a year, but a more expensive car holds up for 10 years or if incomes rise. - Other factors are called nonprice determinants Demand Schedule: a table that shows the quantities of a particular good or service that consumers will purchase at various prices Demand Curve: a graph that shows the quantities of a particular good or service that consumers will demand at various prices - They are the same thing, just different visuals. Both show the inverse relationship between demand and price. Determinants of Demand - If all other factors are not held constant, the demand curve will shift - There are 5 non price determinants (keep in mind, some involve money but not the basic theory of the demand curve) 1. Consumer Preference: The likes and dislikes of a consumer. Let’s look at donut demand (we’ll use this for every category). Maybe the demand is low, because people don’t want the unhealthiness of a donut in their body so they opt for a baked apple instead. 2. Prices of Related Goods: - Substitutes: goods that serve a similar enough purpose that a consumer might purchase one instead of the other. If they are similar, we call them close substitutes. - Complements: goods that are consumed together, so if demand for one goes up then the other is likely to follow - Back to donuts. Let’s say the price of a donut skyrockets, you would substitute with a churro because they both fill the same need for sweet dough. But let’s look at a compliment of donuts, coffee. If donut prices skyrocket then demand for coffee will go down as well, potentially. 3. Incomes: The amount of income people receive, affects demand of goods - Normal Goods: Goods that follow this pattern, as income increases demand increases - Inferior Goods: Goods that follow the opposite pattern, as income falls, demand goes up - Depending on who you ask, donuts can be an inferior good or normal good. A middle class family may buy donuts for a class when they have less income because they can’t afford to buy cookies from a local bakery. They are treated it as an inferior good. But a poorer family might see a donut as a normal good, considering dessert foods are a luxury in their meal budget. They would have to wait for a substantial paycheck to afford a donut for their family to eat. 4. Expectations: Consumers might expect prices to rise and fall and that will affect purchase - Let’s say that all the wheat plants are dying from a mysterious disease and donut prices will be going up. People might rush out and grab the last of donuts while they are still cheap. 5. Number of Buyers: The more the target audience increases then the more demand will increase - If there is an increase in children in the neighborhood, donut sales could potentially go up. Shifts in The Demand Curve - If these 5 factors change, the demand curve will either move to the right or left. - It will always shift horizontally because quantity demanded is changing, not the price (these are non-price). - If demand decreases, it shifts to the left…increases then it goes to the right - Shifts move the entire curve - If only price is being affected then we just move points, rather than shift the whole thing over - Page 58 compares the difference between shift and movement if my wording is muddy - “Change in demand” means non price determinant is changing while “change in quantity demanded” means the price is moving demand Supply Supply: how much of a good or service producers will offer for sale under a given circumstance Quantity Supplied: the amount of a particular good or service that producers will offer for sale at a given price during a specified period Law of Supply: States that all else equal, quantity supplied will rise with price - Unlike the law of demand this is a direct variation rather than inverse relationship - Example: A fisherman has tuna, trout and salmon. If people are buying his salmon and salmon is generating the most money, he will fish for salmon most frequently or even switch to salmon fishing full time. Supply Curve Supply Schedule: a table that shows the quantities of a particular good or service that producers will supply at various prices Supply Curve: a graph that shows the quantities of a particular good or service that producers will supply at various prices - Literally the same thing as demand, but replace demand with supply - It is the willingness to sell Determinants of Supply - When these 5 non price determinants change the entire curve will shift 1. Price of related goods- back to the donut example…let’s say your feeling very uncreative one day so your donut shop only sells jelly filled and glazed donuts. The jelly donuts are not even selling, so then you would make solely glazed donuts 2. Technology- You get a new donut filling machine, so now it’s more efficient to produce donuts. You will increase your supply in this case 3. Prices of Inputs- The cost of sugar goes up by 50%, as a result your supply of donuts goes down because producing them is very costly. 4. Expectations- Let’s say donut sales are projected to go up. Then you would want to have an increased supply made so when they do go up you could capitalize on sales. 5. Number of Sellers- The more donut shops there are, the supply will decrease because more people offer a product and as a result there is more competition. Shifts in Supply Curve - It’s the exact same thing as the demand curve, just with supply - Non price=supply change Price=quantity supplied changes - Supply decreases then curve moves left, increases curve to the right Market Equilibrium - So let’s talk about price…it is determined by the interaction between supply and demand - In a perfect market the quantity supplied=quantity demanded Equilibrium: the situation in the market when the quantity supplied equals the quantity demanded- it’s where the demand curve and supply curve touch Equilibrium Price: Simply, it’s the price at this special point Equilibrium Quantity: The quantity at this special point - Essentially this point is where buyers and sellers agree on a quantity of goods at a given price - The equilibrium price is also called the market clearing price Finding Equilibrium - It is done by trial and error (sorry there is no epic formula) Surplus: when the quantity supplied is higher than the quantity demanded (I’m throwing that word quantity in there on purpose because we are talking about price, not other factors) - This is also called an excess supply and will lead to a lowered price to find equilibrium Shortage: when the quantity demanded is higher than the quantity supplied - also called excess demand and will lead to a higher price to reach equilibrium - Example Time: There is a chapstick on the market that comes with the promise of giving the illusion of enlarged lips without plastic surgery through the use of swelling chemicals. The maker is so confident he produces 5,000 of them, but people are scared of the ingredients so no one buys them. He is left with a surplus. But maybe he only makes 5,000 and women all over the world go wild to try and get their hands on a chapstick. He would then have a shortage. Changes in Equilibrium - When either curve shifts, then equilibrium point will shift too - There are three question, when dealing with a non price change 1. Does the change affect demand? Increase or decrease? 2. Does the change affect supply? Increase or decrease? 3. How does the combination of changes in supply and demand affect the equilibrium price and quantity? - If the demand changes, and supply doesn’t the curve will shift and the equilibrium will change both price and quantity - If supply changes, and demand doesn’t, the equilibrium will still shift in quantity and price - If both supply and demand changes, here is a table to understand what will happen to price and quantity - It’s a careful balance to keep equilibrium in check So hopefully I have “supplied” you with enough information to get through this chapter. If you have any “demands” just let me know. I’m trying to find an “equilibrium” between being informative and over doing it with note length.