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Chapter 4: Demand, Supply, and Markets

by: David Falcone

Chapter 4: Demand, Supply, and Markets ECON 2005

David Falcone
Virginia Tech

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These notes cover Chapter 4: Demand, Supply, and Markets and will be on Exam 1. All outlines are based on the textbook on Aplia: The Principles of Microeconomics by William A. Mceachern.
Principles of Economics
Steve Trost
Class Notes
demand, supply, lawofdemand, Lawofsupply, Substitutioneffect, Demandschedule, Incomeeffect, ShiftofSupply&Demand, Normalgood, Inferiorgood, Equilibrium, Pricefloor, Priceceiling
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This 11 page Class Notes was uploaded by David Falcone on Thursday September 8, 2016. The Class Notes belongs to ECON 2005 at Virginia Polytechnic Institute and State University taught by Steve Trost in Fall 2015. Since its upload, it has received 4 views.


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Date Created: 09/08/16
Chapter 4: Demand, Supply, and Markets  Demand o The quantity consumers are both willing and able to buy at each price during a given period.  You may be able to buy something, but are you willing.  The Law of Demand o Quantity demanded varies inversely with price o Demand, wants, and needs  Wants are unlimited and is not the same as demand  Need is not the same as demand o The substitution Effect of a Price Change  The definition of demand includes the other-things- constant assumption  The price of one good rises so people switch to other goods  The price of goods remains constant o For example, if the price of pizza declines while other prices remain constant, pizza becomes relatively cheaper. Consumers are more willing to purchase pizza when its relative price falls; they substitute pizza for other goods  Substitution effect of a price change o Remember that it is the change in the relative price—the price of one good relative to the prices of other goods—that causes the substitution effect o If all prices changed by the same percentage, there would be no change in relative prices and no substitution effect.  Demand Schedule- How much of a product a household is willing to buy at different prices (during a fixed period of time) o The Income Effect of a Price Change  A fall in the price of a good increases the quantity demanded for a second reason  Money income- the number of dollars received per period, in this case, $30 per week  Real income- Income measured in terms of the goods and services it can buy; real income changes when the price changes o The lower the price, the greater your real income.  income effect of a price change- A fall in the price of a good increases consumers’ real income, making consumers more able to purchase goods; for a normal good, the quantity demanded increases  When the price of a good rises you feel poorer o The Demand Schedule and Demand Curve  Demand can be expressed as a demand schedule or as a demand curve   Demand curve- A curve showing the relation between the price of a good and the quantity consumers are willing and able to buy per period, other things constant  Will eventually hit the x axis and y axis o Y because there’s always a point where no one can pay o X because the demand curve occurs in a finite period of time  A demand curve slopes downward, reflecting the law of demand: Price and quantity demanded are inversely related, other things constant  Individual demand and market demand  The market demand curve shows the quantities demanded per period by all consumers at various prices o Add up the quantities  Shifts of the Demand Curve o Variables that can affect market demand are  The money income of consumers, the prices of other goods, consumer expectations, the number or composition of consumers in the market, and consumer tastes. How could changes in each affect demand?  This increases Demand rather than just quantity demanded (change in price)  Income- Earnings  Wealth- What a house owns minus what it owes  Changes in Consumer Income o In short, an increase in demand (a factor other than price changes)—that is, a rightward shift of the demand curve—means that consumers are willing and able to buy more pizza at each price. o o Normal good- A good, such as new clothes, for which demand increases, or shifts rightward, as consumer income rises o Inferior good- A good, such as used clothes, for which demand decreases, or shifts leftward, as consumer income rises  Changes in the Prices of Other Goods o Two goods are considered substitutes if an increase in the price of one shifts the demand for the other rightward o Goods used in combination are called complements  Two goods are considered complements if the increase in the price of one decreases the demand for the other, shifting that demand curve leftward  Changes in Consumer Expectations o Another factor assumed constant along a given demand curve is consumer expectations about factors that influence demand, such as incomes or prices. A change in consumers’ income expectations can shift the demand curve o a change in consumers ‘price expectations can shift the demand curve  Changes in Consumer Tastes o Choices in food, body art, music, sports, clothing, books, movies, TV shows—indeed, all consumer choices—are influenced by consumer tastes  Tastes- Consumer preferences; likes and dislikes in consumption; assumed to remain constant along a given demand curve  In our analysis of consumer demand, we will assume that tastes are given and are relatively stable o Movement along a given demand curve- Change in quantity demanded resulting from a change in the price of the good, other things constant  A change in price, other things constant, causes a movement along a demand curve, changing the quantity demanded o Shift of a demand curve- Movement of a demand curve right or left resulting from a change in one of the determinants of demand other than the price of the good  A change in one of the determinants of demand other than price causes a shift of a demand curve, changing demand  Supply o Indicates how much producers are willing and able to offer for sale per period at each possible price, other things constant. o The law of supply- states that the quantity supplied is usually directly related to its price, other things constant  The supply schedule and supply curve o o There are two reasons why producers offer more for sale when the price rises  First, as the price increases, other things constant, a producer becomes more willing to supply the good  A higher price makes producers more willing to increase quantity supplied  Higher prices also increase the producer’s ability to supply the good o The opportunity cost of producing a particular good rises as output increases o A higher price makes producers more able to increase quantity supplied  Quantity supplied- The amount offered for sale per period at a particular price, as reflected by a point on a given supply curve  Individual supply- The relation between the price of a good and the quantity an individual producer is willing and able to sell per period, other things constant  market supply- The relation between the price of a good and the quantity all producers are willing and able to sell per period, other things constant  You add up quantities of suppliers  Changes in Technology o The state of technology reflects positively on an economy’s ability to combine resources effectively  Results in a rightward shift of the supply curve  Changes in the Prices of Resources o Higher price of resources= leftward shift o Lower price of resources= rightward shift  Changes in the Prices of Other Goods o Nearly all resources have alternative uses. The labor, building, machinery, ingredients, and knowledge needed to run a pizza business could produce other goods instead o A drop in the price of one of these other goods makes pizza production more attractive  For example, if the price of Italian bread declines, some bread makers become pizza makers so the supply of pizza increases, shifting the supply curve of pizza rightward  Changes in Producer Expectations o For example, a pizza maker expecting higher pizza prices in the future may expand his or her pizzeria now, thereby shifting the supply of pizza rightward o When a good can be easily stored (crude oil, for example, can be left in the ground), expecting higher prices in the future might prompt some producers to reduce their current supply while awaiting the higher price. Thus, an expectation of higher prices in the future could either increase or decrease current supply, depending on the good.  Changes in the Number of Producers o Because market supply sums the amounts supplied at each price by all producers, market supply depends on the number of producers in the market  Markets o Markets sort out differences between demanders and suppliers  Markets reduce transaction costs – the cost of time and information required for exchange  Market Equilibrium o Surplus- too much of something o Shortage- At a given price, the amount by which quantity demanded exceeds quantity supplied; a shortage usually forces the price up o o Thus, a surplus creates downward pressure on the price, and a shortage creates upward pressure. o A market reaches equilibrium when the quantity demanded equals quantity supplied  Not quantity bought= quantity sold o Impersonal market forces synchronize the personal and independent decisions of many individual buyers and sellers to achieve equilibrium price and quantity  Prices reflect relative scarcity. For example, to rent a 26- foot truck one way from San Francisco to Austin, U-Haul recently charged $3,236. Its one-way charge for that same truck from Austin to San Francisco was just $399. Why the difference? Far more people wanted to move from San Francisco to Austin than vice versa, so U-Haul had to pay its own employees to drive the empty trucks back from Texas. Rental rates reflected that extra cost.  Shifts of the Demand Curve o Any of the following could shift the demand for pizza rightward:  an increase in the money income of consumers (because pizza is a normal good);  an increase in the price of a substitute, such as tacos, or a decrease in the price of a complement, such as Pepsi;  a change in consumer expectations that causes people to demand more pizzas now;  a growth in the number of pizza consumers; or  a change in consumer tastes—based, for example, on a discovery that the tomato sauce on pizza has antioxidant properties that improve overall health   Competition among consumers for the limited quantity supplied puts upward pressure on the price. As the price increases, the quantity demanded decreases along the new demand curve, and the quantity supplied increases along the existing supply curve S until the two quantities are equal once again at equilibrium point g. The new equilibrium price is $12, and the new equilibrium quantity is 24 million pizzas per week. Thus, given an upward- sloping supply curve, an increase in demand increases both equilibrium price and quantity. A decrease in demand would initially create a surplus.  Given an upward-sloping supply curve, a rightward shift of the demand curve increases both equilibrium price and quantity and a leftward shift decreases both equilibrium price and quantity.  Shifts of the Supply Curve o Changes that could shift the supply curve rightward include  a technological breakthrough in pizza ovens  a reduction in the price of a resource such as mozzarella cheese  a decline in the price of another good such as Italian bread  a change in expectations that encourages pizza makers to expand production now; or  an increase in the number of pizzerias  o Given a downward-sloping demand curve, a rightward shift of the supply curve decreases price but increases quantity, and a leftward shift increases price but decreases quantity.  Simultaneous Shifts of Demand and Supply Curves o As long as only one curve shifts, we can say how equilibrium price and quantity will change. If both curves shift, however, the outcome is less obvious o o  Disequilibrium o The condition that exists in a market when the plans of buyers do not match those of sellers; a temporary mismatch between quantity supplied and quantity demanded as the market seeks equilibrium o Usually temporary as market forces push toward equilibrium. But sometimes, often as a result of government intervention, when market forces are suppressed, disequilibrium can last a while, perhaps decades, as we will see next  Price Floor o Sometimes public officials force a price above the equilibrium level o achieve a higher price, the government imposes a price floor, or a minimum selling price that is above the equilibrium price o lead to surpluses  suppliers want to sell a lot, but demand is not as high o How can we get rid of the surplus?  Can try to increase demand (out) or decrease supply (back) by shifting the curves  The government can purchase the surplus product  Store it later  Give it away domestically  Give it as foreign aid  Destroy it o Examples of price controls  Tobacco has a price floor (surplus)  How does the govt get rid of it?  Encourage exports to other countries  Buy up surplus  Restrict the amount one can take to market  Minimum wage (surplus of low skilled labor called unemployment)  Quantity of workers supplied id greater than the quantity of workers demanded  In some areas the minimum wage is not effective since the market wage is higher than the minimum wage o  Price Ceilings o a maximum selling price  Set below equilibrium  Can cause a shortage which leads to rationing  Can lead to queuing or searching:  People will wait in line or searching for the good o Problem is that people are giving up time to do something else by waiting in line  Can lead to black markets  A market where illegal trading takes place at market- determined prices  Sell legal products at prices above the legally mandated price ceiling  Results because of a shortage because people are willing to pay more money when they can’t get or get as much of the good as they want (obviously)  Can lead to “Add-ons” and “trade-ins” that become part of the cost of purchasing goods  When goods are bundled and sold together  When you need to trade in one good to get another  Can lead to Favored customers (discrimination by sellers)  Some customers receive special treatment


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