Chapters 3 & 4
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Date Created: 09/15/16
September 13th, 2016 DEMAND: when you talk about the demand side, you are referring to the behavior of the buyers demand vs. quantity demanded (QD) --demand=desire? NO --QD: amount of any good/service that all buyers decide to choose during a period of time given constraints (income, prices) -implies choice: there is always opportunity cost -hypothetical (if, they) -ex) if coffee is $1, I buy more; if coffee is $5, I buy less -depends on price (P) -it is a point ALONG the curve Ceteris Paribus: QD is a relationship b/w P and amount of good/service demanded @each price -inverse relation (if price falls, QD increases); downward sloping curve **this relationship given all factors constant is called Law of Demand** DRAW CURVE Example: maple syrup --the higher the price per bottle, the less people will want the syrup $1 75,000 $2 60,000 ... ... Note: price (P) is on y axis, quantity on x axis (this applied to both demand AND supply) Why does the demand curve slope down? Inversely related Demand vs quantity demanded cont'd --demand: refers to the whole curve -when one of the factors held constant changes - increase in quantity, then curve shifts right ex) income increase Factors That Change The Demand Curve: income and wealth -wealth: everything I own - everything I over -measure over a period of time: flow variable Income Change/ Wealth normal (variable) inferior(variable) Increase demand increase decrease in demand Decrease demand decrease increase in demand Inferior vs. Normal Good --inferior goods: a good that people demand less of as income rises -demand decreases and the curve shifts leftward --normal goods: a good that people demand more of as income rises ex) steak vs. potatoes -curve shifts left for potatoes when income increases; it's cheaper and people don't find it to be their standard of food anymore prices of related goods - substitute good: coffee is good x, tea is good y: if the price of tea(y) doubles, then someone will drink more coffee in order to compensate...the quantity of coffee changes but not the price - complimentary good:coffee and creamer; if the price of coffee shoots up, then I will buy less creamer population --population increase, more buyers --more buyers, therefore an increase in demand expected price ex) I like dark chocolate, but cocoa beans are scarce, so dark chocolate price will increase: I buy more dark chocolate NOW -if buyers expect prices to rise, the current demand will shoot up tastes/preferences --if buyers start preferring an alternate good, then the demand of a current good will fall and the demand curve will shift LEFT ex) lost desire for apples and decided to opt for mangoes instead; demand for mangoes rises and demand for apples decreased SUPPLY: not fixed availability; what sellers choose to offer at each price (P) during a period of time given constraints (input, price, technology ) --comes from the sellers: they choose to supply @ any P quantity that maximized profit --quantity supplied -relationship between P and amount of good/service offered at any point P -positive relationship (if price increases, quantity increases) **the constitutes to the Law of Supply** the Law of Supply --when price of good rises, everything else at a constant, the quantity of good supplied will rise --when sellers can get higher prices for goods, producing and selling become more profitable ex) rise in the price of laptops but not desktops will encourage comp. makers to focus more on laptops, not computers --price and quantity supplied are POSITIVELY RELATED --this translates to an upward curve on a graph, in contrast to the demand curve -each point on the curve shows the quantity that sellers would choose to sell at a specific price --shifts along the curve: -a change in price, we go ALONG the curve (a rise, we go right; a fall, we go left) --a shift in the supply curve -when variables that we once held constant change (like to cost of transportation of a good) ex) if transportation of maple syrup drops, the seller is encouraged to supply more bottles and the curve shifts RIGHT Supply Schedule List (ex. Maple syrup) Price Quantity Supplied $1 25,000 bottles supplied $2 40,000 -change in price (P) you move ALONG the supply curve An increase in quantity at any given price: curve shifts right (INCREASE in supply) Factors that Change the Supply Curve: input price --if they rise, supply less (b/c resources were more expensive) and supply curve will shift LEFT --there are many other factors and sources of labor that create a product, and a change in price in any of those sectors shifts the supply curve --if they decrease, supply more (b/c resources were less expensive) and supply curve shifts RIGHT price of alternatives --alternate/substitute IN PRODUCTION --firms can switch their production of goods and services easily, depending on which they will will give them the most or least amount of profit --when price of alternative rises, supply curve shifts leftward) ex) maple syrup comes from maple sap: could make maple syrup OR instead make maple sugar depending on which will be more profitable number of firms in industry/market --if more people decide to get involved in a particular market, the supply of that good would increase and curve shifts RIGHT --if firms decide to leave the market, supply decreases and curve shifts LEFT ex) maple syrup market: more vendors decide to sell maple syrup, and so more bottles will end up being produced; increase in supply, this shifts the graph to the RIGHT technology --technological advances increase the supply of a good --not only is it more advanced, but it's cheaper and more new ex) replacing sap buckets by tubes draining into a central container for boiling changes in weather/natural events -if weather is good, supply will increase ex) our weather in the US is very good right now, and so we have excess in corn expected price --expectations of future prices of a good will affect the supply and therefore shift the supply curve --if the firm expects market prices will drop next month, up the production and sell more now --if expectation of a future price rising, the curve shifts LEFT --if expectation of a future price falls, the curve shift RIGHT INTERACTION OF SUPPLY AND DEMAND what price (P) will actually prevail in the market? It generally hovers around some particular level aside from a natural disaster, etc... --market is in a state of rest -**equilibrium** -BOTH price and quantity are stable When the market is at an Equilibrium ... --state of rest --price of the good and quantity bought are leveled out - -equilibrium price -price is at a constant until supply or demand curve shifts --equilibrium quantity -the amount bought of a good remains constant until supply to demand curve shifts --finding the equilibrium... -draw supply and demand curves -find where the two curves intersect one another -equilibrium price s found vertically, equilibrium quantity is found horizontally When the variables that were once held at a constant change, supply or demand curve shifts, therefore a NEW EQUILIBRIUM --a shift in demand causes both equilibrium price, equilibrium quantity to rise and a movement ALONG the supply curve --a shift in supply (like due to bad weather) causes supply curve to shift to left and equilibrium price rises while equilibrium quantity falls; movement ALONG the demand curve --if we combine two variables, then both curves shift Chapter 3 Cont'd NOTE: When BOTH curves shifts (D and S) we can determine the direction that BOTH, the equilibrium P AND Q will move Practice: Draw a graph for each of the following Notes change in EQUILIBRIUM P and Q Increase in D and S Increase in D, decrease in S Decrease in D and S Decrease in D, increase in supply The Mathematics of Supply and Demand Demand Function: Qd=100-2P NOTE: the minus implies an INVERSE relationship Supply Function: Qs=3P NOTE: the positive coefficient indicated an upward slope How do we get quantities? Insert price into either demand or supply function Qs=3(20)=60 Qd=100-2(20) Equilibrium --QD=QS Total Expenditure (TE) --price is multiplied by quantity --in this case: (20)(60)=1200 Always try to get price (P) on the left side Set them EQUAL to find the equilibrium Chapter 4 --there are two ways in which the government can intervene to change the free market equilibrium (P*,Q*) -they try and fight the market when they're not okay with the prices -they manipulate the market by imposing taxes and subsidies Fighting the Market: Price Ceilings --price ceiling -regulation -the government imposes a maximum price for a good in a market in response to a steep price -government thinks prices are too high -producers cannot charge more than what the government has issued Ex) buyers are complaining that the price of chocolate at $5 a bar is too expensive; government issues a price ceiling and the good cannot be on the market for more than $3.50 -the decrease in price will make sellers want to supply less(quantity supplied), and so we move ALONG the supply curve -the decrease in quantity supplied will lead to an increase in quantity demanded and so we move along the demand curve NOTE: when QS and QD differ, the short side of the market will prevail -in the case above with the chocolate: QS is less than QD, so SELLERS are on the short side of the market -results in a shortage of chocolate bars **a price ceiling creates a shortage and OC increases for customers/buyers that now wait on long line and spend time trying to get the product** -price ceilings lead to black markets: where goods are sold illegally at higher prices buy are more attainable for buyers **the combo of price ceilings and black markets lead to the buyer paying more for the good than necessary** Ex) rent control---price ceiling in the rental market (in large cities) -goal is to keep housing affordable Problem: black market price in rental units is higher than controlled P Fighting the Market: Price Floors --benefits sellers --a minimum amount below which the price cannot fall --is used to raise prices of goods --for agriculture goods (they tend to have very low prices for their goods): also called "price support programs" -Agriculture Adjustment Act of 1933 -government policy still maintains price floors for peanuts, sugar, and dairy products ex) dairy products -government has SEPARATE floor prices for butter cheese and non fat dairy milk -the prices of these separate dairy products boost prices with dairy products, even those without floor prices (like whole milk) -if the prices for whole milk were plummeting, dairy industry would produce less whole milk and focus more on the dairy products that DO have floor prices (like butter, cheese and non-fat dairy milk) -floor prices lead to quantity demanded to DECREASE, but since the price cannot go down further than the minimum, there is a surplus NOTE: this can lead to farmers/sellers selling illegally at a price below the floor -this pressures the farmers that do abide by floor prices to do the same and eventually the price floor collapses Maintaining a Floor Price to avoid collapse: governments develop a variety of policies --in the US: government promises to buy any unsold product at a guaranteed price (nothing below the floor price) --before even having to take the extra measure to butt off excess supply, the government will try to avoid the price down to its equilibrium value **price floors are usually accompanied by government efforts to limit any excess supplies** --in order for government to eliminate costs, it controls the production and sale of milk to manufacturers and processors --government can order to pay farmers to not produce so much **the government has also other means of influencing the market outcome: uses taxes or subsidies Taxes --the goal is to collect revenue --they distort the free market --excise tax -special tax on certain goods ex) cigarettes --when it is imposed, it can be collected from either the buyer or the seller Statutory burden: burden on party that is responsible for sending the check to the government tax incidence: the division of tax payment between buyers and sellers determined by comparing the new (after tax) and old (pretax) market equilibriums --the in incidence of a tax is collected from sellers generally falls on both sides of the market; buyers pay more and sellers receive less for each unit sold --the incidence of a tax that is collected from buyers will fall on both sides of the market Manipulating the Market: Subsidies --subsidy: the opposite of a tax -the government MAKES a payment to the buyer or seller -lowers prices to buyers and encourages people to buy the good --a subsidy to buyers ex) tuition: provide more than $100 billions on scholarships and other assistance to encourage getting a college education --benefits both sides of the market; buyers pay less and sellers receive more for each unit sold --a subsidy to sellers -same benefit as it is to buyers 9 **a subsidy paid to buyers shifts the demand curve upward by the amount of subsidy**
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