How Markets Work!Supply and Demand

*Demand*Supply*Prices *Market Structures

Law of Demand

– Demand is the desire to own something and the ability to pay for it

– Law of Demand when a good’s price is lower, consumers will buy more of it. When the price is higher, consumers will buy less of it.

– The law of demand is the result of not one pattern of behavior, but of two separate patterns that overlap (substitution effect and the income effect.

Substitute Effect v. Income Effect

– Substitution Effect- When consumers react to an increase in a good’s price by consuming less of that good and more of other goods.

– Income Effect- the change in consumption resulting from a change in real income

– Example 4.2– Understand a demand schedule and

demand curve (81 & 82)

Changes in Demand

– Ceteris Paribus- a Latin phrase that means “all other things held constant”

– A demand curve is accurate as long as Ceteris Paribus holds true

– Movement along the demand curve is called and increase or decrease in quantity demanded

– If the curve shifts this is called a change in demand

– Income can lead to a change in demand• Normal Good- (good that you buy more

of as your income increases) vs. Inferior Good- (good that you buy less of as your income increases)

Changes in Demand

• Prices effect demand of related goods.

– Complements- are two goods that are bought and used together

– Substitutes-are goods used in place of one another

Changes in Demand

– Consumer Expectations • Consumers react to cheaper prices.

Whether the price will rise or fall in the future consumers are going to react to that future price.

– Population• Changes in the size of population can

change the demand for most products. Example the Baby Boom

– Consumer Tastes and Advertising• Fads, trends, what’s popular.

Example asks students what’s popular right now.

Elasticity of Demand

• Elasticity of Demand– Elasticity is the measure of how consumers

react to a change in price – As prices rise and fall your demand will change

for that good. – A good is inelastic when consumers buy it

regardless of the price – A good that is very sensitive to change is called

elastic – Calculate together as a class from pg. 92– If elasticity is greater than 1 then the good is

elastic, if elasticity is less than 1 then goods is inelastic. When the good is exactly one that means that the percentage change in demand is exactly equal to the percentage change in price. (Unitary)

Factors that effect Elasticity• Factors that affect elasticity

– Availability of substitutes- availability of substitutes might affect your demand for a good Example: Cereal

– Relative Importance- How much of your budget do you spend on an item. Example: Gas vs. fast-food

– Necessities vs. Luxuries- Necessity is a good that generally people will always buy, while a Luxury is a good that some could do without

– Change over Time-people may not realize the implications of prices until later, therefore over time a good may be inelastic until substitutes are found or habits are changed.

Supply and Demand

• Law of Supply – Supply is the amount of goods available to

the consumer.– Law of Supply is the tendency of suppliers

to offer more of a good at a higher price. – Quantity supplied is used by economist to

describe how much a good is offered for sale at a specific price

– As the price of a good rises suppliers seeking to make more profit will produce more goods. At the same time more firms will have an incentive to enter the market.

Supply

• Supply Schedule and Supply graph– A chart that lists how much of a good a

supplier will offer different prices– Chart compares two variables that can

change; price per slice and slices supplied

– Supply graph show the quantity supplied of a good at different prices (runs from left to right in a upwards

Change in Supply

• Determinants of Supply– Input Cost—cost that goes into producing

a good or service – Technology –can lower cost– Expectations—if s seller expects the

price to rise in the future they will hold onto their product

– Number of sellers – Government Intervention—through

subsidies, taxes, and regulation the government can influence the supply of a good or service

Elasticity of Supply

• Elasticity of supply and time– Elasticity of supply is the way suppliers

respond to a change in price– In the short run, a firm cannot easily

change its output level, so supply is inelastic. In the long run, firms are more flexible, so supply is more elastic.

– Example of inelastic & elastic “orange farms v. barber”

Supply

• Identify how determinants such as input costs create changes in supply.

• Identify three ways that the government can influence the supply of a good.

• Understand supply and demand in the global economy.

Supply

• Analyze the effects of other factors that affect supply.

Do Prices Matter to Consumers?• Recall the last time you spent

$10 or more. Explain how you made your consumer decision by identifying the expected benefits and the expected costs of your purchase.

Prices

Combining Supply and DemandChanges in market Equilibrium

Role of Prices

Combining Supply and Demand

• Balancing the market– Purpose is to find common

ground between buyers and sellers. (favorable balance of trade) = Equilibrium

– The point of Equilibrium is where the supply schedule and demand schedule intersect

Combining supply and demand

• An unbalanced Market – Disequilibrium (two ways;

excess demand and excess supply)

– Excess demand problems for consumers and excess supply problems for producers

Combining supply and demand

• Government seeks to avoid disequilibrium– The best way for gov’t to

control the market is to control prices

– Price ceilings and Price Floors are the two most common (Example rent control & Minimum wage)

Combining supply and demand

• Cost Price Ceilings– Illegal actions, poor housing,

too much excess demand

• Cost or Price Floors– Decrease in demand, fall in

production, increase in prices of substitutes or compliments

Changes in Market Equilibrium• Read Section 2 • Markets always move

towards equilibrium. • Determinants of Demand and

Supply can push the market into disequilibrium.

Role of Prices

• Prices are a key element to equilibrium.

• Prices solve problems of excess supply or demand.

• In a market system prices are tools used to distribute goods and services, and productive resources.