Chapter 2 Notes
Chapter 2 Notes By the end of this chapter you should be able to: • • • • •
Explain the law of demand and determinants of demand Explain the law of supply and determinants of supply Define equilibrium and explain how Supply and Demand determine equilibrium prices and quantities in a market Use the Supply and Demand model to make predictions about changes in prices and quantities Calculate elasticity and interpret these values.
A market is defined by a particular product being bought and sold in a particular location at a particular time. e.g. Competitive Market-‐ a market with many buyers and sellers so that no single buyer or seller can affect the price Four Key Assumptions of the Supply and Demand Model in Competitive Markets: 1.
Restrict focus to suppl and demand in a single market.
2.
All goods bought and sold are identical
3.
All goods sell for the same price and everyone has the same information
4.
There are many buyers and sellers in the market
Demand Demand is affected by (the Determinants of Demand): 1.
Products own price (does not shift demand, move along)
2.
Number of consumers -> increase income -> increase demand
3.
Consumers income/wealth -> increase income -> increase wealth
4. 5. 6.
Consumer taste/preferences -> stronger preference-> increase demand Prices of related goods -> substitute -> increase price -> increase demand complement -> increase price -> decrease demand expectation of the future -> increase price -> increase demand
ceteris paribus – all else equal
To examine just the effect of changes in a product’s own price on QD we must hold all else equal or assume the Ceteris paribus ________________________________ condition. 1. QD and Price If you are standing at a vending machine with digital prices, and nothing changes except the price of a bag of Doritos decreases, you will want to purchase _______________ bags of Doritos. decrease price increase price Law of Demand-‐ _decrease _____________________ OR __________________________, increase demand ceteris paribas. demand Demand curve: the graphical representation of the relationship between quantity demanded and the price of a commodity, ceteris paribas. Demand (in general): The entire relationship between the quantity of a good that buyers want to buy and the price of that good, ceteris paribas. Activity: Turn to the person next to you, and graph the following demand curve Demand for toy mice: QD=240-‐2P, where QD is the quantity demanded in crates of toy mice and P is the price per crate. Inverse demand curve: P=f( ) What is the inverse demand curve for the demand curve for toy mice above? P=120-0.5Qd Demand Choke Price: the price at which no consumer is willing to purchase any of the good (the _vertical _______________ intercept of the inverse demand curve. What is the Demand Choke Price for toy mice?
It is equivalent to the vertical intercept where Qd=0
What happens when a non-‐price determinant of demand changes? -‐ If something else that influences how much people want to buy changes, then _D _____________ curve changes (shift the entire curve)
-‐If price changes, then __________ changes (move ALONG demand curve) Qd
Activity: With the person sitting next to you, show what happens to the demand curve for mice in each of the following situations: 1. New research comes out showing that toy mice are the most stimulating cat toys available.
consumer taste/ preference
increase demand will shift the D curve to the right
2. Because of the efforts to spay and neuter pets, the cat population declines significantly. # of consumers decrease demand will shift the D cure to the left Supply Quantity Supplied ( )-‐ The amount of a good or service producers plan to sell during a given time period QS is influenced by (Determinants of Supply): 1. products own price 2. costs of production->cost of inputs
technology
3. # of sellers 4. sellers outside the options (eg. complements and substitute in production) Supply curve: The graphical representation of the relationship between quantity supplied and the price of a commodity, ceteris paribas. Supply (in general): the entire relationship between the quantity of some good that producers wish to sell and the price of that good, ceteris paribas. Activity: Turn to the person next to you, and graph the following supply curve Supply curve for toy mice: QD=2P
P=f(Qs) P= Qs/2 Choke price = 0
Inverse supply curve: P=f (Qs ) What is the inverse supply curve for toy mice?
P=0.5Qs
Supply Choke Price: the price where no firm is willing to produce a good, therefore ____________ is zero. P If price changes, _______________ changes. Q
S If something else that affect selling plans at every price changes, then ____________________ changes. Practice 1. Illustrate what happens (generally) to the supply curve for toy mice if the price of face fur increases.
increase cost of production supply curve shift to the left
2. Illustrate what happens (generally) to the supply curve for toy mice if the main machine used for toy mouse production is recalled due to a defect?
decrease in the change of supply supply curve will shift the the left
Determining Price in a Market A market is any situation in which buyers and sellers can negotiate the exchange of goods or services. Bringing the Demand and Supply Curves together gives us a picture of the market for toy mice:
Qd=240-2P Qs=2P 240-2P=2P 240=4P p=60 Q=120
Market Equilibrium-‐ when price balances plans of buyers and sellers. (where _Qd _____=_______) Qs Equilibrium Price (P*)-‐ price where _______=________ Qd Qs Equilibrium Quantity (Q*)-‐quantity bought and sold at P* Ways to find Equilibrium: 1.
S=D find P where Qd=Qs
2.
graphically, where S and D intersect
3.
algebraically: demand and supply equation equal and solve for Q and P
Excess Supply (Surplus)-‐ when _Qs _____>______ Qd Excess Demand (Shortage)-‐when _______>_______ Qs Qd To determine the effect of an event: 1. Does it effect S or D 2. Does it increase or decrease S or D 3.
Show these changes on graph and find what happens to P and Q
Example In the market for toy mice, what happens to equilibrium price and quantity if the price of fake fur increases while cat owners receive a subsidy from the government that effectively increases their income? Direction v. size of an effect The direction of the effect depends on whether Supply, Demand, or both increase or decrease. The size of the effect depends on ____________________________________. The Slope Elasticity Elasticity: the ratio of the percentage change in one value divided by the percentage change in another. Price Elasticity of Demand (supply): the percentage change in quantity demanded (supplied) resulting from a 1% change in price. OR Slope not ___________ equal Elasticity. Why? 1. 2. elastic: >1 inelastic: unit elastic:
0 complements: Py increase Dx decrease Exy
Explain the law of demand and determinants of demand Explain the law of supply and determinants of supply Define equilibrium and explain how Supply and Demand determine equilibrium prices and quantities in a market Use the Supply and Demand model to make predictions about changes in prices and quantities Calculate elasticity and interpret these values.
A market is defined by a particular product being bought and sold in a particular location at a particular time. e.g. Competitive Market-‐ a market with many buyers and sellers so that no single buyer or seller can affect the price Four Key Assumptions of the Supply and Demand Model in Competitive Markets: 1.
Restrict focus to suppl and demand in a single market.
2.
All goods bought and sold are identical
3.
All goods sell for the same price and everyone has the same information
4.
There are many buyers and sellers in the market
Demand Demand is affected by (the Determinants of Demand): 1.
Products own price (does not shift demand, move along)
2.
Number of consumers -> increase income -> increase demand
3.
Consumers income/wealth -> increase income -> increase wealth
4. 5. 6.
Consumer taste/preferences -> stronger preference-> increase demand Prices of related goods -> substitute -> increase price -> increase demand complement -> increase price -> decrease demand expectation of the future -> increase price -> increase demand
ceteris paribus – all else equal
To examine just the effect of changes in a product’s own price on QD we must hold all else equal or assume the Ceteris paribus ________________________________ condition. 1. QD and Price If you are standing at a vending machine with digital prices, and nothing changes except the price of a bag of Doritos decreases, you will want to purchase _______________ bags of Doritos. decrease price increase price Law of Demand-‐ _decrease _____________________ OR __________________________, increase demand ceteris paribas. demand Demand curve: the graphical representation of the relationship between quantity demanded and the price of a commodity, ceteris paribas. Demand (in general): The entire relationship between the quantity of a good that buyers want to buy and the price of that good, ceteris paribas. Activity: Turn to the person next to you, and graph the following demand curve Demand for toy mice: QD=240-‐2P, where QD is the quantity demanded in crates of toy mice and P is the price per crate. Inverse demand curve: P=f( ) What is the inverse demand curve for the demand curve for toy mice above? P=120-0.5Qd Demand Choke Price: the price at which no consumer is willing to purchase any of the good (the _vertical _______________ intercept of the inverse demand curve. What is the Demand Choke Price for toy mice?
It is equivalent to the vertical intercept where Qd=0
What happens when a non-‐price determinant of demand changes? -‐ If something else that influences how much people want to buy changes, then _D _____________ curve changes (shift the entire curve)
-‐If price changes, then __________ changes (move ALONG demand curve) Qd
Activity: With the person sitting next to you, show what happens to the demand curve for mice in each of the following situations: 1. New research comes out showing that toy mice are the most stimulating cat toys available.
consumer taste/ preference
increase demand will shift the D curve to the right
2. Because of the efforts to spay and neuter pets, the cat population declines significantly. # of consumers decrease demand will shift the D cure to the left Supply Quantity Supplied ( )-‐ The amount of a good or service producers plan to sell during a given time period QS is influenced by (Determinants of Supply): 1. products own price 2. costs of production->cost of inputs
technology
3. # of sellers 4. sellers outside the options (eg. complements and substitute in production) Supply curve: The graphical representation of the relationship between quantity supplied and the price of a commodity, ceteris paribas. Supply (in general): the entire relationship between the quantity of some good that producers wish to sell and the price of that good, ceteris paribas. Activity: Turn to the person next to you, and graph the following supply curve Supply curve for toy mice: QD=2P
P=f(Qs) P= Qs/2 Choke price = 0
Inverse supply curve: P=f (Qs ) What is the inverse supply curve for toy mice?
P=0.5Qs
Supply Choke Price: the price where no firm is willing to produce a good, therefore ____________ is zero. P If price changes, _______________ changes. Q
S If something else that affect selling plans at every price changes, then ____________________ changes. Practice 1. Illustrate what happens (generally) to the supply curve for toy mice if the price of face fur increases.
increase cost of production supply curve shift to the left
2. Illustrate what happens (generally) to the supply curve for toy mice if the main machine used for toy mouse production is recalled due to a defect?
decrease in the change of supply supply curve will shift the the left
Determining Price in a Market A market is any situation in which buyers and sellers can negotiate the exchange of goods or services. Bringing the Demand and Supply Curves together gives us a picture of the market for toy mice:
Qd=240-2P Qs=2P 240-2P=2P 240=4P p=60 Q=120
Market Equilibrium-‐ when price balances plans of buyers and sellers. (where _Qd _____=_______) Qs Equilibrium Price (P*)-‐ price where _______=________ Qd Qs Equilibrium Quantity (Q*)-‐quantity bought and sold at P* Ways to find Equilibrium: 1.
S=D find P where Qd=Qs
2.
graphically, where S and D intersect
3.
algebraically: demand and supply equation equal and solve for Q and P
Excess Supply (Surplus)-‐ when _Qs _____>______ Qd Excess Demand (Shortage)-‐when _______>_______ Qs Qd To determine the effect of an event: 1. Does it effect S or D 2. Does it increase or decrease S or D 3.
Show these changes on graph and find what happens to P and Q
Example In the market for toy mice, what happens to equilibrium price and quantity if the price of fake fur increases while cat owners receive a subsidy from the government that effectively increases their income? Direction v. size of an effect The direction of the effect depends on whether Supply, Demand, or both increase or decrease. The size of the effect depends on ____________________________________. The Slope Elasticity Elasticity: the ratio of the percentage change in one value divided by the percentage change in another. Price Elasticity of Demand (supply): the percentage change in quantity demanded (supplied) resulting from a 1% change in price. OR Slope not ___________ equal Elasticity. Why? 1. 2. elastic: >1 inelastic: unit elastic:
0 complements: Py increase Dx decrease Exy
