Essentials of economics

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Essentials of economics Ch 3

• MARKET DEMAND, SUPPLY, AND ELASTICITY

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1. Ceteris Paribus

• Economic theory zeroes in on the most important
  factors that explain an economic phenomenon.
• Ceteris paribus describes the relationship
  between two factors when all other relevant
  factors do not change. (Other things being
  equal)

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2. Market Demand

• Markets bring buyers and sellers together
  buyers who want goods are not necessary going to
  buy them.
• Wants refers to goods and services people would
  accept if it is given away free.
• We demand that quality of a good we are actually
  prepared to buy with our limited income at
  prevailing prices.

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2. Market Demand cont.

• Demand refers to what economic agents actually do
  when confronted with opportunity cost and limited
  income where having more of one good means
  having less of another.
• Demand is thus that amount of a good that people
  are actually prepared to buy at prevailing prices
  and income.
• The demand curve shows the quantities demanded at
  different prices.

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2.1 The Law of Demand Income and Substitution
Effects

• The law of demand states that there is a negative
  (inverse) relationship between the price of good
  and the quantity demanded, ceteris paribus.
• The quantity demanded is the amount of a good or
  service (G/S) we are willing and able to buy at
  the prevailing price.
• This law states that quantity demanded as price
  lowers.

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2.1 The Law of Demand Income and Substitution
Effects

• 2 Factors
• The principle of substitution as the goods price
  falls its relative price falls. Its cheaper
  than the substitute its a better buy we
  purchase more!
• As price falls we can buy the G/S we are used to
  and more!
• When the price of a good falls, people buy more
  because its relative price has fallen (the
  substitution effect), and the price reduction
  increase in purchasing power leads to greater
  purchases of good, including the good itself (the
  income effect).
• The law of demand is thus explained by
  substitution and income effect.

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3. The Demand Curve

• The demand curve shows the quantities of the good
  demanded at different prices, all other factors
  held constant.
• The ceteris paribus relationship between price
  and quantity demanded is negative because of the
  law of demand.
• As price goes up, the quantity demand goes down.

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3.1 Shifts in Demand

• Factors such as prices of goods, income,
  preference, the number of buyers, or expectations
  can change the quantity of goods people are
  prepared to buy the demand curve shifts
• Demand increase when the demand curve shifts to
  the right.
• Demand decrease when the demand curve shifts to
  the left.

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3.1.1 Prices of related goods

• Two goods are substitutes if the demand for one
  rises when the price of the other rises or if
  demands fall when the price of the other falls.
• Two goods are compliments if the demand for one
  rises when the price of the other falls or when
  the demand for one falls when the price of the
  other rises.

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3.1.2 Income

• As income rises, people tend to spend more on
  most, but not all, G/S
• Goods are classified as normal or inferior.
• The demand for a normal good increases (its
  demand curve shifts to the right) as income
  rises.
• The demand for an inferior good fall (its demand
  curve shifts to the left) as income rises.

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3.1.3 Preferences

• Preferences are what people like or dislike
  without regards to their budgets.
• Preferences show the structure of wants when
  goods are given away free.

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3.1.4 The number of potential buyers

• More buyers in the market, the demand rise,
  market change
• Populations grow, immigration increase, people
  move from North to South
• Removal of trade barriers

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3.1.5 Expectations

• Law of demand states that the quantity demanded
  is negatively related to the current price of
  goods.
• Peoples expectation of how the price will behave
  in the future can affect demand.
• Their expectation that the price will rise can
  increase the demand, even if no change in current
  price

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3.2 Shifts in Demand Curves versus Movements
Along a Demand Curve

• Two reasons why the amount of a particular good
  that people are prepared to purchase can differ
• The price of good can change.
• Other factors that affect purchases as well as
  the goods current price can change.
• Both (1 and 2) results in increased sales, but
  are easily confused.

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3.2 Shifts in Demand Curves versus Movements
Along a Demand Curve-cont.

• An increase in demand occurs when the demand
  curve shifts to the right. Consumers are now
  willing to purchase more of the good at each
  price.
• An increase in quantity demanded occurs when the
  price of the good falls and there is a movement
  down the demand curve.

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4. Market Supply

• Universal law of supply the higher the price,
  the greater the quantity supplied.
• The quantity supplied of a G/S is the amount
  offered for sale at a given price.

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4.1 The Supply Curve

• The supply curve shows the quantities of a good
  supplied at different prices, all other factors
  that effect supply being held constant.
• A positive relationship means more is supplied as
  a higher price.

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4.2 Shifts in supply

• Four factors can cause changes
• Prices of Other Goods
• Firms must weigh the opportunity costs of
  producing one good versus another
• Productive resources are limited, choosing the
  right one depends on relative prices
• As the price of other goods increase, the supply
  of the good should fall (its supply curve shifts
  to the left

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4.2 Shifts in supply cont.

• Prices of Inputs
• Goods are produced by combining land, labor, and
  capital resources
• An increase in input process causes a reduction
  in supply (the supply curve shifts to the left).

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4.2 Shifts in supply cont.

• Technology Changes
• Cost of production are determined by resource
  prices and by the efficiency with which resources
  are used. The state of technology dictates this
  efficiency
• Technology is accumulated scientific and
  technical knowledge about how to produce specific
  goods and services
• As technology advances
• More G/S can be produced from the same volume of
  resources
• Cost of production fall and firms are willing to
  supply more of the G/S at the same price as
  before
• Improvement in technology cause supply to
  increase (the supply curve shifts to the right)

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4.2 Shifts in supply cont.

• Number of Sellers
• As more sellers enter the market, larger
  quantities of goods are offered to buyers at the
  same price as before.
• An increase in the number of sellers causes
  supply to increase (the supply curve shifts to
  the right).

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4.3 Shifts in Supply Curves versus Movements
Along a Supply Curve

• The amount of product for sale can increase for 2
  reasons
• The price can rise.
• A factor other than current price can change.
• An increase in supply occurs when the supply
  curve shifts to the right. Sellers are now
  willing to offer more for sale at each price.
• An increase in quantity supplied occurs when the
  price of the good rises, and there is a movement
  up the supply curve. More is offered for sale,
  but the supply curve has not budged.

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4.4 Independence of Supply and Demand

• Shifts in supply do not cause shifts in demand,
  and visa versa
• The factors that increase the demand for a good
  are different from the factors that change the
  supply of the good

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5. Equilibrium Supply and Demand Together

• The demand curve explains what consumers are
  prepared to buy at different prices
• The supply curve explains what producers are
  prepared to sell at different prices

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5.1 Shortages and Surpluses

• A shortage results if the quantity demanded
  exceeds the quantity supplied at the prevailing
  price.
• A surplus results when the quantity supplied
  exceeds the quantity demanded at the current
  price.

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5.2 Equilibrium

• The equilibrium or market-clearing price is the
  price at which the quantity demanded equals the
  quantity supplied by producers
• It is called the equilibrium price because there
  is no automatic tendency to move away from it
• The equilibrium of supply and demand is
  stationary - the price will tend not to change
  once the equilibrium price is reached

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6. Changes in Equilibrium

• Equilibrium connects quantity demanded with
  quantity supplied
• Stable movement away from the equilibrium price
  creates the shortages and surpluses that
  automatically return the market to equilibrium
• Prices change because of shifts in supply and
  demand curves

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6.1 Changes in Demand

• When the prices of substitutes rise, the prices
  of the complements fall, preferences change in
  favor of the product, the number of buyers
  expands, or higher prices are expected in the
  future
• Increases in demand cause both the equilibrium
  price and quantity to increase. The demand curve
  shifts to the right
• Reduction in demand causes both the equilibrium
  price and quantity to fall. The demand curve
  shifts to the left

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6.2 Changes in Supply

• Factors that influence supply
• Reduction in the price of other products
• Reduction in the price of relevant resources
• Increase in number of sellers and
• Technological improvements.

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6.2 Changes in Supply cont.

• An increase in supply causes the equilibrium
  price to fall and the equilibrium quantity to
  rise.
• A decrease in supply causes the equilibrium price
  to rise and the equilibrium quantity to fall.
• Generalizations
• Increases in demand raise prices and quantities,
  ceteris paribus.
• Increases in supply lower prices and raise
  quantities, ceteris paribus

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7. Elasticity and Price

• Elasticity measures responsiveness of quantity
  supplied or quantity demanded to price changes.
• If firms do not increase quantity supplied when
  the price rises, an increase in demand will push
  up the prices substantially higher equilibrium
  price.
• If people are not prepared to buy more at a lower
  price, an increase in supply will result in much
  lower prices, thus a much lower equilibrium price.

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7.1 Price Elasticity of Demand

• The price elasticity of demand is the absolute
  value of the percentage change in quantity
  demanded divided by the percentage change in
  price.
• Law of demand if the price rises the quantity
  demand falls.
• Elasticity of demand are divided into 3
  categories
• Price elasticity of demand is greater than 1,
  demand is elastic.
• Price elasticity of demand is equal to 1, demand
  is unitary elastic.
• Price elasticity of demand is less than 1, demand
  is inelastic
• An elastic demand curve has a less steep slope
  than an inelastic curve.

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7.1.1 Determinants of Price Elasticity of Demand

• Three determinants
• Availability of substitutes
• Relative importance of good in the budget and
• Adjustment time.

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7.1.1 Determinants of Price Elasticity of Demand

• The greater the number of substitutes, the more
  elastic is the demand.
• Goods that make up a small fraction of the
  consumers budget (salt etc.) are more inelastic
  in demand than products that make up a large
  portion of the budget (gasoline).
• The longer the time period people have to adjust
  to price changes, the more elastic is the demand.

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7.2 Price Elasticity of Supply

• Elasticity of supply measures the responsiveness
  of producers to changes.
• The price elasticity of supply is the percentage
  change in quantity supplied divided by the
  percentage change in price.
• Elasticity of supply are also divided into 3
  categories elastic (elasticity of supply greater
  than 1), inelastic (elasticity of supply less
  than 1), and unitary elastic (elasticity of
  supply equals 1).

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7.2 Price Elasticity of Supply cont.

• The most important determinant is the amount of
  time producers have to adjust to the price
  change.
• The more time the producer has to adjust to price
  changes, the greater the elasticity of supply.
• As the price rises, the producer may have limited
  flexibility to respond.