The Circular Flow of Goods and Services

1
The Circular Flow of Goods and Services
Factor Markets
4 Participants
Households
Businesses
Product Markets
2
The Law of Demand
Other things being equal, as price
increases, the corresponding quantity demanded
falls
(price is the only variable that is changed)
3
The Demand Schedule
Selling Quantity Price
Demanded
10
5
4
15
3
25
2
40
1
60
4
The Demand Curve
Graphing
-Plot the points
Price
-Connect the dots
6
5
Downsloping left
to right
4
3
Demand
Demand
2
1
0
10
20
30
40
50
60
Quantity
5
The Law of Supply
Other things being equal, as price increases,
producers will be willing to supply more
(price is the only variable that is changed)
6
The Supply Schedule
Selling Quantity Price
Supplied
60
5
4
40
3
25
2
15
1
10
7
The Supply Curve
Graphing
-Plot the points
Price
-Connect the dots
6
Upsloping right
5
to left
4
3
Supply
2
1
0
10
20
30
40
50
60
Quantity
8
Equilibrium
Where it is possible for buyers and sellers to
realize their choices simultaneously
9
The Demand and Supply Schedules
Selling Quantity Price Demanded
Supplied
60
10
5
40
4
15
25
25
3
3
25
25
15
2
40
10
1
60
10
Together!!
Graphing
-Plot Demand
Price
-Plot Supply
6
D
S
5
4
3
2
D
1
S
0
10
20
30
40
50
60
Quantity
11
Changes in Demand
Movement OF the curve
Caused by a Change in a Determinant
Selling Quantity Price Old
New
Dec
Inc
1
0
6
1
2
0
5
3
4
2
1
2
3
3
4
2
4
5
3
4
6
1
5
6
0
7
5
12
Graphing Changes
Increase in Demand shifts out or to the right
Price
6
5
4
3
2
1
Old
0
1
2
3
4
5
6
Decrease in Demand shifts in or to the left
Quantity
13
Shifting the Demand Curve
Why the curve shifts
1
Consumer Tastes
2
Price of Other Goods
Consumer Incomes
3
Number of Consumers
4
5
Consumer Expectations
14
The Determinants
of Demand
Or why the curve shifts
Consumer Tastes
1
-beanie hats make a comeback
Demand increases
-Hula Hoops go out of style
Demand decreases
15
The Determinants
of Demand
Price of Other Goods
2
If airlines cut ticket prices
More demand for Luggage
Less demand for train tickets
16
Tickets and Luggage are compliments
Compliments are consumed or used together
(inverse relationship)
If ticket prices decrease, demand for Luggage
increases
If ticket prices increase, demand for Luggage
decreases
Airlines and Trains are Substitutes
Substitutes replace each other (direct
relationship)
If air tickets decrease, demand for Train tickets
also decreases
If air tickets increase, demand for Train tickets
also increases
17
The Determinants
of Demand
3
Consumer Incomes
tax cuts increase net incomes
Consumers have more money to spend, demand
increases
-the depreciates against the Euro
Imported goods from Europe cost more dollars,
demand decreases
For Normal Goods!!!
For Normal Goods!!!
18
The Determinants
of Demand
For Inferior Goods
tax cuts increase net incomes
Consumers switch to better goods, demand for Hot
Dogs decreases
-the depreciates against the Euro
Domestic travel looks better, demand increases
19
The Determinants
of Demand
Number of Consumers (also Demographics)
4
-Hurricanes arrive on Labor Day weekend
Fewer tourists touring, demand decreases
NAFTA
North American Free Trade Agreement
Canada sells to 290 million US consumers, demand
for their goods increases
20
The Determinants
of Demand
5
Consumer Expectations
-dealers reduce car prices in August
Car buyers wait, demand decreases
-heavy rains have damaged coffee crop
Consumers expect shortages and higher prices so
they buy more now, demand increases
21
New Equilibrium
Shifting the Demand Curve
Caused by a change in a Determinant of Demand
Price
6
5
P Q
Supply
P2
4
decrease
P1
Current Equilibrium
3
P3
increase
2
P Q
Demand
1
Q3
Q1
Quantity
Q2
1
2
3
4
6
5
0
22
Shifting the Demand Curve
Why the curve shifts
1
Consumer Tastes
2
Price of Other Goods
Consumer Incomes
3
Number of Consumers
4
5
Consumer Expectations
23
a. Changes in Quantity Demanded
or
b. Changes in Demand?
Consumer Incomes rise
more jewelry is purchased.
24
The Barber raises the price of haircuts
and he loses business
25
Price of Toyotas goes up
sales of Chevrolets increase
26
Changes in Supply
Movement OF the curve
Caused by a Change in a Determinant
Selling Quantity Supplied Price
Old New
Dec
Inc
7
5
6
6
5
6
4
5
5
4
4
3
3
2
3
4
2
2
3
1
2
1
1
0
27
Graphing Changes
Increase in Supply shifts out or to the right
Price
6
5
4
Old
3
2
Decrease in Supply shifts in or to the left
1
0
1
2
3
4
5
6
Quantity
28
Shifting the Supply Curve
Why the curve shifts
Resource Prices
1
2
Changes in Technology
3
Prices of other goods
4
Taxes and Subsidies
5
Number of Producers
29
The Determinants
of Supply
Or why the curve shifts
Resource Prices
1
-gas is discovered under CVCC
Supply increases
-Minimum wage goes up
Supply decreases
30
The Determinants
of Supply
2
Changes in Technology
If a more powerful computer is developed
Makes production easier (and cheaper)
- If stronger pollution controls are required
Makes production harder (and costly)
31
The Determinants
of Supply
3
Elements of Nature/Prices of other goods
Shift resources away from high production cost
goods.
Caused by natural disasters or market price of
other goods
32
The Determinants
of Supply
4
Taxes and Subsidies
- taxes discourage production
subsidies encourage production
33
The Determinants
of Supply
5
Number of Producers
more firms increase supply
-fewer firms decrease supply
34
The Determinants
of Supply
6
Producer Expectations
about prices and resource availability
-if prices are expected to increase, more
production
-if prices are expected to decrease, less
production
35
Shifting the Supply Curve
Why the curve shifts
Resource Prices
1
2
Changes in Technology
3
Prices of other goods
4
Taxes and Subsidies
5
Number of Producers
6
Producer Expectations
36
Changes in Quantity Demanded
Movement ALONG the curve
Consumers responding to a Change in the Price of
the good
Caused by factors related to production of the
good
Price
The Supply Schedule!!
6
Harder or costlier to produce, price goes up
5
Supply Curve
decrease
P2
P Q
4
increase
P1
Current Price
3
What makes the Supply Curve Shift??
What makes the Supply Curve Shift??
P3
2
P Q
1
Demand
Easier or less expensive to produce, price goes
down
Q2
Q1
Q3
Quantity
0
1
2
3
4
6
5
37
New Equilibrium
Shifting the Supply Curve
Caused by a change in a Determinant of Supply
Price
6
Supply
5
decrease
P2
P Q
4
increase
P1
Current Equilibrium
3
P3
2
P Q
1
Demand
Q2
Q1
Q3
Quantity
0
1
2
3
4
6
5
38
Changes in Quantity Supplied
Movement ALONG the curve
Response to a Change in the Price of the good
Caused by factors related to consumers
Price
6
5
P2
4
Supply
P1
Current Price
3
P3
2
1
Q2
Q1
Quantity
Q3
1
2
3
4
6
5
0
39
a. Changes in Quantity Supplied
or
b. Changes in Supply?
Production costs decline
dealer sells more cars.
40
Fewer oranges offered
because the price has dropped
41
The government
doubles the excise tax on liquor
42

• Economic Examples

43
Resource Prices, and Product Markets

• A reduction in the supply of unskilled labor

pushes the wage rates of fast-food workers
upward.

• Higher wages cause a reduction in supply.

This leads to higher hamburger prices.
ResourcesMarket
ProductMarket
Price(wage)
Price
S1
2.25
7.50
2.00
6.25
DR
DP
Employment
Quantity
Q1
Q2
E1
E2
44
2. Increase in the Demand for Loanable Funds
Interestrate

• At the interest rate r the quantity of loanable
  funds demanded by borrowers into equals quantity
  supplied by lenders.

S

• An increase in demand will move D1 to D2

r2
the interest rises to r2 and increasing borrowing
to Q2
r1

• Higher interest rates encourage additional
  savings, making it possible to fund more
  borrowing.

D1
Quantity of loanable funds
Q1
Q2
45
3. Increase in the Demand for Foreign Exchange
Exchange rate( per quetzal)

• Begin in equilibrium, where the dollar price of
  the quetzal is .10 (10 cents 1quetzal).

S

• An increase in American demand for Guatemalan
  coffee will also increase the demand for quetzals
  (with which American importers pay Guatemalan
  coffee growers).

0.20
0.10

• Equilibrium occurs where the new demand D2 just
  equals the supply S
• at .20 per quetzal with Q2 gt Q1 quetzals
  clearing the market.

D1
Quantity of quetzal exchange
Q1
Q2
46

• Price Controls

47
1. Price Ceilings

• Price ceiling is a legally established maximum
  price that sellers may charge.

• It stops the price from rising to the equilibrium
  level.

• Example rent control
• The direct effect of a price ceiling is a
  shortage quantity demanded exceeds quantity
  supplied.

48
The Impact of a Price Ceiling
Price(rent)
Rental housing market
S

• In the rental housing market the price (rent)
  P0 would bring the quantity of rental units
  demanded into balance with the quantity
  supplied.

P0

• A price ceiling like P1sets a price below
  equilibrium

P1
quantity demanded QD
exceeds quantity supplied QS
resulting in a shortage.
D
Quantity of housing units
QS
QD
49
2. Price Floors

• Price floor is a legally established minimum
  price that buyers must pay.
• It stops the price from dropping down to
  equilibrium level.

• Example minimum wage
• The direct effect of a price floor above the
  equilibrium price is a surplus quantity supplied
  exceeds quantity demanded.

50
The Impact of a Price Floor
Price
S

• A price floor like P1 imposes a price above
  market equilibrium

P1
causing quantity supplied QD
to exceed quantity demanded QS
P0
results in a surplus.

• Because prices are not allowed to direct the
  market to equilibrium, non-price elements of
  exchange will become more important in
  determining where scarce goods go.

D
Quantity
QD
QS
51
Employment and the Minimum Wage
Price (wage)
S

• Consider where a price (wage) of 4.00 could
  bring the quantity of labor demanded into balance
  with the quantity supplied.

5.15
4.00

• A minimum wage (price floor) of 5.15 would
  increase the earnings of those who were able to
  maintain employment (E1), but would reduce the
  employment of others.

• Those who lose their job (E0 to E1) would be
  pushed into either the unemployment rolls or some
  other less preferred form of employment.

D
Quantity(employment)
E1
E0
52
Elastic and Inelastic Demand Curves

• Elastic demand quantity demanded is sensitive
  to small changes in price.

• Easy to substitute away from good.
• Inelastic demand quantity demanded is not
  sensitive to changes in price.
• Difficult to substitute away from good.

53
Measuring Elasticity
Percent change in Quantity demanded
Percent change in Price
gt 1 Elastic sensitive to Price changes
Price? Quantity? (by more ) TR?
Price ? Quantity ? (by more ) TR ?
lt 1 Inelastic not sensitive to Price changes

Price? Quantity? (by less ) TR ?
Price ? Quantity ? (by less ) TR?
54
Elasticity
What affects Elasticity???
1. Available Substitutes
2. Necessity vs Luxury
3. Proportion of Income
4. Time to shop around
55
Elasticity
And the Drug Problem
Inelastic Demand - necessity
Price
Supply
P1
Demand
Q1
Quantity
56
Elasticity
Change supply
Q then P
or Q then P
Price
Supply
decrease
eradication
P2
increase
P1
legalization
P3
Inelastic Demand
Q2
Q1
Q3
Quantity
57
Elastic and Inelastic Supply Curves
Price
Price
Quantity
Quantity

• Elastic supply quantity supplied is sensitive
  to changes in price.

Inelastic demand quantity supplied is not
sensitive to changes in price.
58
Elasticity
What affects Elasticity of Supply???
1. Time
a. Market Period
b. Short Run
c. Long Run