Supply, Demand and Competition

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Supply, Demand and Competition
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Essential Question How are prices set?
Both Buyer and Seller
Seller??
Buyer??
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Setting an Economys Price System

• To understand how a nations economy functions it
  is important to understand the nations price
  system
• The forces that determine price are called the
  forces of supply and demand
• The place where these two forces meet is called
  the marketplace

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Basic facts

• Consumers have a great influence on the price of
  goods and services.
• Why?
• Market Represents the freely chosen action
  between buyers and sellers.
• Voluntary exchange Buyers and sellers work out
  a deal that suits both sides.

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Demand

• Demand shows how many of a product consumers are
  willing and able to buy at a particular price
  during a specified time period.
• e.g. Swimming suits have a different price and
  quantity demanded in summer vs. winter
• How many of you would like a new car?
• How many of you are able?

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Law of Demand

• Explains the amount people are willing to buy as
  prices change.
• Demand can only occur if a buyer is willing and
  able to buy.
• Three factors that affect what and how much
  people buy are diminishing marginal utility, real
  income, and substitution.

Price goes up Demand goes down
Price goes down Demand goes up

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Diminishing Marginal Utility (DMU)

• Utility Power of a good or service to satisfy.
• Total satisfaction rises with additional units
  purchased, but additional satisfaction
  diminishes.
• People will buy until price exceeds satisfaction.
• Price decreases, people will buy more.

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Real Income Effect

• Income limits the amount of money people can
  spend.
• People cannot keep buying the same amount if
  price increases and income stays the same. (Real
  income effect).
• People are forced to trade-off if price
  increases.
• If price decreases and you buy the same amount,
  your real income has increased.

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Demand Curve

• Demand Curve is a line graph that shows the
  amount of a product that will be purchased at
  each price it shows an inverse relationship and
  is always downsloping
• p

D
Qd
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Remember

• A change along the curve indicates a change in
  price and a change in quantity demanded
• A change of the curve (right or left) indicates
  an across the board change in demand

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Law of Demand

• As price decreases, the quantity demanded
  increases. As the price rises, the quantity
  demanded decreases
• P QD

Price per gallon of water Bottles per week
Jo Pat
.75 90 50
.50 130 70
.35 180 100
.25 290 130
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Demand for hot chocolate in December at the
skating rink
Price Quantity Demanded
.50 30
1.00 25
1.50 20
2.00 15
2.50 10
3.00 5
3.50 0
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Demand Determinants

• Characteristics that will affect the amount
  people will buy. Includes changes in population,
  income, and personal preferences.
• Prices of related goods, income,
  preference/taste, consumer expectations,
  population change

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Demand Determinants

• Prices of Related Goods
• Substitutes Goods that are related in such a way
  that an increase in the price of one leads to an
  increase in the demand for the other goods that
  can be consumed in place of one another (Pepsi
  and Coke)
• Compliments Goods that are related in such a way
  that an increase in the price of one leads to a
  decrease in the demand for the other goods that
  are normally consumed together (hamburgers and
  french fries)

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Determinants cont.

• Income
• Normal Good a good for which demand increases as
  consumer incomes rise (milk)
• Inferior Good A good for which demand decreases
  as consumer incomes rise (ground chuck, bus
  rides)
• As income rises consumers tend to switch from
  consuming these inferior goods to consuming
  normal goods (ex. steak, car/plane)

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Determinants cont.

• Preference/Taste
• Likes and dislikes in consumption
• Consumer Expectations
• Change in future price of goods
• Change in future income
• Population Change
• As the number of consumers in a market changes
  the demand will change

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Law of Supply

• The amount producers are willing to provide at
  various prices.
• As price increases, supply increases.
• As price decreases, supply decreases.
• Law of diminishing returns Adding units of a
  factor of production will increase output for a
  time. Eventually output will decrease.

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Supply Schedule Curves

• A Supply Schedule displays the quantity of a
  product supplied at each price

Price Per Bottle Bottles Supplied
.75 200
.50 130
.35 75
.25 50
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Supply of shovels before a large snowstorm sold
at Lowes
Price Quantity Supplied
4.00 5
8.00 10
12.00 15
14.00 20
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Determinants of Supply

• Technology
• If more efficient technology is discovered
  production costs will fall
• So suppliers will be more willing and able to
  supply more of the good at each price
• Price of Relevant Resources
• Those resources employed in the production of a
  good.

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Determinants cont

• Prices of Alternative Goods
• Price of a good that uses some of the same
  resources as used to produce the good in question
• Producer Expectations
• Shift production according to future prices
• Number of Producers
• of Prod. Increases of supply
• Government Restrictions
• Taxes, quotas, licenses, etc.

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Supply and Demand

• If price falls, demand will increase and supply
  will decrease.
• If price rises, demand will decrease and supply
  will increase.
• Equilibrium price Point where supply and demand
  meet.
• Shortage and surplus
• When demand is greater than supply, a shortage
  occurs.
• When supply is greater than demand, a surplus
  occurs.
• Prices will rise in a shortage and fall in a
  surplus.

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Price Controls

• Price Ceiling Govt set maximum price that can
  be charged for a good or service
• Price Floor -- Govt set minimum price that can
  be charged for a good or service

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Price Elasticity

• How consumers react when prices change.
• Elasticity is determined by
• Existence of substitutes.
• Percentage of income spent on a good or service.
• Time allowed to adjust to a change.

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Types
Elastic Many competing brands. Price increases,
people choose a substitute. Inelastic Not much
competition. Price increases, demand does not
change.
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Steak Elastic or Inelastic ?

• Elastic
• Why? People as a whole can do without steak and
  will substitute chicken or other protein for
  expensive steak

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Milk Elastic or Inelastic ?

• Inelastic
• Why?
• The population as a whole can do without
  steak.but can not do as easily without
  milkespecially families with children

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Gasoline Elastic or Inelastic ?
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What Products are Subject to Elastic Demand ?

• Luxury Items Most customers want luxuries and
  will consider buying them if price drops
• If Price Represents a Large Portion of Family
  Income
• e.g. Mortgage Rates drop from 6.5 to 5.5 people
  will refinance
• Availability of Substitute Items
• e.g. Steak /chicken
• Durable Goods
• Computers, cars, washers, dryers will be in
  greater demand if the price drops

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What Products are Subject to Inelastic Demand?

• Necessities (milk, gasoline)
• Drugs
• Legal (heart medicine antibiotics)
• Illegal (heroin, cocaine)
• Products with no good substitute
• insulin, cancer drugs, etc.
• salt in Middle Ages (preservative)

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Why is Elasticity of Demand Important ?

• What happens if a florist increases the price of
  roses 400 in October ? Will sales go up or down
  ?
• A. Probably, down
• What happens if a florist increases the price of
  roses on February 14th? Will sales go down or
  up?
• A. Probably up Why ? Frantic husbands and
  boyfriends will pay exorbitant prices for a dozen
  roses on Valentines Day.

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Competition

• Competition will exist if different businesses
  produce similar products.
• Perfect Competition
• Large Market
• Similar Product
• Easy entry and exit
• Information obtainable
• No control over price
• Market Price is equilibrium price. (decided by
  supply and demand)

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Imperfect Competition

• One group can have an impact on price.
• Monopoly
• Oligopoly
• Monopolistic Competition
• Barriers to entry
• Government regulations Some goods and services
  are protected from duplication by the government.
• Cost of getting started Large amount of capital
  is needed to begin.
• Ownership of raw materials Companies control
  materials and do not sell to competitors.

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Monopoly

• One group controls the market.
• Single seller
• No substitutes
• No entry
• Complete control over price
• Suppliers can raise prices without losing
  business.

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Types of Monopoly

1. Natural Control of resources. Water company
2. Geographic Control of location Dicks is the
   only sports store in the area
3. Technological Patent on technology
4. Government Created by the government. Illegal
   to enter. Post office
5. Cartel International form of monopoly (OPEC).

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Oligopoly

• A few businesses in competition.
• Domination of a few sellers
• Barriers to entry
• Identical or slightly different products
• Some control of price
• Price wars are common place.

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Oligopoly Examples

• Movie Studios
• Columbia, 20th Century Fox, Warner Bros.,
  Paramount, Universal, and MGM
• Television
• Disney/ABC, CBS Corp., NBC Universal, Time
  Warner, and News Corporation
• Food Processing
• Kraft Foods, PepsiCo, and Nestle
• Telecommunications
• ATT, Verizon, Sprint, and T-Mobile

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Monopolistic Competition

• Numerous sellers
• Easy entry
• Different products
• Competition
• Some control of price
• Substitution and advertising are factors.

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Mergers

• One company joins with another.
• Horizontal Companies in the same business.
• Vertical Company joins with one it buys from.
• Conglomerate Buying of un-related businesses.

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Vertical or Horizontal?

• Google and Bing
• Horizontal
• Paper Company and Saw Mill
• Vertical
• Tostitos and Corn Fields
• Vertical
• Harris Teeter and Ace Hardware
• Conglomerate
• Pepsi and Coke
• Horizontal

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Government policies

• Late 1800s the railroad industry was the biggest
  in the United States.
• Theodore Roosevelt set out to stop monopolies
  with his trust-busting policy, which would
  break up large businesses.
• All mergers must be approved by the Government.