Economics Unit 2How the Market Works!

Chapter 4: DemandChapter 5: SupplyChapter 6: Prices

Understanding Demand

Demand– the desire to own

something and the ability to pay for it

Law of Demand– consumers buy more of

a good when its price decreases and less when its price increases.

Effects on Demand

Substitution effect – when consumers react to

an increase in a goods price by consuming less of that good and more of other goods

hybrid cars Income Effect

– the change in consumption resulting from a change in real income

lottery winner

Demand Curve

What Can Change Your Demand?

Change in Income– Normal Good- a good

that consumers demand more of when incomes increase

More steak, less hamburger

– Inferior Good- a good that consumers demand less of when their incomes increase

Less Ramen Noodles, more progressive soup

What will shift the demand curve?

Income Consumer expectations Consumer tastes and advertising Price of related goods

What will shift the demand curve?

1. Income What % of your income will you spend on something?

2. Consumer expectations Will the price rise today, or tomorrow? Will the price fall today, or tomorrow?

3. Consumer tastes and advertising What is popular today?

4. Price of related goods What is the price of gas? What is the price of cable for your television?

What Can Change Your Demand?

Price of Related Goods– Complements-two

goods are bought and used together Ski’s Boots Poles Bindings

– Substitutes-goods used in place of one another Ski’s and snowboards

Supply

Supply– the amount of available

goods

law of supply– tendency of suppliers to

offer more of a good at a higher price

Cost of Production

Marginal Product of labor– Marginal Product of Labor (5.6) is the change in

output from hiring one more worker (increases, decreases).

Marginal Product of Labor

Labor (# of workers) Marginal Product Output

1 4 42 10 63 17 74 23 65 28 56 31 37 32 18 31 -1

Cost of Production

Increasing Marginal Return– is the level of production in which the marginal

product of labor increases as the number of workers increase.

Diminishing Marginal Return– is the level of production in which the marginal

production of labor decreases as the number of workers increases. Capital MUST EQUAL Labor

Negative Marginal Returns – reverses the productivity of the operation (workers in each

others way).

Cost of Production

Fixed Cost – a cost that does not

change, no matter how much of a good is produced

Rent Machinery repairs Property taxes Salaried workers

– Manager Desks Chairs

Cost of Production

Variable Cost – a cost that rises and

falls depending on how much is produced

Electricity Heat bills Capital to produce the

goods Office supplies

– Paper– Pens and pencils

Hourly workers

Cost of Production

Total Cost – fixed cost plus variable cost– The amount of money required to run the firm

Marginal Cost – the cost of producing one more unit of a good (5.9)

– With beanbags – lower with specialties of the 1st and 3rd, then increases

– More workers --- fixed production Facility

Setting Output

How many employees to hire? – Remember, goal is to maximize profits!

Highest profit? Total Revenue /vs/ Total Costs

Setting Output

Marginal Revenue and Marginal Cost– Marginal Revenue

is an additional income from selling one more unit of a good; sometimes equal to the price.

***The ideal level of output is when marginal revenue equals marginal cost.

The Shut Down Decision

When do you shut down an operation facility?– variable costs – costs when the facility is up and

running.– fixed costs – owner pays whether the factory is

open or closed. Stay open if the benefit of operating (total

revenue) is greater than the variable costs!!!– Total Revenue > Variable Costs

Chapter 6 Prices

Section 1 Objective: – to identify the nature of prices in regards to

supply/demand Section 2 Objective:

– to identify how change in the market affects equilibrium

Section 3 Objective:– to identify the role of prices.

Combining Supply and Demand

Balancing the Market

Buyers and Sellers= Equilibrium

(market clearing)

Demand and Supply

Defining Equilibrium

Equilibrium -the point at which quantity demanded and quantity supplied are equal.

– At equilibrium, the market for a good is stable

Disequilibrium – occurs when the quantity supplied is not equal to quantity demanded.

– every price that is not at equilibrium is at disequilibrium!

Disequilibrium

Excess Demand – is when the quantity demanded is more than the quantity supplied.

1. low prices encourage excess demand

2. as long as there is excess demand, suppliers will keep raising the price until the market cannot handle it.

Disequilibrium

Excess Supply – is when the quantity supplied is more than the quantity demanded.– sellers do not like to

waste their resources on excess supply, especially when the excess cannot be stored.

Changes in Market Equilibrium

Changes in Price– market wants equilibrium price and quantity

Excess demand leads to higher prices. Higher prices lead to rising supply and quantity

demanded to fall. Excess supply will cause price cuts and quantity

demand to rise

Changes in Market Equilibrium

Shifts in the supply curve – advances in technology– new government taxes/subsidies– changes in the prices of raw materials and labor– a shift in the supply curve will create a new

equilibrium

Changes in Market Equilibrium

Understanding a shift in supply – Early 1980s – CD player cost $1000 – In 1987 – CD player cost $300– Today – CD player costs ???

Machines today have more feature and are better than the machines of the early 1980s

Also, the price to produce and manufacture has gone down, so this passes on the savings to us. – Demand is also not as high, either.

Changes in Market Equilibrium

Finding a New Equilibrium – Surplus – situation in which quantity supplied is

greater than quantity demanded; also, known as excess supply Excess supply will lead to decreased prices, which will

lead to an increase in demand.

Changing Equilibrium– Equilibrium changes as the market conditions

change (demand/supply). Sales, Rebates, Price Changes

Changes in Market Equilibrium

Problem of Excess Demand– Ipod’s or PS3’s

Shortage – situation in which quantity demanded is greater

than quantity supplied. Search Costs

– the financial and opportunity costs consumers pay when searching for a good or service.

The Role of Prices

Prices in the Free Market – gives the consumer choices (bartering)

The Advantages of Prices – Price as an incentive can cause consumers to buy more,

which can cause producers to make more.

Prices as Signals– At low prices, people buy………at high prices, people tend

not to buy.– Low prices tend to slow production, whereas high prices

increase production

The Role of Prices

Flexibility 1. Prices are more flexible than output levels.

(Short/Long Run)2. Supply Shock – is a sudden shortage of a good

(excess demand).3. Rationing – is dividing up goods or services

using criteria other than price. *this can be expensive and time consuming

The Role of Prices

Price System is “Free”– The market can control prices without the use of

government Rationing and Shortages

– Former Soviet Union /vs/ The United States– Communism /vs/ Wartime

Black Market – is a market in which goods are sold illegally– Ex: Stealing TV's and Selling them

Importing Illegal OR Prescribed Drugs and selling them