CHAPTER 3

in

competitive markets, demand and supply interact to produce prices

auctions, stock markets are competitive in our economy, most prices are placed on products by firms

competitive

markets

many buyers many sellers no single buyer or seller can affect the price
2

money relative

price price

what we pay for something what something is worth in terms of another product
eg. bananas cost 50 each while chocolate bars cost $1.00
one banana costs half a chocolate bar one chocolate bar costs two bananas

relative

price is more important in economics

3

consumers respond to relative prices

 quantity

demanded

how much consumers wish to purchase at a given price

demand

the entire relationship between price and their quantities demanded

demand demand

schedule curve
4

table setting out price and quantity demanded graphical portrayal of the demand relationship

Law

of Demand

more will be demanded the lower the price, ceteris paribus

ceteris paribus means all else held constant

inverse relationship between price and quantity demanded

substitution effect: consumers purchase more of a product because it is cheaper than others income effect: consumers can afford to purchase more with a given income
5

demand

represents the marginal benefit (MB) consumers receive from a product

consumers purchase a product because it provides value if the benefit > cost, then the consumer purchases the product if the benefit < cost, then the consumer does not purchase the product

 tastes

and preferences

if tastes turn toward a product, demand increases

the demand curve shifts to the right

if tastes turn against a product, demand decreases

the demand curve shifts to the left

consumer

incomes

normal goods goods people like

if consumer incomes increase, demand increases if consumer incomes decrease, demand decreases

inferior goods goods people consume because they cant afford better products
if consumer incomes increase, demand decreases if consumer incomes decrease, demand increases

prices

of related goods

substitutes a product consumers consume in place of another product

if the price of a substitute increases, demand for the other product increases if the price of a substitute decreases, demand for the other product decreases

complements products consumed together

if the price of a complement decreases, demand for the other product increases if the price of a complement increases, demand for the other product decreases 9

 population

if the population of a market area increases, demand increases if the population of a market area decreases, demand decreases

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expected

future prices

if the expected future price is higher, demand increases now if the expected future price is lower, demand decreases now
expected

future incomes

if consumers expect their incomes to increase, demand increases now if consumers expect their incomes to decrease, demand decreases now
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changes in ceteris paribus conditions shift the demand curve

change in demand

changes in the goods own price causes a movement along the curve
change in quantity demanded Figure 3.3, p. 61
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 quantity

supplied

how much producers wish to send to the market at a given price

supply

the entire relationship between price and their quantities supplied

supply supply

schedule curve
13

table setting out price and quantity supplied graphical portrayal of the supply relationship

Law

of Supply

the higher the price consumers are willing to pay, the more producers are willing to supply, ceteris paribus
marginal cost of production increases as production increases, so producers need a higher price to keep producing

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input

prices

if input prices decrease, supply increases

producers can purchase more inputs, produce more the supply curve shifts to the right

if input prices increase, supply decreases

producers cant afford to purchase as many inputs so they produce less the supply curve shifts to the left

technology

a change in technology always increases supply

producer can produce more with the same inputs
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 number

of firms in the industry

if the number of firms in the industry increases, supply increases if the number of firms in the industry decreases, supply decreases

16

prices

of related goods in production

substitutes in production a firm can produce one product or another

if the price of a substitute increases, the firm produces more of it and less of the other
supply of the other decreases

if the price of a substitute decreases, the firm produces less of it and more of the other
supply of the other increases

17

prices

of related goods in production, continued

complements in production the firm produces one product as a by-product of another
if the price of a complement in production increases, the firm produces more of it and of the other
supply of the other increases

if the price of a complement in production decreases, the firm produces less of it and of the other
supply of the other decreases

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 expected

future prices

if suppliers think the future price of their product is lower, they will sell more of it now
supply increases now

if suppliers think the future price of their product is higher, they will hold back production to sell later
supply decreases now

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the

state of nature

if the weather is good, crops will be plentiful, supply of agricultural products will increase an earthquake that destroys factories interferes with production, supply of those products will decrease

20

changes

in ceteris paribus conditions shift the supply curve

change in supply

changes

in the goods own price causes a movement along the curve

change in quantity supplied Figure 3.6, p. 65

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 when

demand or supply changes, they increase or decrease

they do NOT go up or down do NOT use arrows to describe changes in demand and supply
arrows work the same way as the shifts for demand, but they do not work the same way as the shifts for supply

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equilibrium

in the market occurs when demand equals supply

if the price > than the equilibrium price (P*), there is pressure for price to fall if the price < P*, there is pressure for the price to rise

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P*

is a market-clearing price

at P*, every consumer who wishes to purchase the product at that price can do so every supplier who wishes to sell the product at that price can do so
price

is an equilibrator

the price rises or falls to bring demand equal to supply

sometimes the government will prevent price from fluctuating (Ch. 6) this may keep the market from reaching equilibrium

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 when

the price > P*, there is a surplus

not enough consumers want to purchase the product suppliers send too much to the market there will be pressure on the price to fall
when

the price < P*, there is a shortage

consumers wish to purchase a lot of this product suppliers are not willing to supply enough at that low price there will be pressure on the price to rise
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increase decrease increase

in demand in demand in supply

equilibrium price and quantity both increase equilibrium price and quantity both decrease equilibrium price decreases but quantity increases
decrease

in supply
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equilibrium price increases but quantity decreases

increase

in both demand and supply

equilibrium quantity increases change in equilibrium price is indeterminate

decrease

in both demand and supply

equilibrium quantity decreases change in equilibrium price is indeterminate

27

 increase

in demand and decrease in supply

equilibrium price will increase change in equilibrium quantity is indeterminate

decrease

in demand and increase in supply

equilibrium price will decrease change in equilibrium quantity is indeterminate

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demand increases supply increases net effect demand increases supply decreases net effect

P Q P Q P? Q

demand decreases supply increases net effect demand decreases supply decreases net effect

P Q P Q P Q? P Q P Q P? Q

P Q P Q P Q?

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