AP Macroeconomics Chapter 3 Individual Markets Demand Supply

AP Macroeconomics Chapter 3 Individual Markets: Demand Supply

Demand How Much Buyers Want

A Market �Interaction between buyers and sellers • Buyers demand goods • Sellers supply good

Demand An Individual Buyer’s Demand for Corn Price per Bushel � Quantity Demanded per Week $5 10 $4 20 $3 35 $2 55 $1 80 Shows the quantities of product that will be purchased at various prices

Law of Demand �Ceteris Paribus, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls

Exceptions to the Law of Demand �Price can deter people from making purchases • (Reason behind Sales)

Exceptions to the Law of Demand �Diminishing marginal utility • Each buyer will derive less satisfaction from each successive unit purchased

Exceptions to the Law of Demand �The Income Effect • Enables a buyer to purchase more then they would normally buy

Exceptions to the Law of Demand OR… �The Substitution Effect • If a product exceeds the buyers purchasing power, they will a less expensive alternative

The Demand Curve � Relationship between price and quantity • Price must always appear on the Y axis with S&D

Individual Demand P 6 P Qd $5 10 4 20 3 35 2 55 1 80 5 Price (per bushel) Individual Demand 4 3 2 1 0 D 10 20 30 40 50 60 70 80 Q Quantity Demanded (bushels per week) 3 -11

Individual Demand Can Increase or Decrease P 6 P Qd $5 10 4 20 3 35 2 55 1 80 5 Price (per bushel) Individual Demand Change in Quantity Demanded 4 3 2 1 0 D 2 Decrease in Demand 2 4 6 8 10 D 1 D 3 12 14 16 18 Q Quantity Demanded (bushels per week) 3 -12

Market Demand Focused on many buyers instead of individuals � Market Demand = Price most can afford (x) number of buyers � Price per Bushel Quantity Demanded per week, single buyer Number of Buyers Total Quantity in the Market Demanded per week $5 10 X 200 $4 20 X 200 $3 35 X 200 $2 55 X 200 $1 80 X 200 = = = 2, 000 4, 000 7, 000 11, 000 16, 000

Determinants of Demand �Factors that affect purchases Consumers tastes Number of consumers Consumers’ incomes Prices of related goods • Future prices • •

Supply Amounts of a Product Available

Law of Supply �As prices rise, the quantity supplied rises; as price falls, the quantity shipped falls

Individual Supply Can Increase or Decrease P 6 P Qs $5 60 4 50 3 35 2 20 1 5 5 Price (per bushel) Individual Supply S 3 S 1 S 2 4 3 2 1 0 10 20 30 40 50 60 70 Quantity Supplied (bushels per week) Q

Individual Supply Can Increase or Decrease P 6 P Qs $5 60 4 50 3 35 2 20 1 5 5 Price (per bushel) Individual Supply S 3 Change in Quantity Supplied S 1 S 2 4 3 2 Change in Supply 1 0 10 20 30 40 50 60 70 Q Quantity Supplied (bushels per week) 3 -18

Determinants of Supply �Resource Prices • Higher resource prices raise production costs

Determinants of Supply �Technology • Better tech = fewer resources; lowers cost

Determinants of Supply �Taxes and Subsidies • Taxes = higher costs • Subsidies = lower costs

Determinants of Supply �Prices of other goods • Manufacturers may produce similar goods to main product

Determinants of Supply �Price Expectations • Predictions in price of products may raise or lower costs

Determinants of Supply �Number of Sellers in Market • More sellers will lower price (competition) • Less sellers will raise price

Supply and Demand Market Equilibrium

Surpluses �When surpluses occur the price drops to encourage consumption

Shortages �When shortages occur prices tend to rise

Equilibrium Price and Quantity �Market trial and error determine price �“Market-clearing” designates the balance

Elasticity �Measurement of how responsive an economic variable is to a change in another

Elasticity �Elastic variable • Variable that responds more than proportionally to changes in other variables

Elasticity �Inelastic variable • Variable that changes less than proportionally in response to changes in other variables

Factors Affecting Demand Elasticity � 1. The availability of substitutes • The more substitutes, the more elastic the demand will be �Example, if the price of a cup of coffee went up by $0. 25, consumers could replace their morning caffeine with a cup of tea

Factors Affecting Demand Elasticity � Amount of income available to spend on the good • The total a person can spend on a particular good or service �Example: if the price of a can of Coke goes up from $0. 50 to $1 and income stays the same, the income that is available to spend on coke, which is $2, is now enough for only two rather than four cans of Coke

Factors Affecting Demand Elasticity � 3. Time • If the price of cigarettes goes up $2 per pack, a smoker with very few available substitutes will most likely continue buying his or her daily cigarettes. This means that tobacco is inelastic because the change in price will not have a significant influence on the quantity demanded. However, if that smoker finds that he or she cannot afford to spend the extra $2 per day and begins to kick the habit over a period of time, the price elasticity of cigarettes for that consumer becomes elastic in the long run.

Rationing Function of Prices � Forces of supply and demand establish prices

Changes in Demand �Suppose supply is constant, demand increases • Raises equilibrium price and eq. quantity • Lowers with decrease in demand

Changes in Supply �Suppose demand is constant, supply increases • Increase in supply reduces equilibrium price, increases eq. quantity (Q 2) • Supply decreases, eq. price rises, eq. quantity declines (Q 2)

Complex Cases �Supply increase, demand decrease • Price plummets

Complex Cases �Supply decreases; Demand increase • Price will increase

Complex Cases �Supply increase; Demand increase • If increase in supply is greater than increase in demand, the eq. price will fall and vice-versa

Complex Cases �Supply decreases; Demand decreases • If supply decrease is greater then decrease in demand, eq. price will rise and vice-versa

Market Equilibrium Price increase; Demand decrease �Supply decrease; Demand increase �Supply increase; Demand increase �Supply decrease; Demand decrease Quantity ? �Supply ? ? ?

Application: Government-Set Prices Government’s legal limits

Price Ceilings and Shortages �Gov. set max legal price • Sellers may only charge the limit or below • Protects consumers ability to purchase essentials (oil, rent controls, interest rates) • Gov. attempt to restrain inflation through rationing

Price Ceilings Graphical 200 Buyers & 200 Sellers Market Demand 200 Buyers Qd $5 2, 000 4 4, 000 3 7, 000 2 11, 000 1 16, 000 Bushel Surplus 5 Price (per bushel) P Market Supply 200 Sellers 6 S $4 Price Floor 4 3 $2 Price Ceiling 2 7, 000 Bushel Shortage 1 0 2 4 6 7 8 10 D 12 14 16 18 Bushels of Corn (thousands per week) P Qs $5 12, 000 4 10, 000 3 7, 000 2 4, 000 1 1, 000

Black Markets � Buyers may be willing to pay more than price ceiling � Counterfeiting also creates issues

Rent Controls �Protects housing for low-income families • Lower rents = less profits for owners • Owners may build business units instead of homes

Price Floors and Surpluses �Minimum price fixed by government • Protects producers for “low value” products �Examples; Crops, minimum wage

Government Response to Surpluses � Restrict supply; (Farmer Aid Great Depression) � Gov. purchases the surplus (subsidization)