Chapters 4 5 Supply and Demand Microeconomics Microeconomics

Chapters 4 & 5 Supply and Demand

Microeconomics �Microeconomics is the area of economics that deals with behavior and decision making by small units such as individuals �Helps explain how prices are determined and how individual economic decisions are made

Demand �Demand is the desire, ability, and willingness to buy a product �Demand is a microeconomic concept �Individual demand can be shown on a demand schedule and demand curve p. 90

The Law of Demand �States that the quantity demanded of a good or services varies inversely with its price When the price goes up, quantity demanded goes down When the price goes down, quantity demanded goes up

Marginal Utility �Utility-amount of usefulness or satisfaction one gets from the use of a product �Marginal utility-the extra usefulness or satisfaction a person gets from using one more unit of a product �Diminishing marginal utility-states that the extra satisfaction we get from using additional quantities of the product begins to diminish

Donuts Demanded $35 $30 $25 price $20 $15 $10 $5 $0 0 1 2 3 Quantity 4 5 6 7

Changes in Demand �Change in quantity demanded vs. change in demand �A change in demand causes the entire demand curve to shift Income Taste Price of substitutes Price of complements Change in expectations Number of consumers

Elasticity of Demand �Elasticity-measure of responsiveness that tells us how a dependant variable such as quantity responds to a change in an independent variable such as price �Demand is elastic when a given change in price causes a relatively larger change in quantity demanded

Elasticity of Demand �Inelastic- a given change in price causes a relatively smaller change in the quantity demanded �Unit elastic-a given change in price causes a proportional change in quantity demanded

Determinants of Demand Elasticity �Can the purchase be delayed? �Are adequate substitutes available? �Does the purchase use a large portion of income?

Elasticity of Demand �How does elasticity affect profits for businesses?

Supply �Supply is defined as the amount of a product that would be offered for sale at all possible prices that could prevail in the market

The Law of Supply �The principle that suppliers will normally offer more for sale at high prices, and less at lower prices

Donuts Supplied 25 Donues Supplied 20 15 10 5 0 $0 $5 $10 $15 Price $20 $25 $30 $35

Changes in Supply �Change in quantity supplied vs. change in supply �A change in supply causes the entire supply curve to shift Cost of inputs Productivity Technology Taxes and subsidies Expectations Government regulations Number of sellers

Elasticity of Supply �Elasticity-measure of responsiveness that tells us how a dependant variable such as quantity responds to a change in an independent variable such as price �Supply elasticity is a measure of the way in which quantity supplied responds to a change in price

The Theory of Production �The Theory of Production deals with the relationship between the factors of production and the output of goods and services p. 124 �Based on the short run or long run Short run-allows producers to change only the amount of variable input called labor Long run-allows producers to adjust the quantities of all their resources, including capital

The Stages of Production �Increasing returns �Diminishing returns �Negative returns

Production Costs �Fixed cost-costs that incur even if the plant is idle and output is zero (aka overhead) �Variable cost-costs that change when the business rate of operation or output changes �Total cost- the sum of fixed and variable costs �Marginal cost- the extra cost when a business produces one additional unit of a product

Measures of Revenue �Total revenue-number of units sold multiplied by the average price per unit �Marginal revenue-the extra revenue associated with the production and sale of one additional unit of output (key measure) �Break-even point-the total output the business needs to sell in order to cover the total costs

Measures of Revenue �The profit-maximizing quantity of output occurs when marginal cost is exactly equal to marginal revenue