Demand Law of Demand Demand the willingness and

Demand Law of Demand • Demand – the willingness and ability of buyers to buy different quantities of a good at different prices. • Law of demand – the price and the quantity demanded of a good are inversely related.

Substitution effect • The primary reason for the inverse relationship between price and quantity demanded is the substitution effect. • Substitution effect – a consumer will substitute lower-priced goods for higherpriced goods. • See Example 1 A on page 3 -1.

Income effect • The secondary reason for the inverse relationship between price and quantity demanded is the income effect. • Income effect – when the price of a good decreases, the consumer’s income has greater buying power, allowing the consumer to buy a greater quantity of the good. • See Example 1 B on page 3 -1.

Market for Good X Demand Schedule Price $7 Quantity Demanded 0 6 5 5 10 4 15 3 20 2 25 1 30

Demand Curve for Good X

Determinants of demand: • 1. Income. • a. For normal goods, income and demand are directly related. • b. For inferior goods, income and demand are inversely related. • See Example 3 on page 3 -3.

Determinants of demand: • 2. Preferences. • If consumer preference for a good increases, the demand for the good increases. • If consumer preference for a good decreases, the demand for the good decreases. • See Examples 4 A and 4 B on page 3 -3.

Determinants of demand: • 3. Prices of related goods (substitutes or complements). • The demand for a good is directly related to the price of a substitute. • The demand for a good is inversely related to the price of a complement. • See Examples 5 A and 5 B on page 3 -3.

Determinants of demand: • 4. Number of buyers. • An increase in the number of buyers for a good will increase the demand for the good. • A decrease in the number of buyers will decrease the demand. • See Example 6 on page 3 -3.

Determinants of demand: • 5. Expectations of future price. • If buyers expect the price of a good to rise in the future, the demand for the good now will increase. • If buyers expect the price to fall in the future, the demand for the good now will decrease. • See Examples 7 A and 7 B on page 3 -3.

Change in Demand • A change in demand refers to a shift in the demand curve. • A change in demand is caused by a change in one of the determinants of demand.

Change in Quantity Demanded • A change in quantity demanded refers to a movement along the demand curve. • A change in quantity demanded is caused by a change in price.

Supply and Law of Supply • Supply – the willingness and ability of sellers to sell different quantities of a good at different prices. • Law of supply – the price and the quantity supplied of a good are directly related.

Law of Supply • The seller’s goal is profit-maximization. • The higher the selling price, the easier it will be for sellers to cover their cost of production, and thus the greater the quantity supplied. • See Example 8 on page 3 -4.

Market for Good X Supply Schedule Price $1 Quantity Supplied 0 2 5 3 10 4 15 5 20 6 25 7 30

Supply Curve for Good X

Determinant of supply • The determinant of supply is the cost of production. • An increase in the cost of production will cause a decrease in supply (supply curve shifts to the left). • A decrease in the cost of production will cause an increase in supply (supply curve shifts to the right). • See Example 10 on page 3 -5.

Cost of Production • The cost of producing a good can be changed by a number of common factors, including; • 1. The prices of labor and other inputs. • 2. Technology. • 3. Taxes.

Change in Supply • A change in supply refers to a shift in the supply curve. • A change in supply is caused by a change in the cost of production.

Change in Quantity Supplied • A change in quantity supplied refers to a movement along the supply curve. • A change in quantity supplied is caused by a change in price.

Equilibrium • In a free market (a market in which price is free to adjust), the market price will be the equilibrium price. • The equilibrium price is the price where quantity demanded equals quantity supplied.

Equilibrium for Good X

Surplus • A price above equilibrium will result in a surplus. • Competition among the sellers to rid themselves of this surplus will drive the price down until the surplus is eliminated, at the equilibrium price.

Surplus

Shortage • A price below equilibrium will result in a shortage. • Competition among the buyers will drive the price up until the shortage is eliminated, at the equilibrium price.

Shortage

Free Markets and Efficiency • A free market is economically efficient because it produces the quantity of output: • 1. where marginal benefit equals marginal cost. • 2. that maximizes the sum of consumer’s and producer’s surplus.

Consumer’s and Producer’s Surplus

A Change in Equilibrium • Equilibrium price and quantity are determined by demand supply. • A change in demand or supply will result in a new equilibrium price and quantity.

Change Price Quantity • Demand increases Increases

Market Equilibrium

An Increase in Demand

Change Price Quantity • Demand increases Increases • Demand decreases Decreases

Market Equilibrium

A Decrease in Demand

Change Price Quantity • Demand increases Increases • Demand decreases Decreases • Supply increases Decreases Increases

Market Equilibrium

An Increase in Supply

Change Price Quantity • Demand increases Increases • Demand decreases Decreases • Supply increases Decreases Increases • Supply decreases Increases Decreases

Market Equilibrium

A Decrease in Supply

A Price Ceiling • Price ceiling – a maximum legal price. Creates a shortage and leads to: • 1. Fewer exchanges than at equilibrium. • 2. The use of nonprice rationing devices. • 3. Illegal transactions at prices above the ceiling.

Market Equilibrium

A Price Ceiling

A Price Floor • Price floor – a minimum legal price. Creates a surplus and fewer exchanges than at equilibrium. • To maintain a floor price, the government may step in and purchase surplus goods.

Market Equilibrium

A Price Floor

Price Controls and Inefficiency • A price control is economically inefficient because: • 1. A price control eliminates exchanges that would generate more marginal benefit than marginal cost. • 2. A price control eliminates exchanges that would generate additional consumer’s surplus and producer’s surplus.

Consumer’s and Producer’s Surplus

Deadweight Loss of a Price Floor

Markets Are Impersonal • Markets are impersonal in that the decisions of individuals are usually insignificant to the overall market. • Because markets are seen as impersonal forces, it is often politically popular for the government to “control” the market for the good of society.

Markets Are Personal • Markets reflect the personal choices of millions of individual consumers and producers. • When the government intervenes in the market, it is not just controlling some impersonal force; it is interfering with the personal choices of millions of consumers and producers.