Chapters 4-7

Unit 2- Microeconomics: Prices and

Markets

1

Unit 2 ChaptersThis unit covers:

4.14.24.35.1 5.2 6.1 6.2

Chapter 4Section 1

Supply and Demand

3

An Introduction to DemandDEFINED: Demand is the desire, ability, and

willingness to buy a product.Knowing the concept of demand is really

essential to learning how a market economy works. Knowledge of it is important sound business planning.

It’s impossible to determine WHAT, HOW, and FOR WHOM to produce something if you don’t know if anyone wants it, or what they want.

Demand is consumer-based.An Individual Demand Curve illustrates how the

quantity that a person will demand varies, depending upon the price of a good or service.

Example on Page 92 (Figure 4.1)

4

Second ExampleDemand Schedule for Taco Bell Tacos –

Price ($) Quantity Demanded by Bill

$5 0

$4 0

$3 1

$2 2

$1 4

$0.50 6

5

Demand Curve for Taco Bell TacosDemand Curve for Taco Bell Taco’s 

$5 

$4 

$3Cost of Taco’s

$2

$1

0 1 2 3 4 5

6Quantity Demanded By Bill

6

The Demand CurveEconomists analyze demand by listing

prices and desired quantities in a demand schedule (chart). When the demand data is graphed, it forms a demand curve with a DOWNWARD slope.

QUESTION: Another example. Think of something you want to buy. Think of the price? At what price would you be willing to buy the item?

7

The Law of Demand

8

(Pages 93-94)Defined: The Law of Demand states that the

quantity demanded of the good or service varies INVERSELY with the price.

When the price goes up, the quantity demanded goes down.

When the price goes down, the quantity demanded goes up. (Think big sale). A market demand curve illustrates how the quantity

that all interested persons’ (THE MARKET) demand varies depending upon the price of a good or service.

GRAPH ON PAGE 94 (Figure 4.2)

Market Demand Curve

9

Adding Sarah and Greg to the taco chart gets the MARKET DEMAND CURVE. See below:

Price ($)

Quantity

Demanded by Bill

Quantity

Demanded By Sarah

Quantity Demand

ed by Greg

Total

$5 0 0 0 0

$4 0 0 0 0

$3 1 0 1 2

$2 2 1 2 5

$1 4 2 3 9

$0.50 6 3 4 13

Market Demand Curve for Taco Bell Tacos

10

 $5

 Cost $4forTaco $3

$2

$1

0 1 2 3 4 5 6 7 8 9 10

11 12 13Quantity Demanded By Market

Demand and Marginal Utility

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DISCUSSION QUESTION:Why is price an obstacle to buying?

Demand and Marginal Utility (Page 93)Marginal Utility is the extra usefulness or

satisfaction a person receives from getting or using one or more unit of a product.

Principle of diminishing marginal utility states that the satisfaction we gain from buying a product lessens as we buy more of the same product.

The book gives the example of cola as an example of diminishing marginal utility. Food does not always follow this path as strictly as othersOther examples include Xbox, cars (the same), shoes, etchttp://www.youtube.com/watch?v=Cq7xP382FZg

Chapter 4Section 2

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Factors Affecting Demand

I. Change in the Quantity DemandedThe change in the quantity of demand

shows a change in the amount of the product purchased when there is a change in price.

Notice what happens to the quantity when $P goes up/down

Changes in DemandA change in demand is when people buy

different amounts of a product at the same prices.

As a result the entire demand curve shifts to the right to show an increase in demand

OR to the left to show a decrease to in demandThus creating an entirely new demand curve

Change in Demand (p. 99-102)A change in demand is when people buy

different amounts of a product at the same prices.

A change in demand can be caused by changes in the following:Income.

If you get a raise you can afford more.If you lose your job, you can afford less.

Tastes:In / Out of styleSuccessful advertising. Bad PR hit (Milli Vanilli– lip syncing)Product becomes obsolete (Sony’s PlayStation lost customers

to Xbox).

15

Substitutes and ComplementsA price change in a related product (substitutes)

Coke/Pepsi; Butter/Margarine; Burger King/McDonalds – those are substitutes.

The demand for a product tends to increase if the price of its substitute goes up and vice versa.

A price change in a related product (complements)PS2s/Games; hot dogs/buns; DVDs/DVD players; etc.The use of one increases the use of the other.When price of one decreases, consumers buy more

of both and vice versa.QUESTION: What are some examples you can

think of?16

Income EffectMeans that as prices drop, consumers are

left with extra real income. Vice Versa. How do people feel when the $P goes up?

A

B

Change in DemandConsumer expectations.

Always deals with the way people think about the future.

Stocking up before a big storm/hurricane.Choosing not to buy a product that may soon

become obsolete/improved upon:Waiting for PS3 instead of a cheaper PS2Waiting for 3D TV instead of buying plasma or

LCD TVThe number of buyers (consumers)

More buyers, more total demand.Less buyers, less total demand.

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Factors Affecting DemandOn a piece of paper, list three “trendy” items

that you really wanted, dating back to 2004.Try to determine which of the factors related to

demand made them more or less desirable.IncomeTastes:

In/Out of styleSuccessful advertisingBad PR hit

Price change in related product (complement or substitute)

Consumer expectations (future)Number of buyers

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TastesIn / Out of style

http://www.washingtonpost.com/wp-srv/artsandliving/features/2013/year-in-review/the-list.html

Successful advertising. Bad PR hit (Milli Vanilli and now Brittney

Spears in Australia – lip syncing)http://www.youtube.com/watch?v=ovMNl0gG

FNYProduct becomes obsolete (Sony’s

PlayStation 3 lost customers to PlayStation 4).

4. Consumer Expectations

5. Number of ConsumersMore buyers, more total demand.Less buyers, less total demand.

McDonald’s MakeoverWhy would McDonald’s go to the trouble

AND expense of redesigning its restaurant?http://www.youtube.com/watch?v=x32Xrep

gKvw

McDonald’s MakeoverThe company recognizes that the consumer

demand is changing.Which means the company has to change

tooOr What?

McDonald’s MakeoverRisk losing business to competitors that meets

customer demandsSuch changes in demand have an effect on both the

demand schedule AND the demand curveWhen it comes to demand – there are two types of

changes1. Price Changes while all other factors are the

sameOR2. Other factors change while the price stays the

sameIn the case of McDonald’s what are some of these

“other factors?”

1. If the price goes from $20 to 12.50, how much money am I saving?

2. How might that make me feel?3. What might I do with the extra savings? 4. Might this savings account for movement

along the demand curve? 5. What happens in the opposite scenario? 6. Are there any real world examples you

can think of?

Both Income Effect and Substitution Effect affects movement along the demand curve.

The change in quantity demanded can either be an increase or decrease

BUT the demand curve itself does not shift

Chapter 4Section 3

Elasticity of Demand

28

Focus QuestionWhy do governments tend to tax

items like gas, cigarettes and alcohol more heavily than things like vegetables or red meat?This is where we get deeper into the cause

and effect relationship in economics.

29

Group ActivityGroups of 4: (5 mins) List four things you purchase regular

units of every week/month (example: gas).Write your list up on the board

QUESTION TO CLASS: How much do you spend on each item?Are your purchases dependent upon price?

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Dependent vs. Independent Variablehttp://www.youtube.com/watch?v=urQnwl

m4F88Elasticity tells us how a dependent variable

– such as quantity demanded, responds to a change in an independent variable – such as price.

ElasticityElasticity is a general measure of responsiveness;

it tells us how a dependent variable – such as quantity demanded, responds to a change in an independent variable – such as price.

Explaining dependant and independent:If you have 20 iPods ordered by a group of people, that

number is pretty concrete. We know that only 20 iPods were ordered.

Conversely, the price is an independent variable. It’s set by the supplier, and can be arbitrary – meaning anything the supplier wishes to order.

Other measures, such as income or supply can also be understood in terms of elasticity.

32

Elastic Demand Vs Inelastic Demand

Elastic DemandEconomists say that the demand is elastic

when a given change in price causes a relatively larger change in quantity demanded.

AB

ElasticityConsumers react to a change in the price of

a good by changing the amount they demand. Of course, the size of the reaction – either higher or lower, and to what degree – can vary.This response is known as demand elasticity.

The difference between ELASTIC and INELASTIC.When the quantity demanded for a good / service

changes as a result of the price change, then the demand for that good is considered “ELASTIC”

35

Reasons for ElasticityAvailability of Good Quality Substitutes:

Easily substitutable goods will enable buyers to switch to an alternative good and thus such goods will exhibit greater elasticity than goods that do not have substitutes available.

The better the substitute(s) can replace the original good in terms of desirability, affordability, practicality etc. the more elastic the good will become.

A contrasting inelastic good would be water which is non-substitutable so a local community faced with rising water costs will be left with little choice but to pay the increased costs.

Goods and services for which no substitutes exist are generally inelastic.

36

Reasons for ElasticityWhether the good is habit forming or

obligatory: Addictive drugs, whether psychologically addictive or

physically Goods where dependency plays a key role will

naturally exhibit inelastic properties. Classic examples of such goods would be gasoline, alcohol and tobacco or in an extreme case, heroin.

Governments often place taxes on these types of goods, because of their highly inelastic demand since consequently such goods are assured revenue generators.

(GRAPHS ON PAGES 104-105.)

37

How do you determine Elasticity of Demand? Demand Elasticity – also known as PED

– price elasticity of demand is determined by a number of factors that essentially all fall under the umbrella of "choice". By choice we mean the power of choice that the

consumer of a given good holds to give up the consumption of said good. How easy is it to give that item up and not buy it at all, or buy a substitute?

The greater this choice the more price elastic the good will be and, by contrast, as the balance of this power falls in favor of the supplier the more inelastic the good will be.

38

Perceived ValuePerceived Value represents the

absolute maximum price a consumer is willing to pay for a good. When the price exceeds this level, the consumer will give up consumption of this good.Why aren’t more people dropping Verizon

and AT&T and switching to T-Mobile and Sprint for cellular phone service when their pricing is so much better?

39

Perceived ValueThe proportion of the consumer's

income the good represents: Goods which typically make up a small

proportion of people's income will exhibit inelastic qualities. Conversely, goods which form a large proportion of people's income will cause greater responses in demand to comparable % increases or decreases in price. For example, if cinema ticket costs rise by 20%,

decreases in demand are unlikely to be pronounced. However a 15% drop in a "luxury" good such as a car

or LCD Television changes in demand are likely to be relatively greater.

40

Perceived ValueHow closely the good is defined:

Taking our example from (# 2), cigarettes in general are, as discussed, an inelastic good. However a particular brand of cigarettes will exhibit far more elastic properties if its price rises. In general therefore, the exact type of good will affect its PED properties.

41

Perceived ValueHow closely the consumer (end-user) is

defined?: “Choice" is very subjective and factors 1,2 and 3 vary

relative to the individual consumer because every single consumer can potentially have a different Perceived Value of a good.

At nationwide level, if the cost of butter rises significantly consumers can choose to consume margarine instead but a shop who makes and sells butter cookies will not have this option and thus the PED will be far more inelastic in the latter case.

A driver faced with rising gas bills may opt to switch to using the train. However an airline company has no choice but to absorb rising fuel costs and will accordingly have a much more inelastic demand curve for essentially the same good.

42

Perceived ValueHow closely the time period is defined:

The greater the time period, the more possible it may be for a good to be replaced with a substitute.

Using home energy as an example, a gas user faced with rising gas bills will unlikely be able to switch to electric alternatives overnight. However over three months, a switch is far more viable and the PED will be accordingly more elastic.

Likewise, prices are dynamic. Over short time periods, prices of substitutes maybe static, over longer periods, the price of substitutes may drop, making them more appealing.

43

What products can you think of where the graph looks like this?

A contrasting inelastic good would be water which is arguably non-substitutable so a local community faced with rising water costs will be left with little choice but to pay the increased costs forming a price inelastic good.

Determining Elasticity- Without MathCAN THIS PURCHASE BE DELAYED?

If YES – elasticIf no – inelastic

What is the Availability of Good Quality Substitutes? Easily substitutable goods will exhibit greater elasticity.

Whether the good is habit forming or obligatory.

Does the purchase use a large portion of income?If amount is large, then demand tends to be elastic.If the amount is small, the demand tends to be inelastic.

46

Chapter 5: Supply

47

Chapter 5 Section 1

What is Supply?

48

Supply• The concept of supply is based on

voluntary decisions made by producers (both big and small)

• A producer might decide to offer one amount for sale at one price and a different quantity at another price

• Amount of a product offered for sale at all possible prices (that could prevail in the market place)

Law of SupplyBecause producers receive payment for

their products, they will offer more at higher prices

Principle that more will be offered for sale at higher prices than at lower prices

http://video.yahoo.com/watch/398277/2357614

Supply Schedule/CurveIs a listing of the various quantities of a

particular product supplied at all possible prices in the market.

Supply curve – a graph Showing the various Quantities supplied at All possible pricesThat might prevail in theMarket any given time

Law of Supply/DemandFor the Law of Supply, quantity varies

DIRECTLY with price, rather than INVERSELY.

ORIt slopes in the opposite direction (of

demand)

Individual and Market Supply Curves

• Bill, Duane and Sarah are all babysitters. Each supplies their services on an hourly basis for a fee.

•  • At $20 an hour, Bill will make himself available for 30 hours a week. At $15

an hour, he is still willing to work up to 30 hours. At $12 an hour he is only available for 25 hours a week. At $10 an hour, he is willing to work 20 hours a week. At $8 an hour, he’ll work 10 hours. At $5 an hour, he’ll work five hours. And at $3 an hour, he would rather do homework and won’t work any hours.

•  • At $20 an hour, Duane will make himself available for 20 hours a week. At

$15 an hour, he is willing to work up to 18 hours. At $12 an hour he is only available for 15 hours a week. At $10 an hour, he is willing to work 10 hours a week. At $8 an hour, he’ll work 5 hours. At $5 an hour, he’ll work 2 hours. And at $3 an hour, he too would rather do homework and won’t work any hours.

•  • At $20 an hour, Sarah will make herself available for 30 hours a week. At

$15 an hour, she is still willing to work up to 30 hours. At $12 an hour she continues to be available for 30 hours a week. At $10 an hour, she is willing to work 20 hours a week. At $8 an hour, she’ll work 15 hours. At $5 an hour, she’ll work 10 hours. And at $3 an hour, she’ll work 5 hours.

 

Individual Supply ScheduleBill Duane Sarah

$ Price Quantity Supplied

$Price Quantity Supplied

$Price Quantity Supplied

$20 $15$12$10$8$5$3

303025201050

$20 $15$12$10$8$5$3

20181510520

$20 $15$12$10$8$5$3

3030302015105

Market Supply Chart$ Price Quantity Supplied

$20 $15$12$10$8$5$3

8078705030175

Graph of Market Supply Curve $25

$20 *

$15 *

*

$10 *

*

$5 *

*

0

10 20 30 40 50 60 70 80

  

A Change in the Quantity SuppliedIs the change in amount offered for sale in Response to a change in price.

Change in Supply

• Sometimes something happens to cause a change in supply

• A situation where suppliers offer different amounts of products for sale at all possible prices in the market

• This is NOT the same as quantity supplied• Why?• Because we are looking at situations where

the quantity changes even though the price remains the same

Change in Supply

When both old and new quantities are plotted in the form of a graph, it appears as if the supply curve has shifted to the right, showing an increase in supply

Why –Determinants that Change Supply

Cost of ResourcesLand, labor, capital

Productivity

Technology

Taxes and Subsidies

Expectations

Government Regulations

Number of Sellers

Elasticity of Supply• Just as demand has elasticity, supply also has an

elasticity• Supply Elasticity is a measure of the way in which

the quantity supplied responds to a change in price• If an increase in price leads to a proportionally

larger increase in output, supply is elastic• If an increase in price causes a proportionally

smaller change in output, supply is inelastic• Similar to elasticity we learned with demand –

In both cases, elasticity is simply a measure of the way quantity adjusts to a change in price

Three Elasticities1. Elastic Supply2. Inelastic Supply3. Unit Elastic Supply

Elastic SupplyThe change in price causes a proportionally

larger change in quantity suppliedI.E. Doubling the price from $1 to $2 causes

the quantity brought to market to triple from two to six units

Inelastic SupplyIn this case, a change in price causes a

proportionally smaller change in quantity supplied

When the price doubles from $1 to $2, the quantity brought to market goes up only 50 %, or from 2 units to 3.

Unit Elasticity A change in price causes a proportional

change in quantity supplied I.E. as the price doubles from $1 to $2, the

quantity brought to market also doubles.

• 1. Elastic Supply – EXAMPLES – toys, candy, and other products that can be made quickly without huge amounts of capital and skilled required.

• 2. Inelastic Supply – Nuclear power – No matter what price is being offered , electric utilities will find it difficult to increase output because of the huge amount of capital and technology needed before nuclear production can be increased.

• 3. Unit Elastic Supply

• Unlike demand elasticity – the number of substitutes has no bearing on supply elasticity

• Instead only production considerations determine supply elasticity

• If a firm can react quickly to a changing price, then supply is likely to be elastic

• If it cannot then supply will be inelastic

6.1

Prices as Signals

What do you think when you see this picture?

What do you think when you see this picture now?

Brand new 32’ TV, $99

What do you think when you see this picture now?

Brand new 32’ TV, $299

What do you think when you see this picture?

What do you think when you see this picture now?

Cheeseburger only

99 ¢

What do you think when you see this picture now?

Cheeseburger only $25.99

Advantages of pricesPrices are neutral

Prices are flexible

People understand prices

No cost to administer

What to do without prices?Deals with the problem “For Whom to

Produce”

First come, first serveCorruptionRationing

Problems with RationingShare is too small

Administrative cost

Negative impact on the incentive to produce

If Rationing is so bad, why do we do it?

6.1 & 6.2

Supply and Demand

Dynamic Pricinghttp://www.clipsyndicate.com/video/play/14

77909/dynamic_ticket_pricing_gaining_traction_for_sports_video

Kind of neat.

The Price System at WorkThe process of establishing a price can

complicated because buyers and sellers have opposite hopes and desires:

Buyers want to find a great deal Sellers want to het high prices and make

large profitsEconomists agree that as long as there is

competition – prices will be about right under a bidding system

The Price Adjustment ProcessTransactions in a market are voluntaryBuyers and sellers both compromise to

settle the differences so they both gain some benefit

A Market ModelFigure 6.1There is a market demand curveThere is a market supply curveWhen both are put together on the same

graph – you have a “Market Model”Or some clue as to how buyers and sellers

will find the price that is mutually agreeable.

Equilibrium CurveThe intersection of the two curves is called

the equilibrium priceA “perfect price” – it is the place where no

surplus will occur and no shortage will occur either.

This equilibrium price is arrived at through trial and error.

Market Demand and Supply Schedule for Flu Shots

Priceper Unit

QuantityDemanded

QuantitySupplied

$2 14,000 2,000

4 12,000 4,000

6 10,000 6,000

8 8,000 8,000

10 6,000 10,000

12 4,000 12,000

14 2,000 14,000

16 0 16,000

Surplus

Shortage

SurplusThe quantity supplied is greater than the

quantity demandedSuppliers must lower the price to sell the

surplus

ShortageThe quantity demanded is greater than the

quantity supplied at a given priceThe supplier realizes people might have

been willing to spend more because there was a shortage at the price being offered

The supplier will raise the price and the supply to avoid a shortage

Equilibrium PriceThe price “clears the market” – there is no

surplus or shortageThe correct price that buyers and sellers

can both “be happy with”

II. Explaining and Predicting PricesEconomists use market models to explain

changes in prices Prices change due to:Change in supply – which can be caused by a

change in:1. Cost of Resources2. Productivity3. Technology4. Taxes and/or Subsidy5. Expectations6. Government Regulations7. Number of Sellers

Change in Demand1. Income Effect2. The Substitution Effect3. A change in consumer income4. A change in consumer taste5. A change in the price of a

complementary product6. A change in customer expectations

(waiting for the latest model)7. A change in the number of consumers

Changes in BothPrices and competitive marketsEconomists like to see competitive markets

because that is when the price system is most effective

Advantages of a competitive markets is they allocate resources efficiently

A. Sellers compete to meet demand of customers – they have to keep prices low

B. To keep their prices low – they have use their resources wisely – watch their costs

C. Competition among buyers (to have what they want and need) keep prices from falling too low.

A competitive market requires NO ONE to run it.