Lecture 6 : Examining Market Mechanics

Money prices and relative real prices Influences on demand Influences on supply Prices and quantities determined by

demand and supply Why prices change Work for the Week

– Chapter 4 in both book and EIA

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Opportunity Cost and Price

Economic actions arise from scarcity, wants in excess of available resources.

Scarcity implies choices. Choices are influenced by

opportunity costs through substitution.

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Opportunity Cost and Relative Price

The ratio of one price to another is called a relative price.

A relative price is an opportunity cost.

We often measure prices relative to a price index, the average price of a basket of goods.

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Demand, Supply and Relative Prices

Demand and supply determine relative prices. The word “price” means relative price. If we predict a price will fall, we mean its price

will fall relative to the average price of other goods and services.

All movements in price in the market analysis that we examine refers to relative price

movements. Relative Price is not “Money” Price.

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The Price of Wheat

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Demand If a person demands something, they

– Want it,– Can afford it, and– Have made a definite plan to buy it.

Wants are the unlimited desires or wishes that people have for goods and services.

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Demand The quantity demanded of a good or

service is the amount that consumers plan to buy during a given time period at a particular price.

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Demand What determines buying plans?

– The price of the good– The prices of related goods– Income– Population– Preferences– Expected future prices

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Demand The Law of Demand

– Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded.

Reasons for the Law of Demand

– Substitution Effect– Income Effect

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Demand Demand Curve and Demand

Schedule– Demand curves show the relationship between

the quantity demanded of a good and its price (ceteris paribus).

– Demand schedules list the quantities demanded at each different price (ceteris paribus).

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Demand

a 1 9

b 2 6

c 3 4

d 4 3

e 5 2

Price Quantity(dollars per tape) (millions of tapes per week)

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Demand

0 2 4 6 8 10

1

2

3

4

5

6

Quantity (millions of tapes per week)

Pri

ce (

doll

ar p

er ta

pe)

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Demand

0 2 4 6 8 10

1

2

3

4

5

6

Quantity (millions of tapes per week)

Pri

ce (

doll

ar p

er ta

pe)

e

d

c

b

a

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Demand

0 2 4 6 8 10

1

2

3

4

5

6

e

d

c

b

aDemand for tapes

Quantity (millions of tapes per week)

Pri

ce (

doll

ar p

er ta

pe)

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Demand A Change in Demand

– When any factor that influences buying plans other than the price of the good changes, there is a change in demand.

• An increase in demand causes the demand curve to shift rightward.

• A decrease in demand causes the demand curve to shift leftward.

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A Change in Demand Price of Related Goods

– Substitutes - goods used in the place of another good– Complements - goods used in conjunction with

another good

What Happens to Demand if the price of a substitute good increases? A complement?

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A Change in Demand Income

– Normal Goods — demand increases as income increases

– Inferior Goods — demand decreases as income increases

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A Change in Demand Population

– Size and age structure

Preferences

– Attitudes toward goods and services

Expected Future Prices

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DemandOriginal demand schedule New demand schedule

Walkman $200 Walkman $50

Price Quantity Price Quantity (dollars (millions of tapes (dollars (millions of tapes

per tape) per week) per tape) per week))

a 1 9

b 2 6

c 3 4

d 4 3

e 5 2

Assume the original price of Walkmans is $200. The demand schedule showsthe Price-Quantity relationship for tapes.

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DemandOriginal demand schedule New demand schedule

Walkman $200 Walkman $50

Price Quantity Price Quantity (dollars (millions of tapes (dollars (millions of tapes

per tape) per week) per tape) per week))

a 1 9 a' 1

b 2 6 b' 2

c 3 4 c' 3

d 4 3 d' 4

e 5 2 e' 5

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DemandOriginal demand schedule New demand schedule

Walkman $200 Walkman $50

Price Quantity Price Quantity (dollars (millions of tapes (dollars (millions of tapes

per tape) per week) per tape) per week))

a 1 9 a' 1 13

b 2 6 b' 2 10

c 3 4 c' 3 8

d 4 3 d' 4 7

e 5 2 e' 5 6

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Demand

0 2 4 6 8 10 12 14

1

2

3

4

5

6

Quantity (millions of tapes per week)

Pri

ce (

doll

ar p

er ta

pe)

e

d

c

b

aDemand for tapes(Walkman $200)

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Demand

0 2 4 6 8 10 12 14

1

2

3

4

5

6

e

d

c

b

aDemand for tapes(Walkman $200)

Quantity (millions of tapes per week)

Pri

ce (

doll

ar p

er ta

pe)

e'

d'

c'

b'

a'

Demand for tapes(Walkman $50)

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The Demand for Tapes The Law of Demand

– The quantity of tapes demanded• Decreases if:

– The price of a tape rises

• Increases if:

– The price of a tape falls

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The Demand for Tapes Changes In Demand

– The demand for tapes• Decreases if:

– The price of a substitute falls

– The price of a complement rises

– Income falls (a tape is a normal good)

– The population decreases

– The price of a tape is expected to fall in the future

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The Demand for Tapes Changes In Demand

– The demand for tapes• Increases if:

– The price of a substitute rises

– The price of a complement falls

– Income rises (a tape is a normal good)

– The population increases

– The price of a tape is expected to rise in the future

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A Change in the Quantity Demanded Versus a Change in Demand

A movement along a demand curve, which results from a change in price, shows a change in the quantity demanded.

If some other influence on buyers’ plans changes, holding price constant, there is a change in demand.

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A Change in the Quantity Demanded Versus a Change in

Demand

Quantity

Pri

ce

D0

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A Change in the Quantity Demanded Versus a Change in

Demand

Quantity

Pri

ce

D0

Decrease inquantitydemanded

Increase inquantitydemanded

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A Change in the Quantity Demanded Versus a Change in

Demand

Quantity

Pri

ce

D0

P0

Q0 MACRO HAPPENS

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A Change in the Quantity Demanded Versus a Change in Demand

Quantity

Pri

ce

D0

P0

P1

Q0Q1 MACRO HAPPENS

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A Change in the Quantity Demanded Versus a Change in

Demand

Quantity

Pri

ce

D0

P0

P2

P1

Q0 Q2Q1 MACRO HAPPENS

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A Change in the Quantity Demanded Versus a Change in Demand

Quantity

Pri

ce

D0

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A Change in the Quantity Demanded Versus a Change in Demand

Quantity

Pri

ce

D0

D1

Increase in

demand

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A Change in the Quantity Demanded Versus a Change in Demand

Pri

ce

Quantity

D0

D1

D2

Increase inDecrease in demand demand

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A Change in the Quantity Demanded Versus a Change in Demand

Quantity

Pri

ce

D0

D1

D2D0

Decrease inquantitydemanded

Increase inquantitydemanded

Increase in

demand

Decrease in demand

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Movement Along Versus a Shift of the Demand Curve

If the price of a good changes but everything else remains the same, there is a movement along the demand curve.

If the price of a good remains constant but some other influence on buyers’ plans changes, there is a shift of the demand curve.

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A Change in Quantity Demanded Versus a Change

in Demand A movement along the demand curve

shows a change in the quantity demanded.

A shift of the demand curve shows a change in demand.

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