Supply and Demand

Academic Unit 4: Microeconomics

I. Demand

A. Description1. Demand is the desire to own something and

the ability to pay for it.2. Quantity demanded is the amount of a good that

buyers are willing and able to purchase.

3. Law of demand:

PRICEAs price goes

down…DEMANDQuantity

demanded goes up.

PRICEAs price goes

up…

DEMANDQuantity

demanded goes down.

4. Demand schedule - table shows relationship between price of good & quantity demanded.

5. Demand curve represents table on a graph. It slopes from the top left to bottom right.

6. Demand can also be plotted for an entire market.

B. Changes in Demand

1. Substitution Effect: $ , the demand will be effected by substitutes available.

2. Substitutes are goods used in place of another.

3. Income effect: Income rises, the demand will be effected in two different ways:

a. Normal goods: If wealthier, they will buy more of.

b. Inferior goods: If wealthier, they will buy less of.

Changes in Demand cont…

4. Consumer expectations: If customers know there is a sale, they will not buy this week.

5. Population: As population changes in age, goods demanded change.

6. Tastes and advertising: Waves of popularity & advertising will impact demand.

7. Related goods: Complements are goods that are bought together.

8. These shift the entire demand curve. Increases shift to the right. Decreases shift to the left.

C. Extreme Demand

1. Supply shock is when there is a severe shortage.

2. Government may intervene with rationing

3. WWII is an example of high demand, rationing rubber, fuel, nylon, etc.

4. 1970’s: Gasoline rationing.

II. Supply

A. Description1. Quantity supplied is the amount of a

good that sellers are willing and able to sell.

2. Law of Supply: Prices go up…

Supply goes up.

Prices goes down…

Supply goes down.

3. supply schedule - table shows relationship between price of good & quantity supplied.

4. Supply curve is a graphic representation of the supply schedule.

5. The supply curve slopes from bottom left to top right.

6. Both can be shown for a whole market.

B. Changes in Supply1. Rising Costs: Costs of production will cause a decrease in

supply. 2. Technology: Efficiency in production will increase production and

supply. 3. Subsidy: Government financial assistance for producers. 4. Excise tax: Tax on the production, distribution, sale of product. 5. Regulation: Limits on the production will decrease supply. 6. Expectations: Producers will slow or increase production based

on forecasts. 7. These cause the curve to increase (shift to right) or decrease

(shift to left).

III. Supply and Demand Together

A. Equilibrium

Equilibrium Price

Surplus

Shortage

DemandSupply

Price Floor : Minimum Wage

Price Ceiling: Rent Control

1. Equilibrium is when supply and demand are equal.

2. This is the best price in a competitive market where producers makes the most and consumers save the most.

3. If Supply is greater than excess, there is a surplus and producers lower prices to increase sales to equilibrium.

4. If demand is greater, there is a shortage and producers increase prices to decrease demand toward equilibrium.

B. Elasticity1. Elasticity of demand: Sensitivity of demand of consumers to price change. 2. Elastic: Items that are highly sensitive to price change.

a. Doughnutsb. Magazinesc. Un-addictive luxuries

3. Inelastic: Items that are not sensitive to price. a. Gasb. Tobaccoc. Alcohol

4. Elasticity of supply: Sensitivity of suppliers to price change. 5. Elastic: Suppliers will be able to produce more or less of a product due to changes

of prices in the market. a. Breadb. Tires

6. Inelastic: Suppliers will not be able to produce more or less of a product. a. Orangesb. Oil

7. Elasticity is determined by dividing the percentage change in quantity divided by the percentage change in price.

8. The cross-price elasticity of demand measures how much the quantity demanded of one good responds to the price of another good.

Figure 1 The Price Elasticity of Demand

Copyright©2003 Southwestern/Thomson Learning

(a) Perfectly Inelastic Demand: Elasticity Equals 0

$5

4

Quantity

Demand

1000

1. Anincreasein price . . .

2. . . . leaves the quantity demanded unchanged.

Price

Figure 1 The Price Elasticity of Demand

(e) Perfectly Elastic Demand: Elasticity Equals Infinity

Quantity0

Price

$4 Demand

2. At exactly $4,consumers willbuy any quantity.

1. At any priceabove $4, quantitydemanded is zero.

3. At a price below $4,quantity demanded is infinite.

C. Companies and Pricing

1. Suppliers must take into account, the bills they have when producing:

a. Fixed Costs : Same monthly.b. Variable Costs: Varies monthly.c. Fixed + Variable = Total

2. Adding labor (more workers is not always good):a. At first, each additional worker increases output more.

(Increasing Marginal Returns)b. Eventually output will still increase, but more slowly.

(Diminishing marginal returns).c. Soon, production will drop with each worker added. (Negative

marginal returns).

D. Market Structure

1. Chart

Business Organization

Number of Firms

Variety of Goods

Barriers to Entry

Control Over Prices

Example

Perfect Competition Many Homogenous, Identical

None, perfectly free to start a business

None Agricultural products, stock

Monopoly One Unique Difficult if not impossible

Complete Public Sewage

Monopolistic Competition

Many Similar products, but with substitutes

Very Low Little Clothes: Shirts, pants

Oligopoly A Few Similar products, but with substitutes

High, very expensive

Some Cars

2. Monopolies

a. One producer of good/service when there is no substitute

b. Rare in America -2 Reasons i. Americans have passed laws against them

ii. 2. Normally a close substitute can be found

a. A situation in which competition is not desirable or technically possible b. In these cases the government permits franchises.

i. Right to do business in a certain area free from competition ii. 2) Government then regulates the price and quality of service or product.

c. Three Typesi. Geographic Monopoly

a) Based on location b) EX: gas station along a deserted stretch of highway c) EX: a drugstore in a small town d) EX: Laundromat next to apartment building

ii. Technological Monopoly a) A situation in which a technique is discovered or a new invention is created. b) patent - An exclusive right to use, manufacture, or sell any new product, invention or

technique.c) It is good for a certain number of years--then the invention becomes public property. d) copyright - Art and literary works, Exclusive right to publish, sell, or reproduce his/her

work for his or her life plus fifty years iii. Government Monopoly

a) An activity owned and operated by the gov't b) Normally economic products that people fell would not be provided adequately or

properly by private industry. c) 1) local sewage d) 2) national defense e) liquor stores in PA

3. Natural Monopoly

4. Role of Government in Market Structure

A. Anti-Trust Legislation 1. trusts- legally formed combinations of corporations or companies 2. Laws were passed to prevent monopolies and trusts 3. Sherman Anti-Trust Act 1890 - First significant law aimed at ending the monopolies, Standard Oil (Rockefeller) was broken up into smaller companies. 4. Clayton Anti-Trust Act

a. 1914 b. Outlawed price discrimination -the practice of charging customers

different prices for the same product to reduce competition 5. Federal Trade Commission Act

a. 1914 b. Passed to give the government the power to enforce the Clayton Act

through the FTC 6. Robinson-Patman Act

a. 1936 b. Strengthened the Clayton Act by requiring any rebates or discounts on goods to be available to all buyers

5. Why?

a. Inefficient Monopoly - monopolist makes less than the efficient quantity for society.

b. Deadweight loss made by monopoly is same as the loss caused by a tax.

c. Government gets the revenue from a tax, a private firm gets the monopoly profit.

6. Other concerns

a. Price discrimination = practice of selling same product at multiple prices to various customers, even though costs for manufacturing for two customers is same.

b. Horizontal mergers = Standard Oil, buying up or crushing same types of companies.

c. Vertical mergers = US Steel, buying up multiple points of the production process.

d. Conglomerates = various companies bought that have no direct relationship with original production.

7. Oligopolies

a. Few large firms

b. Duopoly – two

c. Collusion = agreement in a market about amount to manufacture or prices to use.

d. Cartel - firms acting in alliance.e. Antitrust laws prohibit specific deals in

oligopolies.

8. Concerns

a. Resale Price Maintenance - occurs when suppliers force retailers to charge a specific price known as fair trade

b. Predatory Pricing occurs when large firms cut prices to drive its competitors out of the market

c. Tying - when firms offer two or more products at single price