chapter 3 economics notes

8/13/2019 Chapter 3 Economics Notes

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Chapter 3 Economics Notes

Section 3.1:

Market: An institution or mechanism that brings together buyers (demanders) and sellers

(suppliers) of particular goods, services, or resources.

All situations that link potential buyers with potential sellers are markets.Demand: A schedule or a curve that shows the various amounts of a product that consumers are

willing and able to purchase at each of a series of possible prices during a specified period of

time.

Shows the quantities of a product that will be purchased at various possible prices,other things equal.

- Demand is simply a statement of a buyers plans, or intentions, withrespect to the purchase of a product.

Demand schedulesreveal the relationship between the price and quantity of anitem that a particular consumer would be willing and able to purchase.

Law of Demand: All else equal, as price falls, the quantity demanded rises, and as price rises,

the quantity demanded falls. A negative/inverse relationship between price and quantity

demanded exists. When discussing price, values are always relative to other options.

Causes for the inverse relationship:1. The law of demand is consistent with common sense. People

ordinarily dobuy more of a product at a low price than a high price.2. The Law of Diminishing Marginal Utility:Each buyer of a

product will derive less satisfaction from each successive unit of

the product consumed.

3. Income Effect:A lower priced good increases the purchasingpower of a buyers money income, enabling the buyer to purchase

more of the product than she or he could buy before.

4. Substitution Effect: Suggests that at lower prices buyers have theincentive to substitute what is now a less expensive product for

similar products that are now relativelymore expensive.

The Demand Curve:


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By convention the quantity demanded is measured on the x-axis and the prices on

the y-axis. The downward slope reflects the law of demand.

Market Demand:Market Demand is derived from the sum of all Individual Demands. At eachprice the Ind. Demand = the total quantity demanded at that price. The price and the total

quantity demand are then plotted as one point on the Market Demand curve.

Price is the most important influence on the amount of a product purchased. Otherfactors also affect purchases howeverthe Determinants of Demand

(demand/curve shifters).

Consumer preferences: Through new products, or other change intastes, a product becomes more desirable.

Number of consumers: ExampleIncreases in life expectancy hasincreased the demand for medical care, retirement communities,and nursing homes.

Consumer incomes: For most products, a rise in income causes anincrease in demand. Consumers buy more steaks, furniture and

computers as their income increases.

Normal Goods (Superior Goods): Products whosedemand varies directlywith money income.

For some products, as income rises, demand decreases (i.e. used

clothes, retread tires, etc.)

Inferior Goods: Goods whose demand varies inverselywith money income.

Price of related goods: - Substitute Good: Goods that can be usedin place of other goods. Two substitute goods move in the same

direction in terms of ones demand and the others prices.

- Complementary Good:Good that is used together withanother good. When two products are complements, the price

of one good and the demand for the other good move in

opposite directions.

- Independent Goods:A change in the price of one gooddoesnt affect the demand for the other.

Consumer expectations: A new customer expectation that eitherprices or income will be higher in the future.


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Changes in Demand: A shift of the entire demand curve to the right or left. It occurs because

the consumers state of mind about purchasing the product has been altered in response to a

change in one or more of the determinants of demand.

Change in Quantity Demanded: A movement from one point to another point (one price-

quantity combination to another) on a fixed demand schedule or curve. The cause of such achange is an increase or decrease in the price of the product under consideration.

Section 3.2:

Supply: A schedule or curve showing the amounts of a product that producers are willing and

able to make available for sale at each of a series of possible prices during a specific period.

Law of Supply: As price rises, the quantity supplied rises; as price falls, the quantity supplied

falls.

To a supplier, price represents revenue, which serves as an incentive to produceand sell the product. To the consumer, price is an obstacle; the higher the price,

the less the consumer will buy.

Supply Curve: The market Supply Curve is obtained by horizontally adding the supply curves

of the individual producers.

Determinants of Supply: A change in supply, meaning the entire supply curve will shift.

1. Resource Prices: Higher resource prices raise production costs, squeeze profitsand then lowers supply output. Lower resource prices reduce production costs and

increase profits, allowing for firms to supply greater output.


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2. Technology: Improvements in technology enable firms to produce units of outputwith fewer resources. Because resources are costly, using fewer of them lowers

production costs and increases supply.

3. Taxes and Subsidies: An increase in sales or property taxes will increaseproduction costs and reduce supply. Subsidies are the opposite of taxes

(government grants).

4. Prices of other goods: Firms that produce more than 1 product might substitutethe production of one good for another to increase profits. Thus there is an

increase in the supply of the product replacing the original.

5. Price Expectations: Changes in expectations about the future price of a productmay affect the producers current willingness to supply that product.

6. The # of Sellers in the market: Other things equal, the larger the number ofsuppliers, the greater the market supply. As more firms enter an industry, the

supply curve shifts to the right.

Changes in Supply: A shift of the entire supply curve to the right or left. It occurs because the

consumers state of mind about purchasing theproduct has been altered in response to a change

in one or more of the determinants of supply.

Change in Quantity Demanded: A movement from one point to another point (one price-

quantity combination to another) on a fixed supply schedule or curve. The cause of such a

change is an increase or decrease in the price of the product under consideration.

Section 3.3:

Surpluses: Instance where a price encourages the production of lots of goods, but discouragesmost consumers from buying it;Excess supply.A very large surplus of a good would prompt

competing sellers to lower the price to encourage buyers to take the surplus of their hands.

surplus cannot persist over a period of time, only temporarily.

Shortages:Occurs when a price discourages the devotion of resources to production and

encourages consumer to buy more than is available.Excess demand.Because many consumers

will not be able to get some of the product, they will be willing to spend more for the available

output. Competition among these buyers will drive the price to something greater.

Equilibrium Price and Quantity:Only at the equilibrium point is the producers quantity that

he is willing to produce and supply = to the quantity that consumers are willing and able to buy.

The price at this point is called the market-clearing or equilibrium price. The point where the

quantity supplied and the quantity demanded (equilibrium point) are in balance is the equilibrium

quantity.

** Graphically, the intersection of the supply curve and the demand curve for a product indicates

the market equilibrium. Any price below the equilibrium creates shortage, above creates surplus.


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Rationing Function of Prices: The ability of the competitive forces of supply and demand to

establish a price at which selling and buying decisions are consistent.

It is the combination of freely made individual decisions that sets the market-clearing price.

Changes in Supply, Demand, and Equilibrium:What effects will changes in supply and

demand have on the equilibrium price and quantity?

Changes in Demand: Supply is constant and demand increases - An increase indemand raises both the equilibrium price and quantity (and vice versa).

Changes in Supply: Demand is constant but supply increases An increase insupply reduces the equilibrium price but increases equilibrium quantity (and vice

versa).

Complex Cases: When both supply and demand change, the effect is acombination of the individual effects:Change in Supply Change in

Demand

Effect on

Equilibrium Price

Effect on

EquilibriumQuantity

1. Increase Decrease Decrease Indeterminate

2. Decrease Increase Increase Indeterminate

3. Increase Increase Indeterminate Increase

4. Decrease Decrease Indeterminate Decrease

Other Special Cases: When a decrease in demand and a decrease in supply, or anincrease in demand and an increase in supply, exactly cancel out. In both cases,

the net effect on equilibrium price will be 0; price will not change.

A Reminder: Other things equal: It is important to remember that specific demand and

supply curves show relationships between prices and quantities demanded and supplied, other

things equal. If you forget the ceteris paribus assumption, you can encounter situations that seem

to be in conflict with basic economic principles.

chapter 3 economics notes

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