Chapter 6 Chapter 6 Demand, Supply, and Demand, Supply, and MarketsMarketsEconomics 11Economics 11

March 2012March 2012

What is a market?What is a market? A A marketmarket is any network that brings is any network that brings

buyers and sellers into contact with one buyers and sellers into contact with one another so they can exchange goods and another so they can exchange goods and servicesservices

It is through markets that our economy It is through markets that our economy answers the three questions: answers the three questions: what to what to produce, how to produce, and for whom produce, how to produce, and for whom to produceto produce

MarketsMarkets A market however, does not have to have a A market however, does not have to have a

physical settingphysical setting business can be done by telephone, fax, internet or business can be done by telephone, fax, internet or

written communication written communication

A market exists wherever the forces of supply A market exists wherever the forces of supply and demand meet to effect an exchangeand demand meet to effect an exchange

In any given market at any given time, the total In any given market at any given time, the total number of sellers constitute the supply and the number of sellers constitute the supply and the total number of buyers constitute the demand total number of buyers constitute the demand

DemandDemand

demanddemand - the quantities of a good or - the quantities of a good or service that buyers are willing and able to service that buyers are willing and able to buy at various prices in a particular buy at various prices in a particular period of time period of time

DemandDemanddemand scheduledemand schedule – a list of prices and the number – a list of prices and the number

you would buy at each price you would buy at each price

demand curvedemand curve – a graph showing the relationship – a graph showing the relationship between price and quantity between price and quantity the vertical (y) axis always measures price, and the horizontal the vertical (y) axis always measures price, and the horizontal

(x) axis always measures quantity (x) axis always measures quantity

as price increases, quantity demanded decreases. as price increases, quantity demanded decreases.

as price decreases, quantity demanded increases.as price decreases, quantity demanded increases.

in other words, there is an inverse relationship between in other words, there is an inverse relationship between quantity demanded and price. quantity demanded and price.

Demand - Demand - downward sloping demanddownward sloping demand

the law of downward sloping the law of downward sloping demanddemand – this law states that when the – this law states that when the price of a good is raised (and there are price of a good is raised (and there are no other changes), less of it will be no other changes), less of it will be demanded. If the price of a good is demanded. If the price of a good is lowered (and there are no other changes) lowered (and there are no other changes) then the quantity demanded will increase. then the quantity demanded will increase.

Demand – Demand – demand and utilitydemand and utility

the law of diminishing marginal the law of diminishing marginal utilityutility – this law states that each – this law states that each additional unit of good consumed at any additional unit of good consumed at any given time yields less satisfaction than given time yields less satisfaction than the one previously consumed the one previously consumed

Demand – Demand – elasticity of demandelasticity of demand

elasticity of demandelasticity of demand – the responsiveness of – the responsiveness of the quantity demanded to a change in price the quantity demanded to a change in price

the demand for McDonalds’ hamburgers is elastic the demand for McDonalds’ hamburgers is elastic

the price drops, more money is spent on the price drops, more money is spent on McDonalds’ burgersMcDonalds’ burgers

the price rises, less money is spent on McDonalds’ the price rises, less money is spent on McDonalds’ burgersburgers

Demand – Demand – elasticity of demandelasticity of demand

factorsfactors determining elasticity of demand : determining elasticity of demand :

lots of substituteslots of substitutes ( (items that have lots of substitutes are items that have lots of substitutes are usually elastic in demandusually elastic in demand demand is affected by price changes demand is affected by price changes) )

small itemssmall items tend to be unaffected by price changes so tend to be unaffected by price changes so they are likely to be inelastic (they are likely to be inelastic (big items in a budget are likely big items in a budget are likely to be elasticto be elastic) )

essential itemsessential items (bread, electricity) tend to have inelastic (bread, electricity) tend to have inelastic demand because consumers cannot readily avoid demand because consumers cannot readily avoid using them using them luxury goods (like a holiday to a tropical destination) tend to luxury goods (like a holiday to a tropical destination) tend to

have elastic demand because consumers can easily stop have elastic demand because consumers can easily stop buying them if prices rise. buying them if prices rise.

Demand – Demand – shifts in demandshifts in demand

shifts in demand occur when there is a change shifts in demand occur when there is a change in the quantity of a product demanded for in the quantity of a product demanded for reasons other than price changes reasons other than price changes

possible causes of a shift in demand: possible causes of a shift in demand: a change in market size a change in market size a change in incomea change in income an increase in the cost of substitutes an increase in the cost of substitutes a change in preference a change in preference

SupplySupply

supplysupply – the quantities of a good or – the quantities of a good or service that sellers are willing and able to service that sellers are willing and able to sell at various prices in a particular period sell at various prices in a particular period of time. of time.

SupplySupplysupply schedulesupply schedule – shows the price-quantity – shows the price-quantity

relationship. relationship.

supply curvesupply curve – a graph showing the relationship – a graph showing the relationship between price and quantitybetween price and quantity

Note that the supply curve slopes up and to the right – Note that the supply curve slopes up and to the right – showing that as prices rise, suppliers are willing and showing that as prices rise, suppliers are willing and able to supply more. able to supply more. There is a direct relationship between price and quantity There is a direct relationship between price and quantity

supplied. supplied.

Supply, Demand, and EquilibriumSupply, Demand, and Equilibrium

Assuming no other changes take placeAssuming no other changes take place, , we know that as the price of a good (we know that as the price of a good (or or serviceservice) falls, more of that good will be ) falls, more of that good will be demanded and less of it supplieddemanded and less of it supplied

Conversely, as the price rises more of it Conversely, as the price rises more of it will be supplied and less of it demanded will be supplied and less of it demanded

Supply, Demand, and EquilibriumSupply, Demand, and Equilibrium

At some point, the quantity supplied and the At some point, the quantity supplied and the quantity demanded will be equal, here supply quantity demanded will be equal, here supply and demand are in and demand are in equilibriumequilibrium. .

In markets, equilibrium is seldom reached. In markets, equilibrium is seldom reached.

There are too many other factors that continuously influence There are too many other factors that continuously influence the supply and demand of goods and services.the supply and demand of goods and services.

However when there is freedom of competition among and However when there is freedom of competition among and between buyers and sellers, the forces of supply and demand between buyers and sellers, the forces of supply and demand move toward equilibrium to resolve the problems of shortages move toward equilibrium to resolve the problems of shortages and surpluses. and surpluses.

Shifts in supply and demandShifts in supply and demand

If incomes generally If incomes generally increaseincrease, then it is , then it is likely that people will be willing and able likely that people will be willing and able to buy more, so the entire demand curve to buy more, so the entire demand curve shifts rightshifts right..

If incomes generally If incomes generally decreasedecrease, the entire , the entire demand curve will demand curve will shift to the leftshift to the left, , because there will be less demandbecause there will be less demand

The role of the market in The role of the market in our economic systemour economic system

Prices act as guides to owners of resources Prices act as guides to owners of resources and indicate where they can get the best deal and indicate where they can get the best deal for their labour, land, or capital. for their labour, land, or capital.

Prices also provide the information and Prices also provide the information and incentive that consumers need to allocate their incentive that consumers need to allocate their scarce resources to meet their needs and scarce resources to meet their needs and wants. wants.

Prices signal shortages and surplusesPrices signal shortages and surpluses

Government Price FixingGovernment Price FixingCeiling pricesCeiling prices A government may feel that the price for a A government may feel that the price for a

good or service is too high, and therefore it good or service is too high, and therefore it fixes a maximum or ceiling price for it. fixes a maximum or ceiling price for it.

The The maximummaximum or or ceiling priceceiling price is the highest is the highest price that may be charged legally for a good or price that may be charged legally for a good or service. service.

For example: rent controlsFor example: rent controls

Government Price FixingGovernment Price FixingFloor pricesFloor prices If the government believes that a price of a If the government believes that a price of a

good or service is too low, it may impose a good or service is too low, it may impose a floor price. floor price.

A floor price is the minimum price below which A floor price is the minimum price below which it is illegal to buy or sell a good or service. it is illegal to buy or sell a good or service.

For example: minimum wage lawsFor example: minimum wage laws

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Law of downward-sloping Law of downward-sloping demanddemand: when the price of a : when the price of a good is raised (and there are no good is raised (and there are no other changes), less of it will be other changes), less of it will be demanded. If the price of a demanded. If the price of a good is lowered, then the good is lowered, then the quantity demanded will increasequantity demanded will increase

Law of diminishing marginal Law of diminishing marginal utility:utility: each additional unit of each additional unit of a good consumed at any given a good consumed at any given time yields less satisfaction than time yields less satisfaction than the one previously consumedthe one previously consumed

Elasticity of demandElasticity of demand: means the : means the responsiveness of the quantity responsiveness of the quantity demanded to a change in price. demanded to a change in price.

If the price of Life brand deodorant goes up by 10%, those who If the price of Life brand deodorant goes up by 10%, those who use it will most likely continue to buy it. Life Brand use it will most likely continue to buy it. Life Brand deodorant costs around $2.00; a 10% increase will bring the deodorant costs around $2.00; a 10% increase will bring the price up to $2.20. Since most people care about how they price up to $2.20. Since most people care about how they smell and can afford the price, sales of Life brand deodorant smell and can afford the price, sales of Life brand deodorant will probably stay the same. On the other hand, if the price will probably stay the same. On the other hand, if the price of a $25 000 car goes up by 10% the price will become $27 of a $25 000 car goes up by 10% the price will become $27 500. This increase may be more than some people can 500. This increase may be more than some people can afford, therefore sales my be affected. Generally afford, therefore sales my be affected. Generally small small items items are are inelasticinelastic, while , while big itemsbig items are are elasticelastic..

In today’s world few of us would be either willing or able to survive for In today’s world few of us would be either willing or able to survive for very long without electricity. We need it for light, heat, cooking, etc. very long without electricity. We need it for light, heat, cooking, etc. On the other hand most of us could survive without a week long On the other hand most of us could survive without a week long holiday in the tropics. This means that holiday in the tropics. This means that essentialessential item tend to have item tend to have inelastic inelastic demand, while demand, while luxuryluxury goods tend to have goods tend to have elastic elastic demand.demand.

The elasticity of demand is affected by The elasticity of demand is affected by timetime. If the price of gas goes . If the price of gas goes up in the short term, then people have little choice but to pay what it up in the short term, then people have little choice but to pay what it costs. The demand is costs. The demand is inelastic. inelastic. If, the price of gas stays high, If, the price of gas stays high, however, people will start to buy more fuel-efficient cars, alternative however, people will start to buy more fuel-efficient cars, alternative fuel vehicles, hybrid vehicles, etc.fuel vehicles, hybrid vehicles, etc.