Supply & Demand

Unit 2 Notes

Voluntary ExchangeA market is created wherever a buyer and

seller meet

Both buyer and seller decide they are better off after the transaction

free to choose

every time you buy something you are telling the store you are okay with the price – dollar vote & consumer sovereignty

Demandwillingness and ability of consumers to purchase a good or service;

about buying

Law of Demandas price rises, quantity demand decreases

P QD

as price falls, quantity demand increasesP QD

INVERSE relationshipquantity demanded: number you buy at a

particular price (1 product)

Demand Curve

Why the law of demand is true Real income effect: as prices change

your ability to buy will change; for example if the price of gas increases you cannot buy as much with the same amount of money

Substitution effect: if there is a cheap alternative people buy that instead

Law of Diminishing Marginal Utility: the more you have of something the less you are willing to pay for each additional one; things get olda. utility means satisfactionb. marginal means additional or extra

Determinants of Demand: cause change in what we demandPopulation ChangeIncome ChangeTaste or preference changeSubstitute goods: something can replace

anotherComplementary goods: items that go

together

PRICE IS NEVER THE REASON!!!

Types of Products in relation to IncomeNormal Good: the more money you make the

more you buy of these; Ex: clothesInferior Goods: the more money you make

the less of these you buy; Ex: Raman noodles

Neutral Goods: buy the same amount; Ex: toilet paper

Elasticity of Demand Elastic Goods Inelastic Goodsprice change has a

large effect on the number bought;

wants, items with many substitutes, in long term;

Ex: soda, new shoes, IPOD

little change in amount bought for any kind of price change

necessities, items with no substitutes, in short term;

Ex: electricity, insulin

Elasticity of Demand

2 Types: Elastic & Inelastic

Follow law of demand – P Revenue

Breaks the law of demand - P Revenue

SupplyWillingness & ability

of producers to make and sell a product

About selling

Law of Supply

P QS

P QS

DIRECT relationship

Stores want profit

Supply Curve

SPrice

Quantity

Determinants of Supply# of businessesTaxes and subsidies = $ taken & given by

gov’tTechnologyPrice of inputs and resources

PRICE IS NEVER THE REASON!!!

EquilibriumWhere QD = QS

Perfect point of profit and efficiencyHard to reachPrices move to force markets to equilibriumDisequilibrium:

Surplus: too much; QD < QS; P

Shortage: run out; QD > QS; P

Equilibrium

E

P

Q

D Ssurplus

shortage

EP

EQ

Gov’t Price ControlsPrice Floors Price CeilingsLowest price that can be

charged for itemCause surplus b/c ppl

cannot reach equilibrium; P to high

Bad idea/Just say noEx: minimum wage

Highest price that can be charged for item

Cause shortage b/c ppl cannot reach equilibrium; P to low

Bad idea/Just say noEx: rent control in NYC

Rationing DeviceDetermines who gets the goods in a FESEx: Price, 1st Come, 1st ServePrice considered most fairThe prices are determined by the interaction

of supply and demand