Chapters 4 & 5:Supply and Demand

Chapters 4 & 5:Supply and Demand

4-1: What is Demand?• Microeconomics is the part of economic theory

that deals with the behavior and decision making by individual units, such as people and firms.– Microeconomic concepts help explain how prices

are determined.

• Demand is the desire, ability, and willingness to buy a product.

• Demand is a concept specifying the different quantities of an item that will be bought at different prices.

•The Law of Demand:There is an inverse relationship between the price of an item and the quantity demanded.

As price goes up, the quantity demanded will go down.As price goes down, the quantity demanded will go up.Video

•Marginal Utility is the additional satisfaction or usefulness a consumer gets from having one more unit of a product.

•Diminishing Marginal Utility states that the extra satisfaction we get from using additional quantities of the product begins to decline.

“How many cars do you really need?”

Demand Schedule – table that lists how much of a product consumers will buy at all possible prices

Price Quantity Demande

d

$30 0

$25 1

$20 2

$15 3

$10 5

$5 8

Demand Curve – a graph showing the quantity demanded at each and every price that might prevail in the market

(graphs in motion)Individual vs. Market Demand Curves

4-2: Factors Affecting Demand

When it comes to demand, there are two types of changes.– When the price of a product changes while all other factors

remain the same, there will be a change in the quantity demanded.

– We move along the existing demand curve. Demand curve does not shift.• Price of hamburger decreases at McDonalds, people will

buy more hamburgers.

– Sometimes other factors change while the price remains the same. Then there will be a change, or shift, in total demand.• If McDonalds redesigns its restaurants to appeal to more

people, they will have more customers, even at the same price.

video

Change in Quantity Demanded

• Caused by a change in price

• Graphically represented by a move along the demand curve

• Income effect – the change in quantity demanded due to the change in a buyers real income– Price goes down, you spend

less, you “feel” richer, you buy more.

• Substitution effect – the change in quantity demanded due to a price change that makes other products more or less costly

Change in Demand

• Caused by a change in factors other than price

• Consumers decide to buy different amounts of the product at the same prices

• Graphically represented by a shift of the demand curve, giving an entirely new demand curve (graphs in motion)

• Can be caused by changes in:– consumer income– consumer tastes (trends)– cost of substitutes– cost of complements– consumer expectations– number of consumers

4-3: Elasticity of Demand• Elasticity is a measure of responsiveness.

– “cause and effect”– how much does a dependent variable respond to

a change in the independent variable– How much does the quantity demanded respond

to an increase or decrease in price? Depends on its elasticity.

• Demand is elastic when a change in price results in a relatively larger change in quantity demanded. (m<-1)

• Demand is inelastic when a change in price results in a relatively smaller change in quantity demanded. (m>-1)

• A product is unit elastic when a change in price results in a proportional change in quantity demanded. (m=-1)

•

1. 3,000 pounds of product A sells for $2.40/pound. If the price drops by 1/6, the amount sold will increase by 25%.

New price = 2.40 * (5/6) = 2.00 New quantity = 3000 * 1.25 = 3750

Old: 3000 * 2.40 = 7200New: 3750 * 2.00 = 7500

2. 20,000 kilos of commodity B sells for $15.00/kilo. The quantity sold decreases by 15% as the price increases by 1/5.

New price = 15.00 * (6/5) = 18.00 New quantity = 20000 * .85 = 17000

Old: 20000 * 15 = 300000New: 17000 * 18 = 306000

3. 1,000 kilo of commodity C brings in $150.00/kilo. The quantity purchased drops 25% when the price is increased by 1/3.

New price = 150 * (4/3) = 200 New quantity = 1000 * .75 = 750

Old: 1000 * 150 = 150000New: 750 * 200 = 150000

4. 5,000 bales of crop D sell for $45.00/bale. The price drops 20%, causing the number of bales purchased to increase 18%.

New price = 45 * .80 = 36 New quantity = 5000 * 1.18 = 5900

Old: 1000 * 5000 * 45 = 225000New: 5900 * 36 = 212400

Price Down & Revenues Up = Elastic

Price Up & Revenues Unchanged = Unit Elastic

Price Down & Revenues Down = Inelastic

Price Up & Revenues Up = Inelastic

5-1: What is Supply?

• Supply is the amount of a product that would be offered for sale at all possible prices that could prevail in the market

• The Law of Supply:– There is an direct relationship between the price

of an item and the quantity supplied.

– As price goes up, the quantity supplied will go up.– As price goes down, the quantity supplied will go

down. (graphs in motion) video

Change in Quantity Supplied• Caused by a change in price

• Graphically represented by a move along the supply curve

Change in Supply• Caused by a change in factors other than price• Producers offer different amounts of the product to sell at

the same prices• Graphically represented by a shift of the supply curve,

giving an entirely new supply curve • Can be caused by changes in:

– cost of resources, productivity, technology, expectations– taxes and subsidies, government regulations– number of sellers

Supply is elastic when a change in price results in a relatively larger change in quantity supplied. (m<+1)

Supply is inelastic when a change in price results in a relatively smaller change in quantity supplied. (m>+1)

A product is unit elastic when a change in price results in a proportional change in quantity supplied. (m=-1)

Supply elasticity is based solely on the nature of the production of a product.

Can it be made quickly without large influxes of capital or skilled labor?

5-2: Theory of Production

The production function shows how total output changes when the amount of a single variable (usually labor) changes over the short run.

The marginal product is the extra output or change in total product caused by adding one more unit of variable input.

Can be illustrated with a production schedule or graph

(graphs in motion)

.

Stages of ProductionI. Increasing marginal returns

- Each additional worker adds more to the total output than the worker before.

II. Decreasing marginal returns- Each additional worker is making a diminishing, but still positive, contribution

III. Negative marginal returns- Each additional worker decreases total output

5-3: Cost, Revenue, and Profit Maximization

Fixed Costs or Overhead - costs that an organization incurs even when there is little or no activity, usually machinery and capital resources

Variable Costs – costs that change when the business’s rate of production or output changes, usually labor and raw materials

Total Costs – sum of the fixed and variable costs

Break-Even Point – level of production that generates just enough income to cover its total operating costs

Total Revenue – all the revenue that a company receives

Marginal Revenue – additional revenue a company receives from the production and sale of one additional unit of output