Demand and Supply

Ch. 4 & 5 & 6Option #1: explain a thorough and

complete example for the vocabulary word

Option #2: draw a graph, image, or representation as an example for the

vocabulary word

1.) law of demandO Def: consumers buy more of a good

when its price decreases and less when its price increases

O A good’s price has an important effect on the amount of that good people will buy.

O The lower the price, the more consumers will buy

O The higher the price, the less consumers will buy

You need to draw this:

My example:

O More people will buy a slice of pizza priced at $1 than at $10.

O Less people will buy a slice of pizza priced at $10 than at $1.

O Your example:

The law of demand results from 2 patterns of human behavior. The first is known as

the…O 2.) substitution effect: O Def: when consumers react to an increase in

a good’s price by consuming less of that good and more of substitute goods.

O 1. increase in price of beef will decrease the quantity demanded for beef and increase the quantity demanded for chicken

O 2. some goods/services can’t be substituted (milk, gas, salt)

My example:

O When the price of pizza becomes more expensive then other foods, like tacos or salads, people are more likely to buy those other foods.

O The result: demand for pizza dropsO The change in spending is known as the

substitute effectO However, if the price of pizza dropsConsumers are more likely to substitute pizza for other choices. This causes the demand for pizza to riseYour example:

The law of demand results from 2 patterns of human behavior. The second is known as

the…O 3.) income effect:O Def: the change in consumption

resulting from a change in real income.O any increase or decrease in the consumer’s

purchasing power caused by a change in the price.O Usually occurs by someone on fixed income

O Remember – economists measure consumption in the amount of a good that is bought, not the amount of money spend to buy it

My example:

O Price of slice of pizza increase – a slice of pizza went from $1 to $2

O I feel poorer O Can’t buy as much as I used to because

of my limited budgetO I buy fewer slices of pizza without

increasing my purchases of other foods – income effect!

O I have to spend $2 for my pizza – I don’t buy more than one piece

O The quantity demanded goes down, even though I’m spending more.

O What happens if the price of pizza falls? O I feel wealthier O If, I start to buy more pizza – that is

income effect too!O Your example:

Demand Schedules

Individual Demand Schedule

Price of a slice of pizza

Quantity demanded per day

Market Demand Schedule

Price of a slice of pizza

Quantity demanded per day

$.50$1.00$1.50$2.00$2.50$3.00

543210

$.50$1.00$1.50$2.00$2.50$3.00

30025020015010050

The Demand Schedule

O A demand schedule is a table that lists the quantity of a good a person will buy at each different price.

O A market demand schedule is a table that lists the quantity of a good all consumers in a market will buy at each different price.

Market Demand Curve

3.00

2.50

2.00

1.50

1.00

.50

0

0 50 100 150 200 250 300 350Slices of pizza per day

Pri

ce p

er

slice (

in

dollars

)

Demand

The Demand CurveOA demand

curve is a graphical representation of a demand schedule.

OWhen reading a demand curve, assume all outside factors, such as income, are held constant.

4.) Demand Curve

O Def: illustrates the quantities demanded at each price by consumers in the market

O Vertical axis shows price, and the horizontal axis shows the quantity demanded

O Because demand rises as prices fall, the demand curve slopes down and to the right

The Demand Curve conti.Market Demand Curve

3.00

2.50

2.00

1.50

1.00

.50

0

0 50 100 150 200 250 300 350Slices of pizza per day

Pri

ce p

er s

lic

e (i

n d

oll

ars)

Demand

2 3 Chapter 4, Section 1

OThree characteristics of every demand curve:

1.Downward sloping2.Must assume ceteris

paribus (all other things held constant)

3.Relationship between price and quantity

OWhat is the one factor that causes a shift in the quantity demanded?

OPriceOYour example:

Demand Schedule & Demand Curve

5.) Normal goods

O Def: a good that consumers demand more of when their income increases

O What I want! O Ex.: Amber’s income increases form $50 to $75 per week. O This increase will cause her to buy more of a normal good at

ever price levelO Plotting the new schedule on a graph would produce a curve

to the right of her original curveO This shift to the right of the curve is called an increase in

demand

Normal good conti…

O If Amber’s income falls from $50 to $25 per week, the demand curve would shift to the left.

O This is called a decrease in demand.O Your example:

6.) inferior goods:

O Def: a good that consumers demand less of when their incomes increase

O What I can afford O Goods that you would buy in smaller

quantities, or none at all, if your income were to rise and you could afford something better.

O Possible examples: macaroni and cheese, generic products, used cars

O Your example:

7.) complements (complementary goods):

O Def: two goods that are commonly bought and used together

O If I buy a pair of skies, I’m likely to buy ski boots as well.• An increase of

the price of ski boots will cause people to buy fewer boots.

• Because skis are useless without boots, the demand for skis will fall at all prices

• Your example:

8.substitute goods:

O Def: goods that can be used to replace the purchase of similar goods when prices rise

O Ex. Snowboards are a substitute for skis O A rise in the price of snowboards will cause

people to buy fewer snowboards, and therefore people will buy more pairs of new skis

O Or, a fall in the price of snowboards will lead consumers to buy fewer skis

O ex. Butter for margarine; turkey for hamO increase in price leads to an increase in

demand for substitute goodsO Your example:

elasticity of demand

O a measure of how consumers react to a change in price

O Describes the way people respond to price changes

O Can be elastic or inelastic

9.) elastic demand:

O Def: describes demand that is very sensitive to a change in price

O If you buy less after a small price increase your demand is elasticO Product has elastic demand if:

O The product is not a necessity O Readily available substitutesO Products cost represents a large portion of a

person’s incomeO Your example:

10.) inelastic demand:O Def: describes demand that is not very

sensitive to a change in priceO If you keep buying despite a price increase,

your demand is inelasticO Demand tends to be inelastic for goods that

have few substitutes, like medicines O Or, for goods that are considered essential like

milkO Your example:

11.) Total Revenue

O Def: total amount of money a firm receives by selling its goods or services

O Determined by two factors:O 1.) The price of the goodsO 2.) And the quantity soldO T.R.: = (Q) Quantity sold X (P) price

chargedO If Ms. Morse’s Pizzeria sells 125 slices

of pizza per day at $2.00 per slice: total revenue would be $250.00 a day

O Your example:

Price

As price increases…

Supply

Quantity supplied increases

Price

As price falls…

Supply

Quantity supplied

falls

12.) The Law of Supply

Def: According to the law of supply, O as price increases, supply increases. By

contrast as price decreases, supply decreases.

O Producers will offer more of a good if prices rise, and less of a good if prices

fall You should draw this:

My example: Ms. Morse’s Pizzeria:

O If price of pizza rises, my cost of making the pizza stays the same, then Ms. Morse’s Pizzeria will earn a higher profit on each slice of pizza

O I will try to produce and sell more pizza to take advantage of the higher prides.

As price of pizza increases…

Quantity of pizza supplied will increase

O The price of pizza starts to fallO Ms. Morse’s Pizzeria will earn less profit

per slice or even lose moneyO Ms. Morse will choose to sell less pizza

and produce something else, like calzones, flatbreads, or sandwiches, that would yield more profit.

O Your ex. As the price of pizza falls…

The quantity or amount of pizza supplied and produced falls.

$.50 1,000

Price per slice of pizza Slices supplied per day

Market Supply Schedule

$1.00 1,500

$1.50 2,000

$2.00 2,500

$2.50 3,000

$3.00 3,500

Supply Schedules

A market supply schedule is a chart that lists how much of a good all suppliers will offer at

different prices.

Market Supply Curve

Pri

ce

(in

do

lla

rs)

Output (slices per day)

3.00

2.50

2.00

1.50

1.00

.50

0

0 500 1000 1500 2000 2500 3000 3500

Supply

13.) Market Supply Curve:

Characteristics of a Supply Curve

1. Relationship between price and quantity supplied

2. Always upward sloping

3. Must have ceteris paribus (“all things held constant”) to exist

Def: A market supply curve is a graph of the quantity supplied of a good by all suppliers at different prices

• A change in price causes a change in the quantity supplied

• Your example:

Elasticity of supply is a measure of the way quantity supplied reacts to a change in price.

Elasticity of Supply

OIf supply is not very responsive to changes in price, it is considered inelastic.

OIf supply is very sensitive to changes in price it is considered elastic.

Why can’t I respond to a change in price for trees,

but I can for haircuts?

Elastic

14.) elastic supply

O Def: If supply is very sensitive to changes in price it is considered elastic.

O The supply is easily expanded or reducedO My example: A service industry like a barbershop has elastic

supply.O If the price of a haircut rises, barber shops and salons can hire

new workers quickly.O New barber shops will start, and existing businesses will stay

open laterO A small increase in Quantity supplied will fall quicklyO Haircut suppliers can quickly change their operations, the

supply of haircuts is elastic price will cause a large increase in quantity supplied, even in the short term

O If the price of haircut drops, shops will close earlier & others will leave the market

O Your example:

15.) inelastic supply:O Def: If supply is not very responsive to changes in price, it

is considered inelastic.O Industries that cannot easily alter production O My example: Orange tree growersO They cannot respond quickly when prices riseO They cannot increase production fastO Orange trees take years to grow and matureO New suppliers/growers would be prevented from entering

the market quicklyO Price on crates of oranges fall – the grove will produce

oranges no matter what the prices are! Growers will still pick and sell nearly as many oranges as before

O Because of the investment in land, trees, and time, most competitors won’t drop out of the market if they can survive.

O Your example:

16.) fixed cost

O Def: a cost that does not change, no matter how much of a good is produced.

O Usually involves the production facility, the cost of building and equipping a factory, office, store, or restaurant.

O Ex. Rent, machinery repairs, and the salaries of workers who keep the business running even when production temporarily stops.

O Your ex.:

17.) variable cost:

O Def: a cost that rises or falls depending on how much is produced

O They include the costs of raw materials and some labor

O Ex. To produce more lemonade, the company (lemonade stand) must purchase more lemons and hire more workers to make the lemonade.

O If the company wants to produce less or cut costs, it can stop buying lemons or have some workers work fewer hours.

O Your ex.:

Is electricity and heating bills fixed costs or variable costs?

O Variable – companies can cut off heat and electricity for the factory and its machines when they are not in use.

18.) total cost O Def: fixed costs plus

variable costs (fixed and variable added together)

O Ex. Fixed costs (stand, equipment), $6 per min. (2nd column)

O Variable costs (costs of lemons, sugar, water, and some labor) rise with the number of cups of lemonade that are being produced.

O Fixed costs and variable costs are added together to find total cost.

O Total cost is shown in the fourth column: TC=TFC + TVC

O Your example:

19.) marginal product of labor O Def: the change in output

from hiring one additional unit of labor (one more worker)

O It measures the change in output at the margin, where the last worker has been hired or fired

O The 1st worker to be hired produces 4 toys an hour, so her marginal product is 4 toys.

O The 2nd worker raises total output from 4 toys an hour to 10 toys, so her marginal product of labor is 6.

O Your example:

Labor(# of workers)

Output(toys per hour)

Marginal product of labor

0 0 ----

1 4 4

2 10 6

3 17 7

4 23 6

5 28 5

6 31 3

7 32 1

8 31 -1

Marginal Product of Labor

20.) increasing marginal returns:

O Def: a level of production in which the marginal product of labor increases as the number of workers increases.

O Ex. 1st worker produces 4 toys per hour.

O Adding a 2nd worker would allow each worker to specialize in one or two tasks.

O Specialization increase output per worker, 2nd worker adds more to output than the 1st: : My toy shop enjoys increasing marginal returns

O In my example, there are benefits for the first 3 workers.

O My toy shop enjoys a rising marginal product of labor for the first 3 workers.

O Your example:

21.) diminishing marginal returns:O Def: a level of production in

which the marginal product of labor decreases as the number of workers increases

O At some point, adding each worker will result in diminishing marginal returns

O Workers may need to wait to use a tool or machine

O As workers are added, there will eventually be negative marginal returns.

O After the 3rd worker is hired, the benefits of specialization end.

O Adding more workers increases total output, but at a decreasing rate, marginal product of labor shrinks as each worker joins the company: DIMINSHING MARGINAL RETURN

O Your example:

Production Costs

Total reven

ue

Profit(total revenue – total cost)

Marginal revenue (market price)

Marginal cost

Total cost (fixed cost +

variable cost)

Variable cost

Fixed cost

Toys (per

hour)$ –36

–20

0

21

40

0

1

2

3

4

$0

24

48

72

96

$24

24

24

24

24

—

$8

4

3

5

$36

44

48

51

56

$0

8

12

15

20

$36

36

36

36

36

57

72

84

93

5

6

7

8

120

144

168

192

24

24

24

24

7

9

12

15

63

72

84

99

27

36

48

63

36

36

36

36

98

98

92

79

216

240

264

288

24

24

24

24

19

24

30

37

36

36

36

36

9

10

11

12

82

106

136

173

118

142

172

209

22.) marginal cost:O Def: the cost of producing one more unit of a goodO Even if this toy company is not producing a single toy, it must pay

$36 an hour for fixed costs. O If the firm decides to produce just one toy an hour, its total cost

rises $8 from $36 to $44 an hour.O The marginal cost of the first toy is $8O Your example:

Production Costs

Total reven

ue

Profit(total revenue – total cost)

Marginal revenue (market price)

Marginal cost

Total cost (fixed cost +

variable cost)

Variable cost

Fixed cost

Toys (per

hour)$ –36

–20

0

21

40

0

1

2

3

4

$0

24

48

72

96

$24

24

24

24

24

—

$8

4

3

5

$36

44

48

51

56

$0

8

12

15

20

$36

36

36

36

36

57

72

84

93

5

6

7

8

120

144

168

192

24

24

24

24

7

9

12

15

63

72

84

99

27

36

48

63

36

36

36

36

98

98

92

79

216

240

264

288

24

24

24

24

19

24

30

37

36

36

36

36

9

10

11

12

82

106

136

173

118

142

172

209

23.) marginal revenue:O Def: the additional income from selling one more unit of a good-

usually the price of a unit.O When a marginal cost is less than marginal revenue, a producer has an

incentive to increase output, since it will earn a profit on the next unit produced

O When marginal cost is more than marginal revenue, a producer has an incentive to decrease output, since it will lose money on the next unit produced

O That is why profits are maximized when marginal cost equals marginal revenue

Production Costs

Total reven

ue

Profit(total revenue – total cost)

Marginal revenue

(market price)

Marginal cost

Total cost (fixed cost +

variable cost)

Variable cost

Fixed cost

Toys (per

hour)

$ –36

–20

0

21

40

0

1

2

3

4

$0

24

48

72

96

$24

24

24

24

24

—

$8

4

3

5

$36

44

48

51

56

$0

8

12

15

20

$36

36

36

36

36

57

72

84

93

5

6

7

8

120

144

168

192

24

24

24

24

7

9

12

15

63

72

84

99

27

36

48

63

36

36

36

36

98

98

92

79

216

240

264

288

24

24

24

24

19

24

30

37

36

36

36

36

9

10

11

12

82

106

136

173

118

142

172

209

marginal revenue conti….O If the company has no control over the market price,

marginal revenue equals market price O Each toy sold at $24 increase the firm’s total revenue by

$24, so marginal revenue is $24.O According to the table, price = marginal cost with 10

toys, so that’s the quantity that maximizes profit at $98

If the firm made only 4 toys per hour, is it making as much money as it can?If the firm made 11 toys an hour, is it making as much money as it can?

The marginal cost of producing 11 toys is higher than the price. The firm actually loses $6 on the sale of the 11 toy.

The firm is better off producing less and keeping costs down

YourEx:

What is a subsidy? What does it mean to be subsidized?

24.) subsidy

O Def: a government payment that supports a business or market

O The government often pays a producer a set subsidy for each unit of a good produced.

O Since the subsidy lower producers’ cost, its effect is usually to increase supply.

O Ex. Governments in developing countries often subsidize manufactures to protect young, growing industries from strong foreign competition.

O Indonesia and Malaysia have subsidized a national car company as a source of pride, even though imported cars were less expensive to build

O Your example:

25.) excise taxO Def: a tax on the production or sale of a good O Governments reduce the supply of some goods

by placing an excise tax on themO Increases production costs by adding an extra

cost for each unit soldO Causes the supply of a good to decrease O Ex. Goods that are harmful to the public good:

cigarettes, alcohol, and high-pollutant gasoline O Your example: