UNIT IIMarkets and

Prices

Law of Demand• Consumers buy more of a good

when its price decreases and less when its price increases

Inverse or IndirectRelationship

• As Price goes Down…...……….Quantity Demanded goes Up• As Price goes Up…….....

…Quantity Demanded goes Down

Elasticity of Demand“Measure of how consumers

react to a price change”• Elastic Demand–Demand that is very sensitive to a change in

price• Inelastic Demand–Demand that is not very sensitive to a

change in price

Factors Affecting Elasticity of Demand

• Availability of Substitutes– More substitutes = Elastic Demand

• Relative Importance– Large % of budget = Elastic Demand

• Necessities vs. Luxuries– Necessities = Inelastic; Luxuries = Elastic

• Change over Time– More time to adjust = Elastic

Law of Supply• Sellers sell more of a good when

its price increases and less when its price decreases

Direct Relationship

• As Price goes Down…...……….Quantity Supplied goes Down• As Price goes Up…….....

…Quantity Supplied goes Up

Elasticity of Supply“Measure of the way Quantity Supplied

reacts to a change in price”

• Elastic Supply–Supply that is very sensitive to a change in price

• Inelastic Supply–Supply that is not very sensitive to a change in

price

Factors Affecting Elasticity of Supply

• Cost of Producing Additional Units–High Cost = Inelastic Supply

• Time–More Time = Elastic Supply

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Supply and Demand Graph

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Market Equilibrium

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Shortages

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Surpluses

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Increase in DemandSupply Constant

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Decrease in DemandSupply Constant

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Factors that Shift Demand

• Substitute Goods– Price of substitute good increases; Demand for other

good increases– Price of substitute good decreases; Demand for other

good decreases• Population– Increase in population; Demand for goods desired by

population increases– Decrease in population; Demand for goods desired by

population decreases

• Advertising– Successful advertising campaign; Demand increase for

that good– Unsuccessful advertising campaign; Demand decreases

for that good• Complementary Goods– Price of complementary good increases; Demand for

other good decreases– Price of complementary good decreases; Demand for

other good increases

• Expectations– Consumer expectation of a price decrease in the

future for a good; Demand for that good “NOW” decreases

– Consumer expectation of a price increase in the future for a good; Demand for that good “NOW” increases

• Income– Normal Goods

• Income rises; Demand for normal goods increases• Income falls; Demand for normal goods decreases

– Inferior Goods• Income rises; Demand for inferior goods decreases• Income falls; Demand for normal goods increase

• Tastes– Increased preference for a good; Demand increases– Decreased preference for a good; Demand decreases

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Increase in SupplyDemand Constant

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Decrease in SupplyDemand Constant

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Factors That Shift Supply

• Technology– Advances in technology for a good; Supply increases– Decreases in technology for a good; Supply

decreases• Regulations– Increases in Gov’t regulations on production of a

good; Supply decreases– Decreases in Gov’t regulations on the production of

a good; Supply increases

• Input Costs– Increase in input costs for a good; Decrease in Supply– Decrease in input costs for a good; Increase in Supply

• Subsidies– Increase in the subsidies for the production of a

good; Supply increases– Decrease in the subsidies for the production of a

good; Supply decreases

• Taxes– Increase in the taxes on the production of a good;

Supply decreases– Decrease in the taxes on the production of a good;

Supply increases• Expectations– Sellers expect a higher price in the future for their

good; Supply “NOW” decreases– Sellers expect a lower price in the future for their

good; Supply “NOW” increases

• Number of Suppliers– Increase in the number of suppliers for a good;

Supply increases– Decrease in the number of suppliers for a good;

Supply decreases