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
S
D
P
Q
Supply and Demand Graph
S
D
P
Q
Market Equilibrium
S
D
P
Q
Shortages
P1
Q1 Q2
S
D
P
Q
Surpluses
P1
Q1 Q2
S
D
P
Q
Increase in DemandSupply Constant
D1
P1
Q1
S
D
P
Q
Decrease in DemandSupply Constant
D1
P1
Q1
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
S
D
P
Q
Increase in SupplyDemand Constant
Q1
S1
P1
S
D
P
Q
Decrease in SupplyDemand Constant
S1
Q1
P1
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
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