CHAPTER 7Demand and Supply

CHAPTER 7SECTION 1

Demand

The “Marketplace”

Consumers influence the price of goods in a market economy. Demand: the amount of a good or service that

consumers are able and willing to buy at various possible prices during a specified time period

Supply: the amount of a good or service that producers are able and willing to sell at various prices during a specified time period

A market represents actions between buyers and sellers.

Voluntary Exchange

The basis of activity in a market economy is the principle of voluntary exchange. Voluntary Exchange: a transaction in which a

buyer and seller exercise their economic freedom by working out their own terms of exchange

The seller sets the price and the buyer agrees to the product and price through the act of purchasing the product

Supply and demand analysis is a model of how buyers and sellers behave in the marketplace.

The Law of Demand

Demand is created only when the customer is both willing and able to buy the product.

The law of demand states: As price goes up, quantity demanded goes

down. As price goes down, quantity demanded goes

up.

The Law of Demand

Real Income Effect People are limited by their income as to what

they can purchase. Real income effect forces people to make

trade-offs. Substitution Effect

People can replace one product with another if it satisfies the same need.

Amazon Prime Music vs. iTunes

The Law of Demand

Diminishing Marginal Utility People will purchase additional items until the

satisfaction from the last unit is equal to the price.

The lessening of this satisfaction with each additional purchase is called diminishing marginal utility.

Utility: the ability of any good or service to satisfy consumer wants

CHAPTER 7 SECTION 2The Demand Curve and

Elasticity of Demand

Graphing the Demand Curve

Demand schedule: a table of prices and the quantity demanded at each price.

To draw a demand curve: List the quantity demanded at each price. The Curve will graph the quantity demanded

of a good or service at each possible price.

Graphing the Demand Curve

Quantity Demanded vs. Demand

A change in quantity demanded is caused by a change in the price of a good.

If something other than price causes demand to increase or decrease, this is known as a change in demand and shifts the demand curve.

Quantity Demanded vs. Demand

Determinants of Demand

Population When population increases, opportunities to

buy and sell increase. Demand for most products increases, shifting

the curve to the right. Income

An increased income allows consumers to buy more products or a greater quantity of a single product.

Tastes and preferences, including facts Refers to what people like and prefer to choose.

Determinants of Demand

Substitutes When a new competitor is added or an old

competitor leaves the market. Butter vs. Margarine

Complementary goods Products that rely upon one another, demand

for one affects demand for the other. The decrease in the price of one product will

cause an increase in demand for both products.

Cameras and film

The Price Elasticity of Demand

Elasticity: economic concept dealing with consumers’ responsiveness to an increase or decrease in price of a product

Price Elasticity of Demand: economic concept that deals with how much demand varies according to changes in price

The Price Elasticity of Demand

Elastic Demand Occurs when the demand for some goods is

greatly affected by the price. One particular brand of coffee increases in

price; consumers will purchase more of the other brands.

Inelastic Demand Occurs when the demand for some goods is

less affected by price. Salt, pepper, and sugar are products

consumers will purchase at almost any cost.

The Price Elasticity of Demand

What Determines Price Elasticity of Demand? How many substitutes exist and how closely

they provide the same quality and service. Fewer or no substitutes make demand inelastic.

Percent of a personal budget spent on an item The higher the percent of budget, the more

elastic the demand. How much consumers have to adjust to the

new price. More time makes for greater elasticity.

CHAPTER 7SECTION 3The Law of Supply and

the Supply Curve

The Law of Supply

Supply is the willingness and ability to provide goods to the consumers.

The Law of Supply states: As the price rises for a good the quantity

supplied generally rises. As the price falls, the quantity supplied also

falls. A direct relationship exists between price

and quantity supplied.

The Incentive of Greater Profit

Increase in price and increase in production leads to an increase in profits.

Higher prices encourage more competition to join the market.

Higher prices turn potential suppliers into actual suppliers, adding to the total output.

The Supply Curve

As with demand, graphs and tables can explain the Law of Supply.

Supply schedule: shows the quantity supplied at each given price.

A supply curve graphs the quantities supplied at each possible price.

The relationship between quantity and price is direct and always moving in the same direction.

The Supply Curve

Quantity Supplied vs. Supply

A change in quantity supplied is caused by a change in price.

Something other than price can cause a change in supply as a whole to increase or decrease.

Quantity Supplied vs. Supply

Determinants of Supply

Price of Inputs The price of inputs, or the costs of production-

raw materials, wages, insurance, utilities, etc.- can cause an increase in supply.

Number of Firms in the Industry Competition, or the number of companies in

an industry, can cause an increase in supply

Determinants of Supply

Taxes An increase in taxes can cause a decrease in

supply. If taxes increase, businesses will not be willing to

supply as much as before because the cost of production will rise.

Technology An improvement in technology can cause an

increase in supply Technology: the science used to develop new

products or methods of production and distribution.

The Law of Diminishing Returns

Adding units to increase production increases total output for a limited time period.

The extra output for each additional unit will eventually decrease.

Businesses will continue to add units of a factor of production until doing so no longer increases revenue.

CHAPTER 7SECTION 4

Putting Supply and Demand Together

Equilibrium Price

In the real world, demand and supply work together.

As the price of goods goes down, the quantity demanded rises and the quantity supplied falls.

As the price goes up, the quantity demanded falls and the quantity supplied rises.

Equilibrium Price

Sellers and buyers work together indirectly to place goods and the equilibrium price.

Equilibrium Price: the price at which the amount producers are willing to supply is equal to the amount consumers are willing to buy

Equilibrium Price

Shifts in Equilibrium Price

If the demand curve shifts due to something other than price, the equilibrium price will change.

If the supply curve shifts due to something other than price, the equilibrium price will change.

Prices Serve as Signals

Rising prices signal producers to make more and consumers to purchase less.

Falling prices signal producers to make less and consumers to purchase more.

Prices Serve as Signals

Types of Signals: Shortages

Occurs when the quantity demanded (at equilibrium price) is greater than the quantity supplied.

Surpluses Occurs when the quantity supplied (at

equilibrium price) is grater than quantity demanded.

Market Forces Can cause the prices to rise or fall to correct

shortages and surpluses.

Price Controls

On occasion the government will get involved in setting prices. If the government believes the market forces

of supply and demand are unfair it may try to protect consumers and suppliers.

Special interest groups use pressure on elected officials to protect certain industries.

Price Controls

Price Ceilings Price Ceilings: a maximum price set by the

government to prevent prices from going above a certain level.

Items in short supply might be rationed. Shortages can lead to a black market, or illegal places

to purchase such products at exorbitant prices. Price Floors

Price Floors: a minimum price set by the government to prevent prices from going below a certain level

Price floors set minimum wage levels and support agricultural prices.