Ch. 3 and 4

Demand and Supply

Ch. 3 Demand and Price Effect

• The Law of Demand – The inverse relationship between the quantity demanded and the price of a product. People will buy more of something at lower prices than at higher prices.

• Demand – quantities of a particular good or service that consumers are willing and able to buy at different prices at a particular time.

• Price effect – the inclination of people to buy less of something at higher prices than they would buy at lower prices.

4 Factors explain why people behave this way:

• Buying power• Diminishing marginal utility• Diminishing personal value• Availability of substitutes

Buying Power

• The quantity of goods and services a person can buy with a given amount of money

Diminishing Marginal Utility

• The point reached when an additional unit of a product consumed is less satisfying than the one before.

Diminishing personal value

• Using a product bought for different purposes, the value you place on the products usefulness

Availability of substitutes

• A good or service that can replace another good or service

Price Elasticity of Demand

• A measure of the impact of the price effect, it indicates a buyer’s eagerness to buy a good or service

• When the price effect is large, the demand is said to be elastic

• Example: in the case of cola, a small change in price causes a relatively large change or “stretch” in the amount demanded. When the price effect is small, the demand is inelastic, which means there is little or no stretch.

Factors that effect price elasticity of demand

• Substitutes – when substitutes are plentiful, demand is elastic

• Percentage of budget – a product’s price tend to be more elastic when the price represents a significant percentage of the household budget

• Time – the longer that people have to adjust to a product’s price change, the more elastic the demand

Relationship between price effect and change in demand

• What causes the demand for a product to increase or decrease?– Change in income– Prices or availability of substitutes– Prices or availability of complementary goods– Change in weather/season– Change in number of buyers– Changes in styles, tastes, and habits– Change in expectations

Ch. 4 Supply and Price Effect

• Supply – the quantity of a good or service producers are willing and able to sell at different prices at a particular time

• Law of supply – a positive relationship between the quantity supplied and the price of the product– As the price rises, the quantity supplied will tend to rise.

As the price declines, the quantity supplied will tend to decline. Supply is not a particular quantity for sale today in the market. It is a list of prices and the quantities that a company is willing and able to supply at each price.

Marginal Cost

• The change in cost for an additional output, and opportunity cost

Market supply

• The total of all individual suppliers’ products in a market at a particular time

Price Elasticity of Supply

• If a change in price causes a large change in the amount supplied, the price effect is significant and supply is elastic

• A change in price has much less influence on the quantity supplied, so the price effect is small and the supply inelastic

• Important element in determining the price elasticity of supply is the ease and speed of bringing new resources into production in response to a higher price. The quicker and easier it is for businesses to expand production, the more elastic the production supply will be.

Relationship between price effect and change in supply

• Price increase and decreases send messages to suppliers of goods and services. Prices encourage producers to increase or decrease their output. As prices rise, the increase attract additional producers, while price decreases drive producers out of the market.

• What causes changes in supply?– Changes in the marginal cost of production– Changes in the number of producers– Change in expectations