ADV ECONOMICS: Chapters 3 and 4 - Supply and Demand

Inferior good

A product whose demand falls when income rises.

Normal good

A product whose demand rises when income rises.

Equilibrium Quantity

This common quantity is called the equilibrium quantity. At any other price, the quantity demanded does not equal the quantity supplied, so the market is not in equilibrium at that price.

Determinants of Demand

1. Substitutes 2. Complementary Goods 3. Income 4. Population 5. Tastes/Preferences 6. Future Expectations

Substitute

A good or service that can be used in place of another good or service. Ex: If the price of a Coke is $5, then people could substitute Pepsi for only $2. This would decrease the demand for coke.

Supply curve

A graphic illustration of the relationship between price, shown on the vertical axis, and quantity, shown on the horizontal axis. Nearly all supply curves slope up from left to right and illustrate the law of supply.

Price

What a buyer pays for a unit of the specific good or service is called a price.

Shift in demand

Changes in demand are shown as shifts in the curve. Therefore, a shift in demand happens when a change in some economic factor (other than price) causes a different quantity to be demanded at every price.

3.5 Demand, Supply and Efficiency: Summary

Consumer surplus is the gap between the price that consumers are willing to pay, based on their preferences and the market equilibrium price. Producer surplus is the gap between the price for which producers are willing to sell a product, based on their costs, and the market equilibrium price. Social surplus is the sum of consumer surplus and producer surplus. Total surplus is larger at the equilibrium quantity and price than it will be at any other quantity and price. Deadweight loss is loss in total surplus that occurs when the economy produces at an inefficient quantity

Chapter 3

Demand and Supply

Chapter 4

Labor and Financial Markets

Usury laws

Laws that impose an upper limit on the interest rate that lenders can charge

Demand and Supply Models

Laws that impose an upper limit on the interest rate that lenders can charge. However, in many cases, these upper limits are well above the market interest rate. For example, if the interest rate is not allowed to rise above 30% per year, it can still fluctuate below that level according to market forces. A price ceiling that is set at a relatively high level is nonbinding, and it will have no practical effect unless the equilibrium price soars high enough to exceed the price ceiling.

Price controls

Laws that the government enacts to regulate prices.

Minimum wage

The U.S. government sets a minimum wage, a price floor that makes it illegal for an employer to pay employees less than a certain hourly rate. In mid-2009, the U.S. minimum wage was raised to $7.25 per hour.

Supply

The amount of some good or service a producer is willing to supply at each price

Law of demand

The inverse relationship between price and quantity demanded. A rise in the price of a good or service almost always decreases the quantity demanded of that good or service. However, a fall in price will increase the quantity demanded. Ex: When the price of gasoline goes up, people look for ways to reduce their consumption by carpooling or using public transportation, thus lowering the demand for gasoline. However when the price of gas goes down more people are willing to buy it, so the demand goes up.

4.3 The Market System as an Efficient Mechanism for Information: Summary

The market price system provides a highly efficient mechanism for disseminating information about relative scarcities of goods, services, labor, and financial capital. Market participants do not need to know why prices have changed, only that the changes require them to revisit previous decisions they made about supply and demand. Price controls hide information about the true scarcity of products and thereby cause misallocation of resources.

Financial capital

The money used to buy the tools and equipment used in production. Those who supply financial capital through saving expect to receive a rate of return, while those who demand financial capital expect to pay a rate of return.

Equilibrium

The point where the supply curve and the demand curve cross. Above the equilibrium represents a surplus, and below represents a shortage.

Law of supply

The positive relationship between price and quantity supplied is the law of supply. Ex: When the price of gasoline rises, it encourages firms to take several actions: expand exploration for oil reserves; drill for more oil; invest in more pipelines and oil tankers; build new oil refineries; purchase additional pipelines and trucks to ship the gasoline to gas stations, and open more gas stations or keep existing gas stations open longer hours. Higher Price = Higher Quantity Supplied Lower Price = Lower Quantity Supplied

Interest rate

The simplest example of a rate of return is the interest rate. When you supply money into a savings account at a bank, you receive interest on your deposit. The interest paid to you as a percent of your deposits is the interest rate. Similarly, if you demand a loan to buy a car, you will need to pay interest on the money you borrow.

Excess Supply "surplus"

When the quantity supplied exceeds the quantity demanded, or any point above the equilibrium.

3.1 Demand, Supply, and Equilibrium in Markets for Goods and Services: Summary

A demand schedule is a table that shows the quantity demanded at different prices in the market. A demand curve shows the relationship between quantity demanded and price in a given market on a graph. The law of demand states that a higher price typically leads to a lower quantity demanded. A supply schedule is a table that shows the quantity supplied at different prices in the market. A supply curve shows the relationship between quantity supplied and price on a graph. The law of supply says that a higher price typically leads to a higher quantity supplied. The equilibrium price and equilibrium quantity occur where the supply and demand curves cross. The equilibrium occurs where the quantity demanded is equal to the quantity supplied. If the price is below the equilibrium level, then the quantity demanded will exceed the quantity supplied. Excess demand or a shortage will exist. If the price is above the equilibrium level, then the quantity supplied will exceed the quantity demanded. Excess supply or a surplus will exist. In either case, economic pressures will push the price toward the equilibrium level.

Demand schedule

A table that shows the quantity demanded at each price is called a demand schedule. Price in this case is measured in dollars per a small soda. The quantity demanded is measured in the number of cans per day.

Supply schedule

A table that shows the quantity supplied at a range of different prices.

Law of Demand

According to the law of demand, a higher rate of return (price) will decrease the quantity demanded. As the interest rate rises, consumers will reduce the quantity that they borrow.

Salary

Or wage. In the labor market, a higher salary leads to a decrease in the quantity of labor demanded, while a lower salary leads to an increase in the quantity of labor demanded.

3.2 Shifts in Demand and Supply for Goods and Services: Summary

Economists often use the ceteris paribus or "other things being equal" assumption: while examining the economic impact of one event, all other factors remain unchanged for the purpose of the analysis. Factors that can shift the demand curve for goods and services, causing a different quantity to be demanded at any given price, include changes in tastes, population, income, prices of substitute or complement goods, and expectations about future conditions and prices. Factors that can shift the supply curve for goods and services, causing a different quantity to be supplied at any given price, include input prices, natural conditions, changes in technology, and government taxes, regulations, or subsidies.

4.2 Demand and Supply in Financial Markets: Summary

In the demand and supply analysis of financial markets, the "price" is the rate of return or the interest rate received. The quantity is measured by the money that flows from those who supply financial capital to those who demand it. Two factors can shift the supply of financial capital to a certain investment: if people want to alter their existing levels of consumption, and if the riskiness or return on one investment changes relative to other investments. Factors that can shift demand for capital include business confidence and consumer confidence in the future—since financial investments received in the present are typically repaid in the future.

4.1 Demand and Supply at Work in Labor Markets: Summary

In the labor market, households are on the supply side of the market and firms are on the demand side. In the market for financial capital, households and firms can be on either side of the market: they are suppliers of financial capital when they save or make financial investments, and demanders of financial capital when they borrow or receive financial investments. In the demand and supply analysis of labor markets, the price can be measured by the annual salary or hourly wage received. The quantity of labor can be measured in various ways, like number of workers or the number of hours worked. Factors that can shift the demand curve for labor include: a change in the quantity demanded of the product that the labor produces; a change in the production process that uses more or less labor; and a change in government policy that affects the quantity of labor that firms wish to hire at a given wage. Demand can also increase or decrease (shift) in response to: workers' level of education and training, technology, the number of companies, and availability and price of other inputs. The main factors that can shift the supply curve for labor are: how desirable a job appears to workers relative to the alternatives, government policy that either restricts or encourages the quantity of workers trained for the job, the number of workers in the economy, and required education.

Inputs

Inputs are what is used in the production process to produce output—that is, finished goods and services. Inputs include labor, materials, and machinery.

Shift in supply

Just as a shift in demand is represented by a change in the quantity demanded at every price, a shift in supply means a change in the quantity supplied at every price.

Price floor

Keeps a price from falling below a certain level, "the floor". Ex: Minimum wage

Price ceiling

Keeps a price from rising above a certain level, "the ceiling" Ex: In some cities, such as Albany, renters have pressed political leaders to pass rent control laws, a price ceiling that usually works by stating that rents can be raised by only a certain maximum percentage each year.

Living wage

Local political movements in a number of U.S. cities have pushed for a higher minimum wage, which they call a living wage. Promoters of a living wage maintain that the minimum wage is too low to ensure a reasonable standard of living. Supporters of the living wage argue that full-time workers should be assured a high enough wage so that they can afford the essentials of life: food, clothing, shelter, and healthcare.

Intertemporal decision making

Participants in financial markets must decide when they prefer to consume goods; now or in the future. Economists call this intertemporal decision making because it involves decision making across time. Unlike a decision about what to buy from the grocery store, decisions about investment or saving are made across a period of time, sometimes a long period.

3.4 Price Ceilings and Price Floors: Summary

Price ceilings prevent a price from rising above a certain level. When a price ceiling is set below the equilibrium price, quantity demanded will exceed quantity supplied, and excess demand or shortages will result. Price floors prevent a price from falling below a certain level. When a price floor is set above the equilibrium price, quantity supplied will exceed quantity demanded, and excess supply or surpluses will result. Price floors and price ceilings often lead to unintended consequences.

Demand curve

Shows the relationship between price and quantity demanded on a graph. Quantity on the horizontal axis and price on the vertical axis. Demand curves will appear somewhat different for each product. However, nearly all demand curves share the fundamental similarity that they slop down from left to right. Demand Curves embody the Law of Demand: As the price increases, the quantity demanded decreases, or as the price decreases the quantity demanded increases.

Demand

The amount of some good or service consumers are willing and able to purchase at each price. Demand is based on needs and wants, which are the same thing from an economist's perspective. Demand is also based on ability to pay. If you cannot pay for it, you have no effective demand.

ceteris paribus

The assumption behind a demand curve or a supply curve is that no relevant economic factors, other than the product's price are changing. Economists call this assumption ceteris paribus meaning "other things being equal." Any given demand or supply curve is based on the ceteris paribus assumption that all else is held equal. A demand curve or a supply curve is a relationship between two, and only two, variables when all other variables are kept constant

Equilibrium Price

The only price where the plans of consumers and the plans of producers agree. It is where the amount of the product consumers want to buy is equal to the amount producers want to sell.

Labor market

The supply of available workers in relation to available work.

Quantity supplied

The total number of units of a good or service producers are willing to sell at a given price. Price is what producers receive for selling one unit of a good or service. A rise in price almost always leads to an increase in quantity supplied of that good or service. A fall in price will decrease the quantity supplied.

Quantity demanded

The total number of units purchased at a price.

Complements

These goods are often used together because consumption of one good tends to enhance consumption of the other. Ex: cereal and milk, golf clubs and golf balls, paper and pens.

Excess Demand "shortage"

When the price is below equilibrium, there is excess demand, or a shortage—that is, at the given price the quantity demanded, which has been stimulated by the lower price, now exceeds the quantity supplied, which had been depressed by the lower price.

3.3 Changes in Equilibrium Price and Quantity: The Four-Step Process: Summary

When using the supply and demand framework to think about how an event will affect the equilibrium price and quantity, proceed through four steps: (1) sketch a supply and demand diagram to think about what the market looked like before the event; (2) decide whether the event will affect supply or demand; (3) decide whether the effect on supply or demand is negative or positive, and draw the appropriate shifted supply or demand curve; (4) compare the new equilibrium price and quantity to the original ones.