Macroeconomics (Eco 12) Chapter 3 Demand, Supply and Market Equilibrium

Price Floor

is a minimum price fixed by the government.

Change in quantity demanded

is a movement from one point to another point—from one price quantity combination to another—on a fixed demand curve.

Supply

is a schedule or curve showing the various amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specific period.

A substitute good

is one that can be used in place of another good. Substitutes: Häagen-Dazs ice cream and Ben & Jerry's ice cream are substitute goods or, simply, substitutes. When two products are substitutes, an increase in the price of one will increase the demand for the other.

A complementary good

is one that is used together with another good. Complements: Because complementary goods (or, simply, complements) are used together, they are typically demanded jointly.

The equilibrium price (or market-clearing price)

is the price where the intentions of buyers and sellers match. It is the price where quantity demanded equals quantity supplied.

Equilibrium quantity

(1) The quantity at which the intentions of buyers and sellers in a particular market match at a particular price such that the quantity demanded and the quantity supplied are equal; (2) the profit maximizing output of a firm.

Changes in Quantity Demanded

A change in demand is a shift of the demand curve to the right (an increase in demand) or to the left (a decrease in demand).

Prices of Related Goods

A change in the price of a related good may either increase or decrease the demand for a product, depending on whether the related good is a substitute or a complement.

Law of Demand

A fundamental characteristic of demand is this: Other things equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls. In short, there is a negative or inverse relationship between price and quantity demanded.

Law of Supply

As price rises, the quantity supplied rises; as price falls, the quantity supplied falls. This relationship is called the law of supply. A supply schedule tells us that, other things equal, firms will produce and offer for sale more of their product at a high price than at a low price.

Inferior Goods

Goods whose demand varies inversely with money income are called inferior goods.

Consumer Expectations

Changes in consumer expectations may shift demand. A newly formed expectation of higher future prices may cause consumers to buy now in order to "beat" the anticipated price rises, thus increasing current demand.

Demand

Demand is a schedule or a curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time.

Demand Schedule

Demand shows the quantities of a product that will be purchased at various possible prices, other things equal.

The Market Supply

Market supply is derived from individual supply in exactly the same way that market demand is derived from individual demand.

Price

Price is an obstacle from the standpoint of the consumer, who is on the paying end. The higher the price, the less the consumer will buy.

Normal Goods

Products whose demand varies directly with money income are called superior goods, or normal goods.

Surplus

The amount by which the quantity supplied of a product exceeds the quantity demanded at a specific (above-equilibrium) price.

The Income Effect

The income effect indicates that a lower price increases the purchasing power of a buyer's money income, enabling the buyer to purchase more of the product than before. A higher price has the opposite effect.

Demand curve

The inverse relationship between price and quantity demanded for any product can be represented on a simple graph, in which, by convention, we measure quantity demanded on the horizontal axis and price on the vertical axis. Its downward slope reflects the law of demand—people buy more of a product, service, or resource as its price falls. The relationship between price and quantity demanded is inverse (or negative).

The substitution effect

The substitution effect suggests that at a lower price buyers have the incentive to substitute what is now a less expensive product for other products that are now relatively more expensive. The product whose price has fallen is now "a better deal" relative to the other products.

Unrelated Goods

The vast majority of goods are not related to one another and are called independent goods.

Change in quantity

a change in quantity supplied is a movement from one point to another on a fixed supply curve.

Change in Supply (Supplied)

a change in supply means a change in the schedule and a shift of the curve. An increase in supply shifts the curve to the right; a decrease in supply shifts it to the left. The cause of a change in supply is a change in one or more of the determinants of supply.

Changes in Supply

a) Resource Prices: The prices of the resources used in the production process help determine the costs of production incurred by firms. Higher resource prices raise production costs and, assuming a particular product price, squeeze profits. b) Technology: Improvements in technology (techniques of production) enable firms to produce units of output with fewer resources. c) Taxes and Subsidies: Businesses treat most taxes as costs. An increase in sales or property taxes will increase production costs and reduce supply. In contrast, subsidies are "taxes in reverse." d) Prices of Other Goods: Firms that produce a particular product, say, soccer balls, can sometimes use their plant and equipment to produce alternative goods, say, basketballs and volleyballs. The higher prices of these "other goods" may entice soccer ball producers to switch production to those other goods in order to increase profits. e) Producer Expectations: Changes in expectations about the future price of a product may affect the producer's current willingness to supply that product. f) Number of Sellers: Other things equal, the larger the number of suppliers, the greater the market supply.

Changes in Demand

a) Tastes: A favorable change in consumer tastes (preferences) for a product—a change that makes the product more desirable—means that more of it will be demanded at each price. b) Number of Buyers: An increase in the number of buyers in a market is likely to increase demand; a decrease in the number of buyers will probably decrease demand. c) Income: How changes in income affect demand is a more complex matter. For most products, a rise in income causes an increase in demand.

The basic determinants of supply

are (1) resource prices, (2) technology, (3) taxes and subsidies, (4) prices of other goods, (5) producer expectations, and (6) the number of sellers in the market. A change in any one or more of these determinants of supply, or supply shifters, will move the supply curve for a product either right or left.

The Supply Curve

curve S is the supply curve that corresponds with the price-quantity supplied data in the accompanying table. The upward slope of the curve reflects the law of supply— producers offer more of a good, service, or resource for sale as its price rises.

Price ceiling

sets the maximum legal price a seller may charge for a product or service.

Allocate efficiency

the particular mix of goods and services most highly valued by society (minimum-cost production assumed).

Productive efficiency

the production of any particular good in the least costly way.

An increase in demand

—the decision by consumers to buy larger quantities of a product at each possible price—may be caused by: • A favorable change in consumer tastes. • An increase in the number of buyers. • Rising incomes if the product is a normal good. • Falling incomes if the product is an inferior good. • An increase in the price of a substitute good. • A decrease in the price of a complementary good. • A new consumer expectation that either prices or income will be higher in the future.