Microeconomics chapter 3

Why does higher price reduce quantity demanded

-Substitution Effect -Income Effect

Income Effect

Faced with higher price and unchanged income, people cannot afford to buy all the things they previously bought. Must decrease quantities demanded of at least some goods and services.

Change in quantity Demanded

Movement along the demand curve. If price of good changes but no other influence on buying plans changes, then demand curve remains stagnant and the point along the curve travels either up or down it.

Change in quantity Supplied

Movement along the supply curve. Changes in influences on selling plans bring either a change in quantity supplied or a change in supply

Example

The Demand for ice-cream cones is, P = 800 - 2Qd The Supply for ice-cream cones is, P = 200 + 1Qs Find equilibrium price and equilibrium quantity: P* = 800 - 2Q* P* = 200 + 1Q* Do basic algebra Q* = 200 Plug back into equation P* = 800 - 2 ( 200 ) P* = 400 The equilibrium price is $400 a cone and equilibrium quantity is 200 cones.

Market Equilibrium (mathematical note)

The price of a good adjusts until, Qd = Qs = Q* To find equilibrium price and equilibrium quantity, substitute Q* for Qd for demand equation and Q* for Qs is supply equation, then price is equilibrium price P*, P* = a - bQ* P* = c + dQ* Notice that, a - bQ* = c + dQ* then, a - c = bQ* + dQ* then, a - c = (b + d ) Q* This simplifies to Q* = ( a - c ) / ( b + d ) When using demand equation we have, P* = ( ad + bc ) / ( b + d ) When using supply equation we have, P* = ( ad + bc ) / (b + d )

Law of Supply

The principle that suppliers will normally offer more for sale at higher prices and less at lower prices

Change in demand

When any factor that influences buying plans changes, other than price of the good. Six main factors 1) Prices of related goods (substitutes & compliments) 2) Expected future prices 3) Income (normal good & inferior good) 4) Expected future income and credit 5) Population 6) Preferences

Change in Supply

When any factor that influences selling plans other than the price of good changes, there is a change in supply. Six main factors that bring changes in supply: 1) Prices of factors of production 2) Prices of related goods produced (substitutes & compliments) 3) Expected future prices 4) Number of suppliers 5) Technology 6) State of technology (earthquakes, tornadoes, etc)

Demand Curve (mathematical note)

When demand curve is a straight line, it follows the equation: P = a - bQd , Where P is price, Qd is quantity demanded, "a" is y-intercept, and slope is "b"

Substitution Effect

When price of good rises, other things remain the same, its relative price--its opportunity cost--rises. Each good has substitutes that can be used in its place.

Supply Curve (mathematical note)

When supply curve is a straight line, it follows the equation: P = c + dQs , Where P is price, Qs is quantity supplied, "c" is y-intercept, and slope is "d"

Law of Demand

consumers buy more of a good when its price decreases and less when its price increases