CH.3 SUPPLY AND DEMAND AND MARKET EQUILIBRIUM
CETERIS PARIBUS
a Latin phrase that means "all other things held constant"
DEMAND CURVE (graph)
a curve that shows the relationship between the price of a product and the quantity of the product demanded
SUPPLY CURVE
a graph of the relationship between the price of a good and the quantity supplied
The substitution effect is when...
a lower price gives an incentive to substitute the lower-priced good for the now relatively higher-priced goods
COMPLEMENTARY GOOD
a product often used with another product
PRODUCTIVE EFFICIENCY
a situation in which a good or service is produced at the lowest possible cost - Competitive markets generate productive efficiency that is the production of any particular good in the least costly way. Sellers that don't achieve the least-cost combination of inputs will be unprofitable and have difficulty competing in the market.
SHORTAGE
a situation in which a good or service is unavailable
DEMAND SCHEDULE (table)
a table that shows the relationship between the price of a good and the quantity demanded
SUPPLY SCHEDULE
a table that shows the relationship between the price of a good and the quantity supplied
CHANGES IN SUPPLY AND EQUILIBRIUM
- An increase in supply results in a decrease in price and an increase in the quantity exchanged. - A decrease in supply results in an increase in price and a decrease in the quantity exchanged.
MARKET EQUILIBRIUM
- Equilibrium occurs where the demand curve and supply curve intersect. - Equilibrium price and equilibrium quantity. - Surplus and shortage. - Rationing function of prices. - Efficient allocation
INFERIOR GOODS
Goods for which demand tends to fall when income rises.
SUBSITUTE GOODS
Goods that can be used as alternatives to another good
MARKETS
Interaction between buyers and sellers. Markets may be: •Local •National •International Price is discovered in the interactions of buyers and sellers.
DETERMINANTS OF SUPPLY
- A change in resource prices •If resource prices (input prices) go up, supply decreases. If resource prices (input prices) go down, supply increases. - A change in technology •If technology increases, supply increases. If we adopt, or use, less efficient technology, supply decreases. - A change in the number of sellers •If the number of sellers increases, supply increases. Economic profits in the market draw producers from less profitable markets into this market. If the number of sellers decreases, supply decreases. Economic losses in the market cause producers to leave market. - A change in taxes and subsidies •If taxes are increased on a specific product, supply decreases. If taxes are decreased, or eliminated on a specific product, supply increases. If subsidies are increased on a specific product, supply increases. If subsidies are decreased on a specific product, supply decreases. - A change in prices of other goods •If the price of another good that the producer could produce with the same resources rises, the supply decreases for the product the producers are currently producing. •If the price of another good that the producer could produce with the same resources falls, the supply increases for the product the producers are currently producing. - A change in producer expectations •If producers expect that the price of the product they are producing will be higher in the future, they cut back on current supply and supply will decrease. If producers expect the price of the product they are producing will be lower in the future, they increase current supply to take advantage of the currently higher price.
DEMAND
- A schedule or 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 specified periods of time. - Demand schedule (table) or demand curve (graph) - Amount consumers are willing and able to purchase at a given price assuming: •Other things equal •Individual demand - Market demand
SUPPLY
- A schedule or curve that shows 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 specified period of time. - Supply schedule or a supply curve - Amount producers are willing and able to sell at a given price - Individual supply - Market supply
CHANGES IN DEMAND AND EQUILIBRIUM
- An increase in demand results in an increase in price and an increase in quantity exchanged. - A decrease in demand results in a decrease in price and a decrease in the quantity exchanged.
This requires large numbers of buyers and sellers acting independently
MARKET
If there are more buyers in the market for a good, demand will ________________________________________, whereas when there are fewer buyers in the market for a good, demand will ___________________________________.
- INCREASE - DECREASE
EFFECTS OF CHANGES OF SUPPLY AND DEMAND
- If supply increases and demand decreases, price declines, but the new equilibrium quantity depends on the relative sizes of shifts in demand and supply. - If supply decreases and demand increases, price rises, but the new equilibrium quantity depends on the relative sizes of shifts in demand and supply. - If supply and demand change in the same direction (both increase or both decrease), the change in equilibrium quantity will be in the direction of the shift but the change in equilibrium price now depends on the relative shifts in demand and supply.
LAW OF DEMAND
- Other things equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls Explanations: •Price acts as an obstacle to buyers •Law of diminishing marginal utility •Income effect and substitution effect
If consumers expect their future income to ___________________, they increase purchases now. If consumers believe their future income will be ____________________, they reduce their demand for some products.
- RISE - LESS
The demand curve illustrates the inverse relationship between price and quantity. The slopes indicate....
- The downward slope indicates a lower quantity (horizontal axis) at a higher price (vertical axis), and a higher quantity at a lower price, reflecting the law of demand.
A change in one or more of these determinants will change demand and shift the demand curve.
- change in buyers taste: smart phone popularity increases, while landlines decrease. - change in number of buyers: decline in birthrate reduces number of baby toys being bought - change in income: A rise in incomes increases the demand for normal goods such as restaurant meals, sports tickets, and necklaces while reducing the demand for inferior goods such as cabbage, turnips, and cheap wine. - change of the prices of related goods: A reduction in airfares reduces the demand for bus transportation (substitute goods); a decline in the price of printers increases the demand for ink cartridges (complementary goods). - change in consumer expectations: Inclement weather in South America creates an expectation of higher future coffee bean prices, thereby increasing today's demand for coffee beans.
Diminishing marginal utility refers to...
- the decrease in added satisfaction that results as one consumes additional units of a good or service - i.e., the second "Big Mac" yields less extra satisfaction (or utility) than the first. Because additional units yield less utility, the price has to be lower to make up for less utility.
NATIONAL MARKET
A geographically dispersed market where customers are spread over a large area - An example of a national market is the US real estate market
PRICE CEILING
A legal maximum on the price at which a good can be sold - Price ceilings are maximum prices that can be charged on a good. - Price ceilings are set on goods that are considered to be necessities, but the equilibrium price is so high that many people are unable to purchase the item. - To be effective, the price ceiling must be set below the equilibrium price. - When price ceilings are placed on a good, this creates a chronic shortage which makes it difficult to determine how to ration the limited output for all of the consumers who are willing and able to buy the good. - The shortages often lead to black markets where the good is sold at a higher price than the price ceiling. - Price ceilings distort the efficient allocation of resources.
PRICE FLOOR
A legal minimum on the price at which a good can be sold - Price floor: •Prices are set above the market price. •Chronic surpluses. Example is the minimum wage law. - A price floor is a minimum price fixed by the government. A price at or above the price floor is legal; a price below it is not.
SURPLUS
A situation in which quantity supplied is greater than quantity demanded
In this chapter, the focus is on markets that are....
COMPETITIVE
________________________________________ goods are goods that we consume jointly. It isn't beneficial to have one without its complement.
COMPLEMENTARY GOODS - When the price of one complement increases, the demand for the other complement decreases. - When the price of one complement decreases, the demand for the other complement increases. - Some examples are cell phones and cell phone service, tuition and textbooks.
When deriving demand, we are assuming that the only factor that causes consumers to buy more or less is the price of the good. It is assumed that all other factors that influence the amount that consumers will buy are.....
CONSTANT - Market demand is derived by summing the individuals' demand curves.
A schedule or 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 specified periods of time.
DEMAND
_______________________________ are those things that can shift the entire demand curve causing demand to change.
DETERMINANTS - When most consumers experience the same change in tastes for a particular good, the demand for the good will change. - If there is a preferable change in tastes, demand will increase. - On the other hand, if there is an unfavorable change in tastes, demand will fall.
At ____________________________________ the markets are economically efficient
Equilibrium
DETERMINANTS OF DEMAND
Factors other than price that determine the quantities demanded of a good or service
Producers are willing to produce and sell more of their product at a __________________________ price than at a ________________________ price.
HIGH PRICE THAN LOW PRICE - There is a direct relationship between price and quantity supplied. - Given product costs, a higher price means greater profits and thus an incentive to increase the quantity supplied. - Beyond some level of output, producers usually encounter increasing costs per added unit of output
The income effect occurs as a lower price _________________________ the purchasing power of money income; this enables the consumer to buy more at a lower price (or less at a higher price) without having to reduce consumption of other goods.
INCREASES
___________________________ goods are goods we buy more of as our income decreases.
INFERIOR - We buy fewer inferior goods if our income increases
_______________________________ goods are goods that we buy more of as our incomes increase.
NORMAL - Most of the goods that we buy are normal goods. - We buy fewer normal goods when our income decreases.
LAW OF SUPPLY
Other things equal, as the price rises, the quantity supplied rises and as the price falls, the quantity supplied falls. Explanation: •Price acts as an incentive to producers. •At some point, costs will rise.
______________________________ is discovered in the interactions of buyers and sellers.
PRICE
An inverse relationship exists between ________________________ and _________________________________ demanded.
PRICE AND QUANTITY - Prices act as obstacles for buyers and keep them from being able to buy everything that they want. - So, it makes sense that with a limited income, consumers will buy more at lower prices.
To be part of the supply of a good, producers have to be willing and able to...
PRODUCE THE GOOD - When creating supply, we are assuming that the only factor that causes firms to produce more or less is the price of the good. - It is assumed that all other factors that influence the amount that firms will produce are constant. - Market supply is created by summing the individual firms' supply curves.
GOVERNMENT SET PRICES: PRICE CEILING
Price ceiling: •Set below equilibrium price •Rationing problem •Black markets Example is rent control.
EFFICENT ALLOCATION
Productive efficiency •Producing goods in the least costly way •Using the best technology •Using the right mix of resources Allocative efficiency •Producing the right mix of goods •The combination of goods most highly valued by society
____________________________________ goods are goods that we use in place of another.
SUBSTITUTE GOODS - A perfect substitute is a good that we use in place of the other without any loss of satisfaction. - If the price of one good increases, the demand for its substitute increases. - If the price of one good decreases, the demand for the other substitute decreases. - Some examples are Colgate and Crest toothpaste, Nike and Reebok shoes
Because price and quantity supplied are directly related, the ____________________________ ______________________________ graphs as an upsloping curve. Other things equal, producers will offer more of a product for sale as its price rises and less of the product for sale as its price falls.
SUPPLY CURVE
RATIONING FUNCTION OF PRICES
The ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent. - Prices automatically rise and fall and bring a market closer to equilibrium. - Prices are the best tool for eliminating market shortages and surpluses.
BLACK MARKETS
an illegal market that breaks government rules on prices or sales
MARKET
any arrangement that allows buyers and sellers to exchange things
If consumers expect the future price of a product to be lower, they...
decrease their current demand for the product
ALLOCATION
the action or process of allocating or distributing something.
INTERNATIONAL MARKET
developing and performing marketing activities across national boundaries - the New York Stock Exchange is an international market.
EFFICIENT ALLOCATION
economy allocates its resources so that consumers are as well off as possible
NORMAL GOODS
goods that consumers demand more of when their incomes rise
If consumers expect the future price of a product to be higher, they...
increase their current demand for the product
To be part of the demand for a good, consumers have to be willing and able to....
purchase the good
CHANGES IN SUPPLY
shifts the supply curve - A change in one or more of the determinants of supply causes a change in supply. - An increase in supply is shown as a rightward shift of the supply curve, as from S1 to S2. - A decrease in supply is depicted as a leftward shift of the curve, as from S1 to S3. - Caution: These changes in supply are to be distinguished from a change in quantity supplied, which is caused by a change in the price of the product and is a movement from one point to another point on a fixed supply curve.
LOCAL MARKET
suppliers within close proximity to the buyer - An example of a local market is the farmer's market that brings together buyers and sellers of produce in the summer
EQUILIBRIUM QUANTITY
the amount bought and sold at the equilibrium price •The rationing function of prices is the ability of competitive forces of supply and demand to establish a price where buying and selling decisions are coordinated. •At prices above this equilibrium, note that there is an excess quantity supplied, or a surplus. •At prices below this equilibrium, note that there is an excess quantity demanded, or shortage. •At equilibrium the markets are economically efficient.
INCOME EFFECT
the change in consumption that results when a price increase causes real income to decline
INDIVIDUAL DEMAND
the demand of an individual consumer
EQUILIBRIUM PRICE
the price at which the amount producers are willing to supply is equal to the amount consumers are willing to buy •The equilibrium price is also known as the market-clearing price. - Graphically, note that the equilibrium price and quantity are where the supply and demand curves intersect. - It is important to note that it is not correct to say supply equals demand.
LAW OF DIMINISHING MARGINAL UTILITY
the principle that consumers experience diminishing additional satisfaction as they consume more of a good or service during a given period of time
MARKET DEMAND
the sum of the individual demands of all consumers in the market
MARKET SUPPLY
the sum of the quantities supplied by each seller in the market at each price
INDIVIDUAL SUPPLY
the supply of an individual producer
SUBSITUTION EFFECT
when consumers react to an increase in a good's price by consuming less of that good and more of other goods
ALLOCATIVE EFFICIENCY
when the mix of goods being produced represents the mix that society most desires •The competitive process also generates allocative efficiency which is producing the combination of goods and services most valued by society. - Allocative efficiency requires that there be productive efficiency. Productive efficiency can occur without allocative efficiency. Goods can be produced in the least costly method without being the most wanted by society. Allocative and productive efficiency occur at the equilibrium price and quantity in a competitive market. Resources are neither over-allocated nor under-allocated based on society's wants.
Amount consumers are willing and able to purchase at a given price assuming:
•Other things equal •Individual demand