Chapter 3: Supply and Demand

Post hoc ergo propter hoc

("After this, therefore because of this") It attempts to prove that because a second event followed a first event, the second event was the results of the first.

Black Markets

Consumers trying to pay more than the price ceiling and firms willing to sell it for more profit.

Common goods

Non-excludable and rivalrous (timber, natural resources, and ammonium)

Public goods

Non-rivalrous and non-excludable goods (lighthouse, fireworks, and national defense)

Club goods

Non-rivalrous but excludable (country club, television, and internet)

Distinguish between a normal good and an inferior good. What is the economic definition of each?

Normal good is a good for which, other things equal, an increase in income leads to an increase in demand. Inferior is a good for which, other things equal, an increase in income leads to a decrease in demand. Results of change in consumer income.

What's the difference between Productive efficiency and Allocative efficiency?

Productive efficiency (issue of resources) is when resources are used in the best way to produce a given output (improved capital, human capital, efficient, etc.). Allocative efficiency is when resources are used in the way consumers want them to be.

What draws firms into industries?

Profitable industries

Private Goods

Rivalrous and exludable goods (shirts, hats, computers, and gatorade)

Opportunity Costs

Sacrifice of the next best alternative when a choice is made

How are two complementary goods related?

There is an inverse relationship between the price of one good and the demand of another.

How are two substitute goods related?

There is an inverse relationship between the price of one good and the demand of another.

State the one explanation for the Law of Supply. Be able to explain this thoughtfully and thoroughly.

When there is a change in price there is change in profit, which gives the firms the incentive or disincentive to produce a good which results in a change in quantity supplied. (1. change in price 2. change in profit 3. change in quantity supplied)

change in supply

a change in the quantity supplied of a good or service at every price; a shift of the supply curve to the left or right. This is caused by a change in one of the seven determinants of supply.

Rivalrous

a good or service is rivalrous if, when one person consumes one unit of it, there is one less unit available for others to consume

supply schedule

a schedule showing the amounts of a good or service that sellers (or a seller) will offer at various prices during some period.

Rationing Problem

when the amount of need exceeds the amount of attainable resource, the problem becomes how to distribute it. Caused by price ceilings

Change in supply vs. Change in quantity supplied

○ A change in the price of a good leads to a change in quantity supplied, resulting in movement from point to point along the fixed supply curve. ○ A change in one of seven determinants of supply leads to a change in supply, resulting in a shift of the supply curve to the left or the right.

Independent goods

Goods that are not related to one another

Rent controls

Government imposed maximum or minimum rent cost. Rent ceiling causes shortage and suppliers are less willing to rent out.

Diminishing marginal utility

In any specific time period, each buyer of a product will derive less satisfaction from each successive unit of the product consumed. (marginal is the additional, so marginal utility is the change in utility derived from quantity consumed of a good)

Determinants of Supply

1. Change in government policy (G) -Taxes/Subsidies -Other 2. Change in resources (land, labor, entrepreneurial ability, and capital) (R) -Quantity -Quality 3. Change in producer expectations (of future prices) (E) 4. Change in cost of production (C) 5. Change in price of another good the firm could produce (A) 6. Change in number of suppliers (N) 7. Change in technology (T) GREC ANT

6 basic determinants of demand

1. Change in the price of a complementary good, (C) 2. Change in Consumer tastes (preferences), (P) 3. Change in consumer expectations of future prices, (E) 4. Change in the Number of potential buyers, (N) 5. Change in consumer income, (I) 6. Change in the price of a substitute good, (S)

Ways two goods are related

1. Resource used to produce another (input or capital) (Supply) 2. Substitute good (Demand) 3. Complement good (Demand) 4. Two goods produced by the same firm (Supply) 5. Not related

What can a government do to combat a surplus?

1. Restrict supply by ensuring farmers take some land out of production 2. Increase demand by researching new uses for a product 3. Purchase the surplus and subsidize the farmers

Distinguish between a change in quantity supply and a change in supply. What causes each? What is the result of each?

A change in quantity supplied is merely movement along a fixed supply curve, and the only cause of a change in quantity supplied is a change in price. As a result of a change in price, the change in quantity demanded is inversely related. A change in supply is movement of the entire curve either right if increasing or left if decreasing. This is caused by the seven determinants of supply. The result is a change in quantity supplied at each price point instead of just one.

Normal good

A good for which a change in consumer income is directly related to demand for the good.

Inferior good

A good for which a change in consumer income is inversely related to demand for the good.

Non-rivalrous good

A good for which one person's consumption doesn't prevent another person from consuming it. (club goods are non-rivalrous but excludable)

Non-excludable good

A good where it is impossible to prevent others from consuming it once it is provided (non-excludable but rivalrous are common goods)

Price ceiling

A legal maximum on the price at which a good can be sold. Always imposed below equilibrium to have effect. Helps consumers get more consumer surplus but creates shortage.

Price Floor

A legal minimum on the price at which a good can be sold Always set above equilibrium. Helps Firms by making a minimum price higher than the equilibrium price. Creates permanent surplus

Change in quantity demanded

A movement form one point to another point on a fixed demand curve

Quality control

A set of tests put into the product process and at the completion of the production process to check that various stages of manufacture are completed within specifications.

Surplus

A situation in which quantity supplied is greater than quantity demanded. Consumers are hurt because prices are higher and they can't purchase as much. Note change is always negative.

Rationing function of Prices

Ability of competitive forces of supply and demand to establish a price at which selling and buying decisions are consistent. Equilibrium price is caused by individual decisions in the market. (all buyers who are willing and able to pay $3 for corn will get corn, and all producers who are willing and able to offer corn for $3 will sell it)

Distinguish between complements and substitutes. What is the economic definition of each?

Complementary goods are goods that are consumed together. Price of a good and demand for its complement are inversely related. Substitute goods are goods that are consumed separately.Price of a good and demand for its substitute are directly related

Public good

Goods that are non-excludable non-rivalrous in consumption

Difference between change in Demand and change in Quantity Demanded. Causes? Effects?

Demand is the intention of buyers about how much of a product they intend to buy at different prices, it is a game plan. It is caused by the six determinants of demand. Change in quantity demanded is a change in the amount demanded, a number, and is caused only by a change in price. The effect of change in demand is more or less quantity demanded for a good along the entire good, at every price. The effect of a change in quantity demanded is just more purchased at a higher price or less at a lower price.

Three explanations for the Law of Demand

Diminishing marginal utility, income effect, substitution effect

Distinguish between the Income Effect and a Change in Consumer Income.

Income effect is the change in price of a good that changes the purchasing power which changes quantity demanded, however nominally the money is the same. Change in consumer income is just more or less income for the consumer. Real and nominal change

Change in Number of Potential Buyers

Increased number of potential buyers affects demand. Demographics, embargo, immigration (Baby boom, demand for diapers increases. Embargo on Cuban cigars lifted. Millions of Mexican immigrants enter US, demand for Mexican food increases)

Correlation vs. Causation

Just because there is correlation does not mean causation. Ex: More ice cream consumption happens and so does more crime, but doesn't mean crime increases because of ice cream. Repeated thing.

Efficiency Lost (Deadweight loss)

Lost benefit to society when market deviates from equilibrium

Demand

Schedule showing various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices over a period of time (a consumer buys 10 bushels of corn PER WEEK at $5 per bushel)

Difference between Substitution Effect and Change in the Price of a Substitute Good

Substitution effect is the change in price of a good changes the relative price of the good which changes quantity demanded. The change in the price of a substitute takes just you and your competitor into consideration, and a change in their substitute changes the demand for your good. (change in the price of a substitute is a change in the price of one good that changes demand for another, while the substitution effect is the change in the price of a good which changes quantity demanded for that good.)

Excise Tax

Tax on production that decreases supply because it is increasing the cost of production for the company per unit (dollar) tax on production.

Income effect

The ________ ________ indicates that a change in price causes a change in the price of the purchasing power of the consumer's income. (1. change in price leads to a 2. change in purchasing power of consumers leads to a 3. change in quantity demanded)

Substitution effect

The ________ ________ suggest 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. (1. change in the price of a substitute cause 2. a change in the relative price of the good which causes 3. a change in the quantity demanded)

Law of increasing marginal costs

The cost of producing each additional unit of a good or service incurs a greater cost than the previous unit. Why the supply curve is upsloping, they have to sell the good for more because it costs more to produce.

Consumer Surplus

The difference between what a consumer is willing to pay for a good and the amount the buyer actually (has to) pays for it. What they're willing to pay is on the demand curve. What they have to pay is the equilibrium price Benefit that accrues over and above what the consumer has to pay.

Producer Surplus

The difference between what the producers get to keep from the sale and what they are willing to sell for. Equilibrium price is what they have to sell for. What they're willing to sell for is along the supply curve. The benefit that the producer gets over and above what they're willing to sell for

Fallacy of Composition

The false assumption that what is true for a part will also be true for the whole. (Peter is unhappy so the whole class is unhappy). In truth: What is true for one is not true for all. Flight 91- if I stand up I'll get killed, but if we all stand up we can stop them.

Product Mix

The particular assortment of goods and services that a business offers to meet the needs of its market(s) and its company goals.

Productive efficiency

The production of any particular good in the least cost way.

law of supply

There is a direct relationship between price and quantity supplied, everything else equal. The independent variable is the price of a good, and the dependent variable is the quantity supplied of that good.

How are two complementary goods related?

There is a direct relationship between the price of one good and the demand of another.

How are two substitute goods related?

There is a direct relationship between the price of one good and the demand of its substitute.

State the Law of Demand. Identify the dependent and independent variables in the relationship.

There is an inverse relationship between price and quantity demanded on a graph. Price is the independent variable and quantity demanded is the dependent.

Capacity utilization

production level compared to capacity

Allocative efficiency

the particular mix of goods and services most highly valued by society. Occurs when marginal benefit = marginal cost. (Demand represents marginal benefit of the good in utility and supply represents marginal cost of producing it. Always occur at equilibrium)

Excludable

the property of a good whereby a person can be prevented from using it