Economics Chapters 3 and 4 Test

Changes in Demand

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). Shifts are caused by a change in one or more of the determinants of demand.

Change in Demand

A change in one or more of the determinants will change the underlying demand data and the location of the demand curve.

Changes in Quantity Demanded

A change in quantity demanded is a movement from one point to another point on a fixed demand curve. The cause of such change is an increase or decrease in the price of the product under consideration.

Changes in Quantity Supplied

A change in quantity supplied is a movement from one point to another point on a fixed supply curve. The cause of such a movement is a change in the price of the product being considered.

Tastes

A favorable change in consumer tastes will result in more of a product being demanded at every price. The opposite is also true. Tastes include usefulness of a product

Market Period

A period in which producers of a product are unable to change the quantity produced in response to a change in price. During this time period, the supply of a product is fixed, or supply is perfectly inelastic.

Price Elasticity of Demand

According to the law of demand, when price goes up, consumers demand fewer quantities of a product. If the price of a product falls, quantity demanded will rise. But when the price of a product changes, by how much more (or less) will consumers buy? To help answer this question, we will use a measurement called the Price Elasticity of Demand. For some products, consumers are highly responsive to price changes. Demand for such products is relatively elastic or simply elastic. For other products, consumers' responsiveness is only slight, or in rare cases non-existent. Demand is said to be relatively inelastic, or simply inelastic.

The Law of Demand

All else equal (ceteris paribus), as price falls, the quantity demanded rises, and vice versa.

Price Elasticity along a Linear Demand Curve

Along a linear demand curve, elasticity varies over the different price ranges. Because elasticity involves relative or percentage changes in price and quantity, as you move along a demand curve, the percentage changes in price and quantity will vary.

Number of Buyers

An increase in the number of possible buyers will also increase demand at every price level. It could be in a particular market, ie. Elderly, baby boomers

Number of Sellers

As more suppliers enter an industry, the supply curve shifts to the right As suppliers leave an industry, the supply curve shifts to the left.

Changes in Supply

Because supply is a schedule or curve, a change in supply means a change in the schedule and a shift of the supply curve. Shifts are caused by a change in one or more of the determinants of supply.

Demand

Demand is a schedule or curve that shows the various amounts of a product that consumers are willing and able to buy at each of a series of possible prices during a specific period. A curve illustrating the inverse relationship between the price of a product and the quantity demanded of it, other things equal, is the demand curve. It slopes downward to reflect the Law of Demand. Individual demand is the demand schedule or curve of a single consumer. Market demand is the sum of all the individual demands. By adding the individual quantities demanded by all consumers at each of the various possible prices, we get the market demand.

Determinants of Supply

Determinants of supply are those factors that cause supply to change. The basic determinants of supply are (1) resources prices, (2) technology, (3) taxes and subsidies, (4) price of other goods, (5) expected prices, and (6) the number of sellers in the market.

The Price-Elasticity Coefficient

Economist measure the degree of price elasticity or inelasticity of demand with the coefficient Ed. (Coefficient of demand elasticity)

Total Revenue Test

Elasticity is important to firms because when the price of their products change, so does their profit (total revenue minus total costs). TR= Price*Quantity This represents the total number of dollars received by a firm from the sale of a product in a particular period. Total revenue and the price elasticity of demand are related. The total-revenue test can determine elasticity by examining what happens to total revenue when price changes. If demand is elastic, a decrease in price will increase total revenue, and an increase in price will reduce total revenue. If demand is inelastic, a price decrease will decrease total revenue, while an increase in price will increase total revenue. If demand is unit elastic, total revenue remains constant when prices rise or fall.

Inferior Goods

Have a negative income elasticity of demand. As income rises, the demand for them falls. Ei < 0

Resource Prices

Higher resource prices raise production costs, reduce profits Reduction in profits reduces incentive for firms to supply output at each product price

Prices of Other Goods

If the price of "product A" goes up, and profit goes up, firms will switch their resources away from the production of product B in order to make more of product A. Therefore there will be a decrease in the supply of product B even though there was no price change for product B.

Price Ceiling

If the price of a product is unfairly high, the government can set a price ceiling, or a legal maximum price a seller may charge for a product. This purportedly enables consumers to obtain some "essential" good or service that they could not afford at the equilibrium price; however, it also creates a shortage of the good.

Expected Prices

Impact of expected change in prices varies Some producers may withhold goods from market now to put them on the market later when prices rise thereby reducing supply in the present Other producers may produce extra supply now in anticipation of a price increase

Technology

Improvements in technology allow firms to be more efficient and reduce costs therefore increasing profits. Increased profits encourages firms to increase supply

Market Equilibrium

In competitive markets, buyers and sellers have no control over prices. When buyers and sellers interact in a free competitive market, the equilibrium price and equilibrium quantity is determined by the intersection of the demand and supply curves. The equilibrium price, or market-clearing price, is the price at which the intentions of buyers and sellers match. The equilibrium quantity is the quantity demanded and quantity supplied that occurs at the equilibrium price in a competitive market. Any price above the equilibrium price would create a surplus, or excess supply; quantity supplied exceeds quantity demanded. Surpluses drive prices down to equilibrium. As prices fall, the incentive to produce declines and the incentive for consumers to buy increases. Any price below the equilibrium price would create a shortage, or excess demand; quantity demanded exceeds quantity supplied. Shortages push prices up equilibrium. As prices rise, the incentive to produce increases and the incentive for consumers to buy decreases.

Determinants of Price Elasticity of Demand

In general, there are four determinants that can affect the price elasticity of demand: -Substitutability -Proportion of Income -Luxuries versus Necessities -Time Price elasticity of demand is greater: -the larger the number of substitute goods that are available -the higher the price of a product relative to one's income -the more that a good is considered to be a "luxury" rather than a "necessity" -the longer the time period under consideration

Government-Set Prices

In most markets, prices are free to rise or fall with changes in demand and supply. However, sometimes the resulting price in a market is "too high" or "too low". Government may place legal limits on how high or how low a price or prices may go. High prices may be unfair to buyers whereas low prices may be unfair to sellers.

Price Elasticity of Supply and Time Periods

In the short run, producers are able to change the quantities of some but not all the resources they employ. This time period is too short to change plant capacity but long enough to use fixed plant more or less intensively. The supply of a product is more elastic than the market period. In the long run, producers are able to change all the resources they employ. This time period is long enough for firms to adjust their plant sizes and for new firms to enter (or existing firms to exit) the industry. The supply of a product is more elastic than in the short run.

Income Elasticity of Demand

Income elasticity of demand measures the responsiveness of consumer purchases to changes in consumer income. The coefficient of income elasticity of demand Ei is determined with the formula EI= percentage change in quantity demanded percentage change in income

Market Supply

Market supply is derived from individual supply by "horizontally adding" the supply curves of the individual producers.

Markets

Markets bring together buyers ("demanders") and sellers ("suppliers"). Some markets are local while others are national or international. Markets help to determine the prices and quantities bought and sold of millions of goods and services.

Price Elasticity of Supply

Price elasticity of supply measures the responsiveness of sellers to changes in the price of a product. If producers are relatively responsive, supply is elastic. If producers are relatively insensitive to price changes, supply is inelastic. If Es < 1, supply is inelastic. If Es > 1, supply is elastic. If Es = 1, supply is unit-elastic. Since price and quantity supplied are directly related, Es is never negative. The amount of time it takes producers to shift resources between alternative uses to alter production of a good can determine the degree of price elasticity of supply. The easier and more rapid the transfer of resources, the greater is the price elasticity of supply. The longer a firm has to adjust to a price change, the greater the elasticity of supply.

Unit Elasticity

Product demand for which price changes and changes in quantity demanded are equal; Ed = 1

Elastic Demand

Product demand for which price changes cause relatively larger changes in quantity demanded; Ed > 1

Inelastic Demand

Product demand for which price changes cause relatively smaller changes in quantity demanded; Ed < 1

Perfectly Elastic

Product demand for which quantity demanded can be any amount at a particular price.

Perfectly Inelastic

Product demand for which quantity demanded does not respond to a change in price.

Supply

Supply is a schedule or curve showing the amounts of a product that producers will make available for sale at each of a series of possible prices during a specific period. A curve illustrating the positive, or direct relationship between the price of a product and the quantity supplied of it, other things equal, is the supply curve. It slopes upward to reflect the Law of Supply.

Taxes and Subsidies

Taxes are considered a cost Taxes up, profits down and firms will want to reduce supply Subsidies are taxes in reverse. They lower costs which increases profit and makes firms want to supply more

The Law of Supply

The Law of Supply states that, all else equal, as price rises, the quantity supplied rises, and vice versa.

Change in Income

The effects of changes in income vary depending on the type of product demanded. When income rises, all else equal, the demand for normal goods increases, while the demand for inferior goods decreases. Most goods are normal goods, or superior goods. The demand for these increases or decreases directly with changes in income. The demand for inferior goods increases or decreases inversely with money income. If income rises, the demand for a normal good increases and the demand for an inferior good decreases.

Determinants of Demand

When a demand curve is drawn, other factors, called determinants of demand, are held constant. Determinants of demand are factors other than price that locate the position of a demand curve. These include: (1) tastes, (2) number of buyers, (3) income, (4) prices of related goods, and (5) expected prices.

Complex Cases

When both supply and demand change, the effect is a combination of the individual effects. The relative sizes of the change in demand and supply will determine the effect on equilibrium price and quantity. In some cases, the effect is certain; in others the effect depends on the size of the shifts.

Changes in Demand (2)

When supply is constant, an increase in demand will result in a higher equilibrium price and quantity. If demand falls, equilibrium price and quantity decrease.

Price Floor

When the price of a good or service is "too low", the government can set a price floor, or a minimum fixed price that sellers can charge. The goal is to provide a sufficient income for certain groups of resource suppliers, or producers who would otherwise receive very low incomes at the equilibrium price. However, a surplus of the good is created.

Prices of Related Goods

When two goods are related (as substitutes or complements), a change in the price of one good may either increase or decrease the demand for the other product. A substitute good is one that can be used in place of another good. A complementary good is one that is used together with another good. If two goods are substitutes, an increase in the price of one will increase the demand for the other. If two goods are complements, an increase in the price of one will decrease the demand for the other. Most goods are unrelated to one another. For these independent goods, a change in the price of one will have virtually no effect on the demand for the other.

Normal Goods

Will have an income elasticity of demand that is positive. More of them are demanded as income increases. Ei > 0

Changes in Supply

With a constant demand, if supply increases, equilibrium price falls while equilibrium quantity rises. If supply decreases, equilibrium price rises, and equilibrium quantity falls.