Macroeconomics Chapter 3

Law of Demand

"Other things equal, as price falls, the quantity demanded rises; and as price rises, the quantity demanded falls." -there is a negative or inverse relationship between price and quantity demanded.

Law of Supply

"other things equal, FIRMS will produce and offer for sale more of their product at a HIGH PRICE than at a lower price" -a positive or direct relationship prevails between price and quantity supplied. -the firm will not produce the more costly units unless it receives a higher price for them.

Determinants of Demand

(or demand shifters) 1. consumers' tastes (preference) 2. the number of buyers in the market 3. consumers' incomes 4. the prices of related goods 5. consumer expectations

Equilibrium Price

(or market-clearing price) - is the price where the intentions of buyers and sellers match. - QD=QS - there is neither a shortage nor a surplus

Normal Goods

(or superior goods) Products whose demand varies DIRECTLY with money income. - for most products, a RISE in income causes an Increase in demand

Determinants of Supply

(or supply shifters) 1. resource prices 2. technology 3. taxes and subsidies 4. prices of other goods 5. producer expectations 6. the number of sellers in the market shift to the right: increase

Surplus

- excess supply - surpluses drive prices DOWN. the large surplus would prompt competing sellers to lower the price to encourage buyers to take the surplus off their hands.

Shortage

- quantity demanded exceeds quantity supplied. - excess demand shortages drive UP the price

Supply

-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

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.

Demand

-is a schedule or a curve -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 shows the quantities of a product that will be purchased at various possible prices, other things equal.

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"

Demand Curve

-the inverse relationship between price and quantity demanded for any product, 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 or resource as its price falls.

Diminishing Marginal Utility

Consumption is subject to diminishing marginal utility. -because successive units of a particular product yield less and less marginal utility, consumers will buy additional units only if the price of those units is progressively reduced.

Inferior Goods

Goods whose demand varies INVERSELY with money income -examples are: used clothing, third-hand automobiles, charcoal grills, soy-enhanced burgers

Rationing Function of Prices

The ability of the competitive forces of supply and demand to establish a price at which selling and buying decisions are consistent. -the market outcome says that all buyers who are WILLING AND ABLE to pay the cost will obtain it.

Relate how supply and demand interact to determine market equilibrium.

The equilibrium price and quantity are established at the intersection of the supply and demand curves. The interaction of market demand and market supply adjusts the price to the point at which the quantities demanded and supplied are equal. The ability of market forces to synchronize selling and buying decisions to eliminate potential surpluses and shortages is known as the rationing function of prices. The equilibrium quantity in competitive markets reflects both PRODUCTIVE efficiency (least-cost production) and ALLOCATIVE efficiency (producing the right amount of the product relative to other products.)

Explain how supply can change

The market supply curve is the horizontal summation of the supply curves of the individual producers of the product. Changes in one or more of the determinants of supply (*resource prices, *production techniques, *taxes or subsidies, *the prices of other goods, *producer expectations, or *the number of sellers in the market) shift the supply curve of a product

Describe demand.

Demand is a schedule or curve representing the willingness of buyers in a specific period to purchase a particular product at each of various prices. The law of demand implies that consumers will buy more of a product at a low price than at a high price. So, other things equal, the relationship between price and quantity demanded is negative or inverse and is graphed as a downsloping curve.

Price Control

distort market signals and so resources are misallocated: too few resources are allocated to rental housing and too many to alternative uses. -makes it less attractive for landlords/owners to offer housing on the market -make it unprofitable for owners to repair or renovate their rental units.

Price Ceiling

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

Allocative 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. :when society produces a product at the lowest achievable per-unit cost, it is expending the least-valued combination of resources to produce that product and therefore is making available more-valued resources to produce other desired good.

Equilibrium Quantity

the quantity at which the intentions of buyers and sellers match, so that the quantity demanded and the quantity supplied are equal.

Change in Supply

its key idea is that costs are a major factor underlying supply curves; anything that affects costs (other than changes in output itself) usually shifts the supply curve. a change in supply, then, is a change in the schedule and a shift of the curve

Explain how changes in supply and demand affect equilibrium prices and quantities.

A change in either demand or supply changes the equilibrium price and quantity. INCREASE in demand RAISE BOTH equilibrium price and quantity; INCREASE in supply LOWER equilibrium price and RAISE equilibrium quantity. Simultaneous changes in demand & supply affect equilibrium price and quantity in various ways, depending on their direction and relative magnitudes.

Differentiate change in demand and change in quantity demanded.

A shift to the right is an increase in demand; a shift to the left is a decrease in demand. A change in demand is different from a change in the quantity demanded, as *quantity demanded is a movement from one point to another point on a fixed demand curve because of a change in the product's price.*

How is change in supply different from change in the quantity supplied?

A shift to the right is an increase in supply; a shift to the left is a decrease in supply. In contrast, a change in the price of the product being considered causes a change in the quantity supplied, which is shown as a movement from one point to another point on a fixed supply curve.

Explain how demand can change

Market demand curves are found by adding horizontally the demand curves of the many individual consumers in the market. Changes in one or more of the determinants of demand (*consumer tastes* , *the # of buyers in the market* *the prices of related goods* , *the income of consumers* , *and consumer expectations*) shift the market demand curve.

Characterize and give examples of markets.

Markets bring buyers and sellers together. Some markets are local, others international. Some have physical locations while others are online. It is where large numbers of buyers and sellers come together to buy and sell standardized products. All such markets involve demand, supply, price, and quantity, with price being "discovered" through the interacting decisions of buyers and sellers.

Substitute Good

One that can be used IN PLACE OF another good - a change in the price of a related good may either - examples are: Haagen Dazs ice cream v. Ben & Jerry's, Colgate v. Crest, Nikes v. Reeboks - an INCREASE in the price of one will INCREASE the demand for another.

Complementary Good

One that is used TOGETHER with another good - examples are: computers and software, cell phones and cellular service - if the price of a complement goes UP, the demand for the related good will DECLINE.

Describe supply.

Supply is a schedule or curve showing the amounts of a product that producers are willing to offer in the market at each possible price during a specific period. *The law of supply states that, other things equal, producers will offer more of a product at a high price than at a low price.* Thus, the relationship between price and quantity supplied is positive or direct, and supply is graphed as an UPSLOPING curve.

Change in Quantity Demanded

a MOVEMENT from one point to another point (from one price-quantity combination to another) on a fixed demand curve. -occurs because of an increase or decrease in the PRICE of the product under consideration

Change in Demand

a SHIFT of the demand curve to the RIGHT (increase in demand) or to the LEFT (decrease in demand) -occurs because the consumers' state of mind about purchasing the product has been altered in response to a change in one or more of the determinants of demand.

Price Floor

a minimum price fixed by the government. -a price floor at or above the price floor is legal; -a price below it is not.

Change in Quantity Supplied

a movement from one point to another on a fixed supply curve.

Identify what government-set prices are and how they can cause product surpluses and shortages.

a price ceiling is a MAXIMUM PRICE set by government and designed to help consumers. Effective Price ceilings produce persistent product shortages, and if an equitable distribution of the product is sought, government must ration the product to consumers. a price floor is a MINIMUM price set by government and is designed to aid producers. Effective price floors lead to persistent product surpluses; the government must either purchase the product or eliminate the surplus by imposing restrictions on production or increasing private demand. Legally fixed prices stifle the rationing function of prices and distort the allocation of resources.

The Supply Curve

corresponds with the price-quantity supplied data. 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.