Principle of Economics Brief Chapter 3
What is a change in demand?
A shift of the entire demand curve.
What is a change in supply?
A shift of the entire supply curve.
Who first described Supply and Demand?
British economist Alfred Marshall.
Factors that shift supply curves
Input prices Technology Weather Expectations of future price changes Change in the number of sellers
What is excess demand?
The amount by which quantity demanded exceeds quantity supplied when the price of a good lies below the equilibrium price.
What is buyer's surplus?
The difference between the buyer's reservation price and the price he or she actually pays.
What is a seller's reservation price?
The smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to the marginal cost.
Markets and Social Welfare Recap
When the supply and demand curves for a good reflect all significant costs and benefits associated with the production and consumption of that good, the market equilibrium will result in the largest possible economic surplus. But if people other than buyers benefit from the good, or if people other than sellers bear costs because of it, market equilibrium need not result in the largest economic surplus.
Four Rules that govern the effect of Supply and Demand Shifts
*An increase in the demand will lead to an increase in both the equilibrium price and quantity *A decrease in demand will lead to a decrease in both the equilibrium price and quantity *An increase in supply will lead a decrease in the equilibrium price and an increase in the equilibrium quantity *A decrease in supply will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity.
What is the definition of equilibrium?
A balanced or unchanging situation in which all forces at work within a system are canceled by others.
What is efficiency (economic efficiency)?
A condition that occurs when all goods and services are produced and consumed at their respective socially optimal levels.
What is a supply curve?
A supply curve is a schedule or graph showing the quantity of a good that sellers wish to sell at each price. Supply curves are upward sloping in respect to price. The upward slope may be seen as the consequence of the Low Hanging Fruit Principle because as we expand production we turn first to those whose opportunity cost is lowest, and only then to others with a higher opportunity cost.
The Efficiency Principle
Efficiency is an important social goal because when the economic pie grows larger, everyone can have a larger slice.
Market Equilibrium Recap
Market equilibrium, the situation in which all buyers and sellers are satisfied with their respective quantities at the market prices, occurs at the intersection of the supply and demand curves. The corresponding price and quantity are called the equilibrium price and the equilibrium quantity. Unless prevented by regulation, prices and quantities are driven toward their equilibrium values by the actions of buyers and sellers. If the price is initially too high, so that there is excess supply, frustrated sellers will cut their price in order to sell more. If the prices is initially too low, so that there is excess demand, competition among buyers drives the price upward. This process continues until equilibrium is reached.
What is excess supply?
The amount by which quantity supplied exceeds quantity demanded when the price of a good exceeds the equilibrium price.
What is a demand curve?
A demand curve is a schedule or graph showing the quantity of a good that buyers wish to buy at each price. A demand curve is downward sloping on a graph with respect to price. A price increase causes the quantity demanded to drop as buyers will substitute the good for another one (substitution effect) or if the buyer can just cannot afford as many of the good because of lower purchasing power. (income effect). The downward slope reflects the fact that the reservation price of the marginal buyer declines as the quantity of the good bought increases.
What is an inferior good?
A good whose demand curve shifts leftward when the incomes of buyers increase and rightward when the incomes of buyers decrease. Having less money means the demand for an inferior good increases.
What is a normal good?
A good whose demand curve shifts rightwards when the incomes of buyers increase and leftwards when the incomes of buyers decrease. Having more money means demand for a normal good increases.
The Equilibrium Principle (also called No Cash on the Table Principle)
A market in equilibrium leaves no unexploited opportunities for individuals but may not exploit all gains achievable through collective action.
What is a change in the quantity demanded?
A movement along the demand curve that occurs in response to a change in price.
What is a change in the quantity supplied?
A movement along the supply curve that occurs in the response to a change in price.
What does the term "cash on the table" mean?
Economic metaphor for unexploited gains from exchange. When people have failed to take advantage of all mutually beneficial exchanges, we often say that there is cash on the table.
Factors that shift Supply Recap
Factors that cause an increase (rightward or downward shift) in supply: 1. A decrease in the cost of materials, labor, or other inputs used in the production of the good or service. 2. An improvement in technology that reduces the cost of producing the good or service. 3. An improvement in the weather (especially for agricultural). 4. An increase in the number of suppliers. 5. An expectation of lower prices in the future. ***When these factors move in the opposite direction, supply with shift left/upward.
Factors that shift Demand Recap
Factors that cause an increase (rightward/upward shift) in demand: 1. A decrease in the price of complements to the good or service. 2. An increase in the price of substitutes for the good or service. 3. An increase in income (for a normal good). 4. An increase preference by demanders for the good or service. 5. An increase in the population of potential buyers. 6. An expectation of higher prices in the future. ***When these factors move in the opposite direction, demand will shift left/downward.
What is market equilibrium?
Market equilibrium occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price. A feature of private markets for goods and services is their automatic tendency to gravitate toward their respective equilibrium prices and quantities. This tendency is is a simple consequence of the Incentive Principle.
What is the income effect?
The change in the quantity demanded of a good that results because a change in the price of a good changes the buyer's purchasing power.
What is the substitution effect?
The change in the quantity demanded of a good that results because buyers switch to or from substitutes when the price of the good changes.
What is total surplus?
The difference between the buyer's reservation price and the seller's reservation price.
What is seller's surplus?
The difference between the price received by the seller and his or her reservation price.
What is a buyer's reservation price?
The largest dollar amount the buyer would be willing to pay for a good.
Demand and Supply Curve Recap
The market for a good consists of the actual and potential buyers and sellers of that good, For any given price, the demand curve shows the quantity that demanders would be willing to buy and the supply curve shows the quantity that suppliers of the good would be willing to sell. Suppliers are willing to sell more at higher prices (supply curves slope upward) and demanders are willing to buy less at higher prices (demand curves slope downward).
What is the definition of a market?
The market for any good consists of all buyers and sellers of that good.
What is the socially optimal quantity?
The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good. It is the level that the marginal cost and marginal benefit are the same.
What is equilibrium price and quantity?
The values of price and quantity for which quantity supplied and quantity demanded are equal. The equilibrium price and quantity for a good are where the supply and demand curve intersect.
What is a complement?
Two goods are complements in consumption if an increase in the price of one good causes a leftward shift in the demand curve for the other (or if a decrease causes a rightward shift). Price goes up of one good, demand goes down for the other. Complements are goods that are more valuable used in combination than when used alone.
What are substitutes?
Two goods are substitutes in consumption if an increase in the price of one causes a rightward shift in the demand curve for the other (or if a decrease causes a leftward shift). In many applications, substitutes serve similar functions for people. If the price of one goes up, the demand for the other goes up (because the demand for the original went down due to price increase).
