Chapter Introduction Section 1: Demand Section 2: The Demand Curve and Elasticity of Demand Section 3: The Law of Supply and the Supply Curve Section 4: Putting Supply and Demand Together Visual Summary 1. Scarcity is the basic economic problem that requires people to make choices about how to use limited resources. 2. Buyers and sellers voluntarily interact in markets, and market prices are set by the interaction of demand and supply. In this chapter, read to learn about how the relationship between supply and demand sets the prices you pay for goods and services. Section Preview In this section, you will learn about the law of demand and how it affects choices you make. Content Vocabulary • demand • real income effect • supply • substitution effect • market • utility • voluntary exchange • marginal utility • law of demand • law of diminishing marginal utility • quantity demanded Academic Vocabulary • analysis • alternate Can you define the word demand? A. Yes B. No A. A B. B 0% B A 0% The Marketplace In a market economy, buyers and sellers set prices. The Marketplace (cont.) • In a market economy, consumers collectively have a great deal of influence on prices of all goods and services. • The demand of a good or service creates supply. • A market represents the freely chosen actions between buyers and sellers. The Marketplace (cont.) • In a market economy, individuals decide for themselves the answers to: – What? – How? – For Whom? The Marketplace (cont.) • A market economy is based on the principle of voluntary exchange. – Supply and demand analysis is a model of how buyers and sellers operate in the marketplace. Which type of market do you feel you use the most? A. Stores B. Services C. Entertainment D. Internet shopping 0% A A. B. C. 0% D. B A B C 0% D C 0% D The Law of Demand The law of demand states that as price goes up, quantity demanded goes down, and vice versa. The Law of Demand (cont.) • The law of demand explains consumer reactions to changing prices in terms of the quantities demanded of a good or service. There is an inverse or opposite relationship between quantity demanded and price. View: The Law of Demand The Law of Demand (cont.) • Several factors explain the inverse relation between price and quantity demanded, or how much people will buy of any item at a particular price. • Factors include: – Real income effect – Substitution effect The Law of Demand (cont.) • Diminishing marginal utility: – Utility – Marginal utility – Law of diminishing marginal utility Do you feel that the law of demand benefits you as a shopper? A. Always B. Sometimes 0% C A 0% A. A B. B C.0%C B C. Never Section Preview In this section, you will learn more about the relationship between price and demand. Content Vocabulary • demand schedule • demand curve • complementary good • elasticity • price elasticity of demand • elastic demand • inelastic demand Academic Vocabulary • visual • concept • specific Do you feel that a demand for certain items changes quickly? A. Always B. Sometimes 0% C A 0% A. A B. B C.0%C B C. Never Graphing the Demand Curve A demand curve is a graph that shows the relationship between the price of an item and the quantity demanded. Graphing the Demand Curve (cont.) • Economist can show the relationship between a change in quantity demanded and a change in demand using a demand curve. View: Graphing the Demand Curve Graphing the Demand Curve (cont.) • A demand schedule is a table reflecting quantities demanded at different possible prices. • A demand curve shows the quantity demanded of a good or service at each possible price. Demand curves slope downward, clearly showing the inverse relationship. Does looking at a table or graph help you understand the law of demand? A. Definitely B. Somewhat 0% C A 0% A. A B. B C.0%C B C. Not at all Determinates of Demand A change in the demand for a particular item shifts the entire demand curve to the left or right. Determinates of Demand (cont.) • Factors that can affect demand for a specific product or service: – Changes in population – Changes in income – Changes in people’s tastes and preferences View: If Population Increases View: If Income Decreases View: If Preferences Change Determinates of Demand (cont.) – The availability and price of substitutes – The price of complementary goods • The decrease in the price of one good will increase the demand for its complementary. View: If Price of Substitute Decreases View: If Price of Complement Decreases A change in the demand of a product shifts the demand curve which way? A. Up and down B. Horizontally C. Left and Right D. Vertically 0% A A. B. C. 0% D. B A B C 0% D C 0% D The Price Elasticity of Demand Elasticity of demand measures how much the quantity demanded changes when price goes up or down. The Price Elasticity of Demand (cont.) • For some goods, a rise or fall in price greatly affects the amount people are willing to buy. This economic concept is referred to as elasticity. • The measure of how much consumers respond to a given change in price is referred to as price elasticity of demand. View: Demand vs. Quantity Demanded View: Goods with… The Price Elasticity of Demand (cont.) • Luxury items, vacations, high-end electronics, even coffee are examples of elastic goods/services and have a very elastic demand. • Staple foods, medicine, spices have an inelastic demand. A price change has little impact on the quantity demanded by consumers. View: Elasticity of Demand The Price Elasticity of Demand (cont.) • Three factors determine the price elasticity of demand for an item: – The existence of substitutes – The percentage of a person’s total budget devoted to the purchase of that good – The time consumers are given to adjust to a change in price View: What Affects Demand Elasticity? A vacation to Australia is an example of which type of demand? A. Elastic B. Inelastic A. A B. B 0% B A 0% Section Preview In this section, you will learn more about the relationship between price and supply. Content Vocabulary • law of supply • quantity supplied • supply schedule • supply curve • technology • law of diminishing returns Academic Vocabulary • incentive • impose Can you explain the law of supply? A. Yes B. Somewhat C. Not at all 0% C B A 0% A. A B. B C.0%C Profits and the Law of Supply The law of supply states that as price goes up, quantity supplied goes up, and vice versa. Profits and the Law of Supply (cont.) • To understand pricing, you must look at both demand and supply. • The law of supply states that as the price of a good rises, the quantity supplied also rises. As the price falls, the quantity supplied also falls. – The higher the price of a good, the greater the incentive is for a producer to produce more. View: The Law of Supply A higher price on an item serves what type of purpose for the producer? A. It returns higher revenues from sales. B. It covers the costs of producing more. E. A & C 0% 0% 0% E A B C D E D A D. A & B 0% B 0% A. B. C. D. E. C C. It allows them to save money for the next product. The Supply Curve A supply curve is a graph that shows the relationship between price and quantity supplied. The Supply Curve (cont.) • The law of supply can also be shown visually using a supply schedule and a supply curve. View: Graphing the Supply Curve The Supply Curve (cont.) • A supply schedule is a table showing quantities supplied at different possible prices. • The supply curve is an upward-sloping line that shows in graph form the quantities producers are willing to supply at each possible price. According to the supply curve, what is the relationship between price and quantity supplied? A. Direct B. Inverse A. A B. B 0% B A 0% The Determinants of Supply A change in the supply of a particular item shifts the entire supply curve to the left or right. The Determinants of Supply (cont.) • Many factors affect the supply of a specific product. Four of the major determinants are: – The price of inputs – The number of firms in the industry – Taxes imposed or not imposed View: If Inputs Become Cheaper View: If Number of Firms Increases View: If Taxes Increase The Determinants of Supply (cont.) – Technology • Any improvement in technology will increase supply. View: If Technology Improves Production Which way will the supply curve shift if there is an increase in supply? A. Right B. Left C. Up D. Down 0% A A. B. C. 0% D. B A B C 0% D C 0% D The Law of Diminishing Returns When a business wants to expand, it has to consider how much expansion will really help the business. The Law of Diminishing Returns (cont.) • Will product output continue to increase proportionally as more workers are hired? • The law of diminishing returns shows that as more units of a factor of production are added to the other factors of production, after a certain point, the extra output for each additional unit hired will begin to decrease. View: Supply vs. Quantity Supplied View: Diminishing Returns Have you ever noticed a change in a restaurant that started small but decided to expand? A. A big change B. A medium change 0% C A 0% B C. No change at all A. A B. B C.0%C Section Preview In this section, you will learn about how supply and demand interact to affect prices and about restrictions the government sometimes places on this process. Content Vocabulary • equilibrium price • shortage • surplus • price ceiling • rationing • black market • price floor Academic Vocabulary • assume • eliminate Do you know why shortages in supply might occur? A. Yes B. Somewhat 0% C A 0% A. A B. B 0% C. C B C. Not really Equilibrium Price In free markets, prices are determined by the interaction of supply and demand. Equilibrium Price (cont.) • Demand and supply operate together. As the price of a good goes down, the quantity demanded rises and the quantity supplied falls (and vice versa). • The point at which the quantity demanded and quantity supplied meet is called the equilibrium price. View: Equilibrium Price View: Change in Equilibrium Price When the supply or demand curves shift, the equilibrium price also changes. A. True B. False A. A B. B 0% B A 0% Prices as Signals Under a free-enterprise system, prices function as signals that communicate information and coordinate the activities of producers and consumers. Prices as Signals (cont.) • Rising prices signal producers to produce more and consumers to purchase less. • Falling prices signal producers to produce less and consumers to purchase more. • A shortage occurs when at the current price, the quantity demanded is greater than the quantity supplied. • Prices above the equilibrium price reflect a surplus to suppliers. Prices as Signals (cont.) • When a market economy operates without restriction, it eliminates shortages and surpluses. – When a shortage occurs, the price goes up to eliminate the shortage. – When surpluses occur, the price falls to eliminate the surplus. If a company didn’t make enough of a certain shoe, and the demand for it was high, what would happen to the price? A. It would increase. A 0% 0% C C. It would stay the same. A. A B. B 0% C. C B B. It would decrease. Price Controls Under certain circumstances, the government sometimes sets a limit on how high or low a price of a good or service can go. Price Controls (cont.) • The government sometimes gets involved in setting prices if it believes such measures are needed to protect consumers and suppliers. Price Controls (cont.) • A price ceiling is a government-set maximum price that may be charged for a particular good or service. – Effective price ceilings, and resulting shortages, often lead to non-market ways of distributing goods and services such as rationing and leading to the black market. View: Price Ceilings and Price Floors Price Controls (cont.) • Conversely, a price floor, is a government-set minimum price that can be charged for goods and services. Do you feel that the government should be able to intervene in the market? A. Always B. Sometimes 0% C A 0% A. A B. B 0% C. C B C. Never The law of demand states that as price goes up, quantity demanded goes down. As price goes down, quantity demanded goes up. The law of supply states that as price goes up, quantity supplied also goes up. As price goes down, quantity supplied goes down. The point at which the quantity demanded and the quantity supplied meet is called the equilibrium price. Economic Concepts Transparencies Transparency 8 Supply and Demand Select a transparency to view. demand: the amount of a good or service that consumers are able and willing to buy at various possible prices during a specified time period supply: the amount of a good or service that producers are able and willing to sell at various prices during a specified time period market: the process of freely exchanging goods and services between buyers and sellers voluntary exchange: a transaction in which a buyer and a seller exercise their economic freedom by working out their own terms of exchange law of demand: economic rule stating that the quantity demanded and price move in opposite directions quantity demanded: the amount of a good or service that a consumer is willing and able to purchase at a specific price real income effect: economic rule stating that individuals cannot keep buying the same quantity of a product if its price rises while their income stays the same substitution effect: economic rule stating that if two items satisfy the same need and the price of one rises, people will buy more of the other utility: the ability of any good or service to satisfy consumer wants marginal utility: an additional amount of satisfaction law of diminishing marginal utility: rule stating that the additional satisfaction a consumer gets from purchasing one more unit of a product will lessen with each additional unit purchased demand schedule: table showing quantities demanded at different possible prices demand curve: downward-sloping line that shows in graph form the quantities demanded at each possible price complementary good: a product often used with another product elasticity: economic concept dealing with consumers’ responsiveness to an increase or decrease in the price of a product price elasticity of demand: economic concept that deals with how much demand varies according to changes in price elastic demand: situation in which a given rise or fall in a product’s price greatly affects the amount that people are willing to buy inelastic demand: situation in which a product’s price change has little impact on the quantity demanded by consumers law of supply: economic rule stating that price and quantity supplied move in the same direction quantity supplied: the amount of a good or service that a producer is willing and able to supply at a specific price supply schedule: table showing quantities supplied at different possible prices supply curve: upward-sloping line that shows in graph form the quantities supplied at each possible price technology: the use of science to develop new products and new methods for producing and distributing goods and services law of diminishing returns: economic rule that says as more units of a factor of production are added to other factors of production, after some point total output continues to increase but at a diminishing rate equilibrium price: the price at which the amount producers are willing to supply is equal to the amount consumers are willing to buy shortage: situation in which the quantity demanded is greater than the quantity supplied at the current price surplus: situation in which quantity supplied is greater than quantity demanded at the current price price ceiling: a legal maximum price that may be charged for a particular good or service rationing: the distribution of goods and services based on something other than price black market: “underground” or illegal market in which goods are traded at prices above their legal maximum prices or in which illegal goods are sold price floor: a legal minimum price below which a good or service may not be sold To use this Presentation Plus! product: Click the Forward button to go to the next slide. 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