Unit 2Microeconomics: Prices and Markets
Chapters 4-7
1
Unit 2 Chapters
 This unit covers:
 4.1
 4.2
 4.3
 5.1
 5.2
 6.1
 6.2
Supply and Demand
Chapter 4
Section 1
3
An Introduction to Demand
 DEFINED: Demand is the desire, ability, and willingness to buy a
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

4
product.
Knowing the concept of demand is really essential to learning how
a market economy works. Knowledge of it is important sound
business planning.
It’s impossible to determine WHAT, HOW, and FOR WHOM to
produce something if you don’t know if anyone wants it, or what
they want.
Demand is consumer-based.
An Individual Demand Curve illustrates how the quantity that a
person will demand varies, depending upon the price of a good or
service.
Example on Page 92 (Figure 4.1)
Second Example
 Demand Schedule for Taco Bell Tacos –
5
Price ($)
Quantity Demanded by Bill
$5
0
$4
0
$3
1
$2
2
$1
4
$0.50
6
Demand Curve for Taco Bell Tacos
Demand Curve for Taco Bell Taco’s
$5
$4
$3
Cost of Taco’s
$2
$1
0
1
2
3
Quantity Demanded By Bill
6
4
5
6
The Demand Curve
 Economists analyze demand by listing prices and desired
quantities in a demand schedule (chart). When the
demand data is graphed, it forms a demand curve with a
DOWNWARD slope.
 QUESTION: Another example. Think of something you
want to buy. Think of the price? At what price would you
be willing to buy the item?
7
The Law of Demand
 (Pages 93-94)
 Defined: The Law of Demand states that the quantity
demanded of the good or service varies INVERSELY with the
price.
 When the price goes up, the quantity demanded goes down.
 When the price goes down, the quantity demanded goes up.
(Think big sale).
 A market demand curve illustrates how the quantity that all
interested persons’ (THE MARKET) demand varies depending upon
the price of a good or service.

8
GRAPH ON PAGE 94 (Figure 4.2)
Market Demand Curve
 Adding Sarah and Greg to the taco chart gets the MARKET DEMAND
CURVE. See below:
9
Price ($)
Quantity
Demanded
by Bill
Quantity
Demanded
By Sarah
Quantity
Demanded
by Greg
Total
$5
0
0
0
0
$4
0
0
0
0
$3
1
0
1
2
$2
2
1
2
5
$1
4
2
3
9
$0.50
6
3
4
13
Market Demand Curve for Taco Bell
Tacos
$5
Cost
for
Taco
$4
$3
$2
$1
0
1 23
4
5
6
7
8
9
10
11
Quantity Demanded By Market
10
12
13
Demand and Marginal Utility
 DISCUSSION QUESTION:
 Why is price an obstacle to buying?
 Demand and Marginal Utility (Page 93)
 Marginal Utility is the extra usefulness or satisfaction a person
receives from getting or using one or more unit of a product.
 Principle of diminishing marginal utility states that the satisfaction we
gain from buying a product lessens as we buy more of the same
product.
 The book gives the example of cola as an example of diminishing
marginal utility. Food does not always follow this path as strictly as
others
 Other examples include Xbox, cars (the same), shoes, etc
 http://www.youtube.com/watch?v=Cq7xP382FZg
11
Factors Affecting Demand
Chapter 4
Section 2
12
I. Change in the Quantity
Demanded
 The change in the quantity of demand shows a change in the
amount of the product purchased when there is a change in
price.
 Notice what happens to the quantity when $P goes up/down
Changes in Demand
 A change in demand is when people buy different amounts of a
product at the same prices.
 As a result the entire demand curve shifts to the right to show an
increase in demand
 OR to the left to show a decrease to in demand
 Thus creating an entirely new demand curve
Change in Demand (p. 99-102)
 A change in demand is when people buy different
amounts of a product at the same prices.
 A change in demand can be caused by changes in the
following:
 Income.
 If you get a raise you can afford more.
 If you lose your job, you can afford less.
 Tastes:
 In / Out of style
 Successful advertising.
 Bad PR hit (Milli Vanilli– lip syncing)
 Product becomes obsolete (Sony’s PlayStation lost customers to Xbox).
15
Substitutes and Complements
 A price change in a related product (substitutes)
 Coke/Pepsi; Butter/Margarine; Burger King/McDonalds –
those are substitutes.
 The demand for a product tends to increase if the price of its
substitute goes up and vice versa.
 A price change in a related product (complements)
 PS2s/Games; hot dogs/buns; DVDs/DVD players; etc.
 The use of one increases the use of the other.
 When price of one decreases, consumers buy more of both and
vice versa.
 QUESTION: What are some examples you can think of?
16
Income Effect
 Means that as prices drop, consumers are left with extra real
income. Vice Versa.
 How do people feel when the $P goes up?
A
B
Change in Demand
 Consumer expectations.
 Always deals with the way people think about the future.
 Stocking up before a big storm/hurricane.
 Choosing not to buy a product that may soon become
obsolete/improved upon:
 Waiting for PS3 instead of a cheaper PS2
 Waiting for 3D TV instead of buying plasma or LCD TV
 The number of buyers (consumers)
 More buyers, more total demand.
 Less buyers, less total demand.
18
Factors Affecting Demand
 On a piece of paper, list three “trendy” items that you
really wanted, dating back to 2004.
 Try to determine which of the factors related to demand
made them more or less desirable.
 Income
 Tastes:
 In/Out of style
 Successful advertising
 Bad PR hit
 Price change in related product (complement or substitute)
 Consumer expectations (future)
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 Number of buyers
Tastes
 In / Out of style
 http://www.washingtonpost.com/wp-
srv/artsandliving/features/2013/year-in-review/the-list.html
 Successful advertising.
 Bad PR hit (Milli Vanilli and now Brittney Spears in Australia
– lip syncing)
 http://www.youtube.com/watch?v=ovMNl0gGFNY
 Product becomes obsolete (Sony’s PlayStation 3 lost
customers to PlayStation 4).
4. Consumer Expectations
Always deals with the way people think about the
future.
• Examples:
 Stocking up before a big storm/hurricane.
 Choosing not to buy a product that may soon become
obsolete/improved upon:
 Waiting for PS3 instead of a cheaper PS2
 Waiting for 3D TV instead of buying plasma or LCD TV
5. Number of Consumers
 More buyers, more total demand.
 Less buyers, less total demand.
McDonald’s Makeover
 Why would McDonald’s go to the trouble AND expense of
redesigning its restaurant?
 http://www.youtube.com/watch?v=x32XrepgKvw
McDonald’s Makeover
 The company recognizes that the consumer demand is
changing.
 Which means the company has to change too
 Or What?
McDonald’s Makeover
 Risk losing business to competitors that meets customer
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demands
Such changes in demand have an effect on both the demand
schedule AND the demand curve
When it comes to demand – there are two types of changes
1. Price Changes while all other factors are the same
OR
2. Other factors change while the price stays the same
In the case of McDonald’s what are some of these “other
factors?”
 1. If the price goes from $20 to 12.50, how much money am
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I saving?
2. How might that make me feel?
3. What might I do with the extra savings?
4. Might this savings account for movement along the
demand curve?
5. What happens in the opposite scenario?
6. Are there any real world examples you can think of?
 Both Income Effect and Substitution Effect affects
movement along the demand curve.
 The change in quantity demanded can either be an increase
or decrease
 BUT the demand curve itself does not shift
Elasticity of Demand
Chapter 4
Section 3
28
Focus Question
 Why do governments tend to tax items like gas,
cigarettes and alcohol more heavily than things
like vegetables or red meat?
 This is where we get deeper into the cause and effect
relationship in economics.
29
Group Activity
 Groups of 4: (5 mins)
 List four things you purchase regular units of every
week/month (example: gas).
 Write your list up on the board
 QUESTION TO CLASS:
 How much do you spend on each item?
 Are your purchases dependent upon price?
30
Dependent vs. Independent Variable
 http://www.youtube.com/watch?v=urQnwlm4F88
 Elasticity tells us how a dependent variable – such as quantity
demanded, responds to a change in an independent variable –
such as price.
Elasticity
 Elasticity is a general measure of responsiveness; it tells
us how a dependent variable – such as quantity
demanded, responds to a change in an independent
variable – such as price.
 Explaining dependant and independent:
 If you have 20 iPods ordered by a group of people, that number
is pretty concrete. We know that only 20 iPods were ordered.
 Conversely, the price is an independent variable. It’s set by the
supplier, and can be arbitrary – meaning anything the supplier
wishes to order.
 Other measures, such as income or supply can also be
32
understood in terms of elasticity.
Elastic Demand Vs Inelastic Demand
Elastic Demand
 Economists say that the demand is elastic when a given
change in price causes a relatively larger change in quantity
demanded.
A
B
Elasticity
 Consumers react to a change in the price of a good by
changing the amount they demand. Of course, the size of
the reaction – either higher or lower, and to what degree
– can vary.
 This response is known as demand elasticity.
 The difference between ELASTIC and
INELASTIC.
 When the quantity demanded for a good / service changes as a
result of the price change, then the demand for that good is
considered “ELASTIC”
35
Reasons for Elasticity
 Availability of Good Quality Substitutes:
 Easily substitutable goods will enable buyers to switch to an
alternative good and thus such goods will exhibit greater
elasticity than goods that do not have substitutes available.
 The better the substitute(s) can replace the original good in
terms of desirability, affordability, practicality etc. the more
elastic the good will become.
 A contrasting inelastic good would be water which is nonsubstitutable so a local community faced with rising water costs
will be left with little choice but to pay the increased costs.
 Goods and services for which no substitutes exist are
generally inelastic.
36
Reasons for Elasticity
 Whether the good is habit forming or obligatory:
 Addictive drugs, whether psychologically addictive or physically
 Goods where dependency plays a key role will naturally exhibit
inelastic properties. Classic examples of such goods would be
gasoline, alcohol and tobacco or in an extreme case, heroin.
 Governments often place taxes on these types of goods,
because of their highly inelastic demand since
consequently such goods are assured revenue generators.
 (GRAPHS ON PAGES 104-105.)
37
How do you determine Elasticity of
Demand?
 Demand Elasticity – also known as PED – price
elasticity of demand is determined by a number of
factors that essentially all fall under the umbrella of
"choice".
 By choice we mean the power of choice that the consumer of a
given good holds to give up the consumption of said good. How
easy is it to give that item up and not buy it at all, or buy a
substitute?
 The greater this choice the more price elastic the good will be
and, by contrast, as the balance of this power falls in favor of the
supplier the more inelastic the good will be.
38
Perceived Value
 Perceived Value represents the absolute maximum
price a consumer is willing to pay for a good. When the
price exceeds this level, the consumer will give up
consumption of this good.
 Why aren’t more people dropping Verizon and AT&T and
switching to T-Mobile and Sprint for cellular phone service
when their pricing is so much better?
39
Perceived Value
 The proportion of the consumer's income the
good represents:
 Goods which typically make up a small proportion of people's
income will exhibit inelastic qualities. Conversely, goods which
form a large proportion of people's income will cause greater
responses in demand to comparable % increases or decreases in
price.
 For example, if cinema ticket costs rise by 20%, decreases in demand are
unlikely to be pronounced.
 However a 15% drop in a "luxury" good such as a car or LCD Television
changes in demand are likely to be relatively greater.
40
Perceived Value
 How closely the good is defined:
 Taking our example from (# 2), cigarettes in general are, as
discussed, an inelastic good. However a particular brand of
cigarettes will exhibit far more elastic properties if its price
rises. In general therefore, the exact type of good will affect its
PED properties.
41
Perceived Value
 How closely the consumer (end-user) is
defined?:
 “Choice" is very subjective and factors 1,2 and 3 vary relative to
42
the individual consumer because every single consumer can
potentially have a different Perceived Value of a good.
 At nationwide level, if the cost of butter rises significantly
consumers can choose to consume margarine instead but a shop
who makes and sells butter cookies will not have this option and
thus the PED will be far more inelastic in the latter case.
 A driver faced with rising gas bills may opt to switch to using
the train. However an airline company has no choice but to
absorb rising fuel costs and will accordingly have a much more
inelastic demand curve for essentially the same good.
Perceived Value
 How closely the time period is defined:
 The greater the time period, the more possible it may be for a good
to be replaced with a substitute.
 Using home energy as an example, a gas user faced with rising gas
bills will unlikely be able to switch to electric alternatives overnight.
However over three months, a switch is far more viable and the PED
will be accordingly more elastic.
 Likewise, prices are dynamic. Over short time periods, prices of
substitutes maybe static, over longer periods, the price of substitutes
may drop, making them more appealing.
43
What products can you think of where
the graph looks like this?
 A contrasting inelastic good would be water which is
arguably non-substitutable so a local community faced with
rising water costs will be left with little choice but to pay the
increased costs forming a price inelastic good.
Determining Elasticity- Without
Math
 CAN THIS PURCHASE BE DELAYED?
 If YES – elastic
 If no – inelastic
 What is the Availability of Good Quality
Substitutes?
 Easily substitutable goods will exhibit greater elasticity.
 Whether the good is habit forming or obligatory.
 Does the purchase use a large portion of
income?
 If amount is large, then demand tends to be elastic.
 If the amount is small, the demand tends to be inelastic.
46
Chapter 5: Supply
47
What is Supply?
Chapter 5
Section 1
48
Supply
• The concept of supply is based on voluntary decisions made
by producers (both big and small)
• A producer might decide to offer one amount for sale at one
price and a different quantity at another price
• Amount of a product offered for sale at all possible prices
(that could prevail in the market place)
Law of Supply
 Because producers receive payment for their products, they
will offer more at higher prices
 Principle that more will be offered for sale at higher prices
than at lower prices
 http://video.yahoo.com/watch/398277/2357614
Supply Schedule/Curve
 Is a listing of the various quantities of a particular product
supplied at all possible prices in the market.
Supply curve – a graph
Showing the various
Quantities supplied at
All possible prices
That might prevail in the
Market any given time
Law of Supply/Demand
 For the Law of Supply, quantity varies DIRECTLY with price,
rather than INVERSELY.
 OR
 It slopes in the opposite direction (of demand)
Individual and Market Supply Curves
•
Bill, Duane and Sarah are all babysitters. Each supplies their services on an hourly basis for a fee.
•
•
At $20 an hour, Bill will make himself available for 30 hours a week. At $15 an hour, he is still
willing to work up to 30 hours. At $12 an hour he is only available for 25 hours a week. At $10 an
hour, he is willing to work 20 hours a week. At $8 an hour, he’ll work 10 hours. At $5 an hour, he’ll
work five hours. And at $3 an hour, he would rather do homework and won’t work any hours.
•
•
At $20 an hour, Duane will make himself available for 20 hours a week. At $15 an hour, he is
willing to work up to 18 hours. At $12 an hour he is only available for 15 hours a week. At $10 an
hour, he is willing to work 10 hours a week. At $8 an hour, he’ll work 5 hours. At $5 an hour, he’ll
work 2 hours. And at $3 an hour, he too would rather do homework and won’t work any hours.
•
•
At $20 an hour, Sarah will make herself available for 30 hours a week. At $15 an hour, she is still
willing to work up to 30 hours. At $12 an hour she continues to be available for 30 hours a week.
At $10 an hour, she is willing to work 20 hours a week. At $8 an hour, she’ll work 15 hours. At $5
an hour, she’ll work 10 hours. And at $3 an hour, she’ll work 5 hours.
Individual Supply Schedule
Bill
Duane
Sarah
$ Price
Quantity
Supplied
$Price
Quantity
Supplied
$Price
Quantity
Supplied
$20
$15
$12
$10
$8
$5
$3
30
30
25
20
10
5
0
$20
$15
$12
$10
$8
$5
$3
20
18
15
10
5
2
0
$20
$15
$12
$10
$8
$5
$3
30
30
30
20
15
10
5
Market Supply Chart
$ Price
Quantity Supplied
$20
$15
$12
$10
$8
$5
$3
80
78
70
50
30
17
5
Graph of Market Supply Curve
$25
$20
A Change in the Quantity Supplied
Is the change in amount offered for sale in
Response to a change in price.
*
$15
*
*
$10
*
*
$5
*
*
0
10
20
30
40
50
60
70
80
Change in Supply
• Sometimes something happens to cause a change in supply
• A situation where suppliers offer different amounts of
products for sale at all possible prices in the market
• This is NOT the same as quantity supplied
• Why?
• Because we are looking at situations where the quantity
changes even though the price remains the same
Change in Supply
When both
old and new
quantities
are plotted
in the form
of a graph, it
appears as if
the supply
curve has
shifted to
the right,
showing an
increase in
supply
Why –
Determinants that Change Supply
Productivity
Cost of Resources
Land, labor, capital
Technology
Taxes and
Subsidies
Expectations
Government
Regulations
Number of Sellers
Elasticity of Supply
• Just as demand has elasticity, supply also has an elasticity
• Supply Elasticity is a measure of the way in which the
quantity supplied responds to a change in price
• If an increase in price leads to a proportionally larger
increase in output, supply is elastic
• If an increase in price causes a proportionally smaller change
in output, supply is inelastic
• Similar to elasticity we learned with demand – In
both cases, elasticity is simply a measure of the way
quantity adjusts to a change in price
Three Elasticities
 1. Elastic Supply
 2. Inelastic Supply
 3. Unit Elastic Supply
Elastic Supply
 The change in price causes a proportionally larger change in
quantity supplied
 I.E. Doubling the price from $1 to $2 causes the quantity
brought to market to triple from two to six units
Inelastic Supply
 In this case, a change in price causes a proportionally smaller
change in quantity supplied
 When the price doubles from $1 to $2, the quantity brought
to market goes up only 50 %, or from 2 units to 3.
Unit Elasticity
 A change in price causes a proportional change in quantity
supplied
 I.E. as the price doubles from $1 to $2, the quantity brought
to market also doubles.
• 1. Elastic Supply – EXAMPLES – toys, candy, and other
products that can be made quickly without huge amounts of
capital and skilled required.
• 2. Inelastic Supply – Nuclear power – No matter what price
is being offered , electric utilities will find it difficult to
increase output because of the huge amount of capital and
technology needed before nuclear production can be
increased.
• 3. Unit Elastic Supply
• Unlike demand elasticity – the number of substitutes has no
bearing on supply elasticity
• Instead only production considerations determine supply
elasticity
• If a firm can react quickly to a changing price, then supply is
likely to be elastic
• If it cannot then supply will be inelastic
Prices as Signals
6.1
What do you think when you see this
picture?
What do you think when you see this
picture now?
Brand new
32’ TV, $99
What do you think when you see this
picture now?
Brand new
32’ TV, $299
What do you think when you see this
picture?
What do you think when you see this
picture now?
Cheeseburger
only 99 ¢
What do you think when you see this
picture now?
Cheeseburger
only $25.99
Advantages of prices
 Prices are neutral
 Prices are flexible
 People understand prices
 No cost to administer
What to do without prices?
 Deals with the problem “For Whom to Produce”
 First come, first serve
 Corruption
 Rationing
Problems with Rationing
 Share is too small
 Administrative cost
 Negative impact on the incentive to produce
If Rationing is so bad, why do we do it?
Supply and Demand
6.1 & 6.2
Dynamic Pricing
 http://www.clipsyndicate.com/video/play/1477909/dyna
mic_ticket_pricing_gaining_traction_for_sports_video
 Kind of neat.
The Price System at Work
 The process of establishing a price can complicated because
buyers and sellers have opposite hopes and desires:
 Buyers want to find a great deal
 Sellers want to het high prices and make large profits
 Economists agree that as long as there is competition – prices
will be about right under a bidding system
The Price Adjustment Process
 Transactions in a market are voluntary
 Buyers and sellers both compromise to settle the differences
so they both gain some benefit
A Market Model
 Figure 6.1
 There is a market demand curve
 There is a market supply curve
 When both are put together on the same graph – you have a
“Market Model”
 Or some clue as to how buyers and sellers will find the price
that is mutually agreeable.
Equilibrium Curve
 The intersection of the two curves is called the
equilibrium price
 A “perfect price” – it is the place where no surplus will occur
and no shortage will occur either.
 This equilibrium price is arrived at through trial and error.
Market Demand and
Supply Schedule for
Flu Shots
Price
per Unit
Quantity
Demanded
Quantity
Supplied
$2
14,000
2,000
4
12,000
4,000
6
10,000
6,000
8
8,000
8,000
10
6,000
10,000
12
4,000
12,000
14
2,000
14,000
16
0
16,000
Surplus
Shortage
Surplus
 The quantity supplied is greater than the quantity demanded
 Suppliers must lower the price to sell the surplus
Shortage
 The quantity demanded is greater than the quantity supplied
at a given price
 The supplier realizes people might have been willing to spend
more because there was a shortage at the price being offered
 The supplier will raise the price and the supply to avoid a
shortage
Equilibrium Price
 The price “clears the market” – there is no surplus or
shortage
 The correct price that buyers and sellers can both “be happy
with”
II. Explaining and Predicting Prices
 Economists use market models to explain changes in prices
 Prices change due to:
 Change in supply – which can be caused by a change in:
 1. Cost of Resources
 2. Productivity
 3. Technology
 4. Taxes and/or Subsidy
 5. Expectations
 6. Government Regulations
 7. Number of Sellers
Change in Demand
 1. Income Effect
 2. The Substitution Effect
 3. A change in consumer income
 4. A change in consumer taste
 5. A change in the price of a complementary product
 6. A change in customer expectations (waiting for the latest
model)
 7. A change in the number of consumers
Changes in Both
 Prices and competitive markets
 Economists like to see competitive markets because that is when





the price system is most effective
Advantages of a competitive markets is they allocate resources
efficiently
A. Sellers compete to meet demand of customers – they have to
keep prices low
B. To keep their prices low – they have use their resources wisely –
watch their costs
C. Competition among buyers (to have what they want and need)
keep prices from falling too low.
A competitive market requires NO ONE to run it.