Economics Unit 2
How the Market Works!
Chapter 4: Demand
Chapter 5: Supply
Chapter 6: Prices
Understanding Demand

Demand
–

the desire to own
something and the ability
to pay for it
Law of Demand
–
consumers buy more of
a good when its price
decreases and less
when its price increases.
Effects on Demand

Substitution effect
–
when consumers react to
an increase in a goods
price by consuming less
of that good and more of
other goods


hybrid cars
Income Effect
–
the change in
consumption resulting
from a change in real
income

lottery winner
Demand Curve
What Can Change Your Demand?

Change in Income
–
Normal Good- a good
that consumers demand
more of when incomes
increase

–
More steak, less
hamburger
Inferior Good- a good
that consumers demand
less of when their
incomes increase

Less Ramen Noodles,
more progressive soup
What will shift the demand curve?




Income
Consumer expectations
Consumer tastes and advertising
Price of related goods
What will shift the demand curve?
1.
Income

2.
Consumer expectations


3.
Will the price rise today, or tomorrow?
Will the price fall today, or tomorrow?
Consumer tastes and advertising

4.
What % of your income will you spend on something?
What is popular today?
Price of related goods


What is the price of gas?
What is the price of cable for your television?
What Can Change Your Demand?

Price of Related
Goods
–
Complements-two
goods are bought and
used together




–
Ski’s
Boots
Poles
Bindings
Substitutes-goods
used in place of one
another

Ski’s and snowboards
Supply

Supply
–

the amount of available
goods
law of supply
–
tendency of suppliers to
offer more of a good at a
higher price
Cost of Production

Marginal Product of labor
–
Marginal Product of Labor (5.6) is the change in
output from hiring one more worker (increases,
decreases).
Marginal Product of Labor
Labor (# of workers)
1
2
3
4
5
6
7
8
Marginal Product
4
10
17
23
28
31
32
31
Output
4
6
7
6
5
3
1
-1
Cost of Production



Increasing Marginal Return
– is the level of production in which the marginal
product of labor increases as the number of
workers increase.
Diminishing Marginal Return
– is the level of production in which the marginal
production of labor decreases as the number of
workers increases.
 Capital MUST EQUAL Labor
Negative Marginal Returns
–
reverses the productivity of the operation (workers in each
others way).
Cost of Production

Fixed Cost
–
a cost that does not
change, no matter how
much of a good is
produced






Rent
Machinery repairs
Property taxes
Salaried workers
– Manager
Desks
Chairs
Cost of Production

Variable Cost
–
a cost that rises and
falls depending on how
much is produced





Electricity
Heat bills
Capital to produce the
goods
Office supplies
– Paper
– Pens and pencils
Hourly workers
Cost of Production

Total Cost – fixed cost plus variable cost
–

The amount of money required to run the firm
Marginal Cost – the cost of producing one
more unit of a good (5.9)
–
–
With beanbags – lower with specialties of the 1st
and 3rd, then increases
More workers --- fixed production Facility
Setting Output

How many employees to hire?
–

Remember, goal is to maximize profits!
Highest profit? Total Revenue /vs/ Total
Costs
Setting Output

Marginal Revenue and Marginal Cost
–
Marginal Revenue

is an additional income from selling one more unit of a
good; sometimes equal to the price.
***The ideal level of output is when marginal
revenue
equals marginal cost.
The Shut Down Decision

When do you shut down an operation facility?
–
–

variable costs – costs when the facility is up and
running.
fixed costs – owner pays whether the factory is
open or closed.
Stay open if the benefit of operating (total
revenue) is greater than the variable costs!!!
–
Total Revenue > Variable Costs
Chapter 6 Prices

Section 1 Objective:
–

Section 2 Objective:
–

to identify the nature of prices in regards to
supply/demand
to identify how change in the market affects
equilibrium
Section 3 Objective:
–
to identify the role of prices.
Combining Supply and Demand

Balancing the Market
Buyers and Sellers
=
Demand and Supply
Equilibrium (market clearing)
Defining Equilibrium

Equilibrium -the point at which quantity
demanded and quantity supplied are equal.
–

At equilibrium, the market for a good is stable
Disequilibrium – occurs when the quantity
supplied is not equal to quantity demanded.
–
every price that is not at equilibrium is at
disequilibrium!
Disequilibrium

Excess Demand – is
when the quantity
demanded is more
than the quantity
supplied.
1.
2.
low prices encourage
excess demand
as long as there is
excess demand,
suppliers will keep
raising the price until
the market cannot
handle it.
Disequilibrium

Excess Supply – is
when the quantity
supplied is more
than the quantity
demanded.
–
sellers do not like to
waste their
resources on excess
supply, especially
when the excess
cannot be stored.
Changes in Market Equilibrium

Changes in Price
–
market wants equilibrium price and quantity



Excess demand leads to higher prices.
Higher prices lead to rising supply and quantity
demanded to fall.
Excess supply will cause price cuts and quantity
demand to rise
Changes in Market Equilibrium

Shifts in the supply curve
–
–
–
–
advances in technology
new government taxes/subsidies
changes in the prices of raw materials and labor
a shift in the supply curve will create a new
equilibrium
Changes in Market Equilibrium

Understanding a shift in supply
– Early 1980s – CD player cost $1000
– In 1987 – CD player cost $300
– Today – CD player costs ???
 Machines today have more feature and are
better than the machines of the early 1980s
 Also, the price to produce and manufacture
has gone down, so this passes on the
savings to us.
– Demand is also not as high, either.
Changes in Market Equilibrium

Finding a New Equilibrium
–
Surplus – situation in which quantity supplied is
greater than quantity demanded; also, known as
excess supply


Excess supply will lead to decreased prices, which will
lead to an increase in demand.
Changing Equilibrium
–
Equilibrium changes as the market conditions
change (demand/supply).

Sales, Rebates, Price Changes
Changes in Market Equilibrium

Problem of Excess Demand
– Ipod’s or PS3’s

Shortage
–

situation in which quantity demanded is greater
than quantity supplied.
Search Costs
–
the financial and opportunity costs consumers pay
when searching for a good or service.
The Role of Prices

Prices in the Free Market 
–

The Advantages of Prices 
–

gives the consumer choices (bartering)
Price as an incentive can cause consumers to buy more,
which can cause producers to make more.
Prices as Signals
–
–
At low prices, people buy………at high prices, people tend
not to buy.
Low prices tend to slow production, whereas high prices
increase production
The Role of Prices

Flexibility
1.
2.
3.
Prices are more flexible than output levels.
(Short/Long Run)
Supply Shock – is a sudden shortage of a good
(excess demand).
Rationing – is dividing up goods or services
using criteria other than price.
*this can be expensive and time consuming
The Role of Prices

Price System is “Free”
–

Rationing and Shortages
–
–

The market can control prices without the use of
government
Former Soviet Union /vs/ The United States
Communism /vs/
Wartime
Black Market – is a market in which goods
are sold illegally
–
Ex: Stealing TV's and Selling them

Importing Illegal OR Prescribed Drugs and selling them