Definitions

1. Definitions • Supply and Demand: the name of the most important model in all economics • Price: the amount of money that must be paid for a unit of output • Market: any mechanism by which buyers and sellers negotiate price • Output: the good or service and/or the amount of it sold

2. Definitions (continued) • Consumers: those people in a market who are wanting to exchange money for goods or services • Producers: those people in a market who are wanting to exchange goods or services for money • Equilibrium Price: the price at which no consumers wish they could have purchased more goods at that price; no producers wish that they could have sold more • Equilibrium Quantity: the amount of output exchanged at the equilibrium price

3. Quantity Demanded and Quantity Supplied • Quantity demanded: how much consumers are willing and able to buy at a particular price during a particular period of time • Quantity supplied: how much firms are willing and able to sell at a particular price during a particular period of time

4. Markets • Capitalism • free markets in financial capital as well as goods and services • freedom to borrow or lend • profits go to the owners of capital • Communism • capital and the profit that it generates is controlled by a government authority. • a government authority decides how the money is used. • Socialism • a significant part of the profit generated by financial capital goes to government in the form of taxes. • a government uses the tax money to counter the wealth impacts of the distribution of profit.

5. Heritage Foundation Index of Economic Freedom (Most Free)

6. Heritage Foundation Index of Economic Freedom (Most Oppressed)

7. The Scientific Method and Ceteris Paribus • Scientists • conduct experiments in laboratories. • use replication and verification to ensure the accuracy of their conclusions. • Social Scientists • cannot experiment on their subjects. • must use models and look at the effects of individual variables within those models. • Economists • hold variables constant within models to examine the effect of other variables. • use the Latin phrase ceteris paribus which means “holding other things equal” to identify this is the case.

8. Demand and Supply • Demandis the relationship between price and quantity demanded, ceteris paribus. • Supply is the relationship between price and quantity supplied, ceteris paribus.

9. The Supply and Demand Model

10. The Demand Schedule • The Demand Schedule presents, in tabular form, the price and quantity demanded for a good.

11. Figure 1 The Demand Curve P $2.50 $2.00 $1.50 $1.00 $0.50 0 Q/t 0 10 20 30 40 50 Demand

12. The Supply Schedule • The Supply Schedule presents, in tabular form, the price and quantity supplied for a good.

13. Figure 2 The Supply Curve P $2.50 $2.00 $1.50 $1.00 $0.50 0 Q/t 0 10 20 30 40 50 Supply

14. Equilibrium, Shortages, and Surpluses • Equilibrium is the point where the amount that consumers want to buy and the amount that firms want to sell are the same. This occurs where the supply curve and the demand curve cross. • Shortage (Excess Demand): the condition where firms do not want to sell as many as consumers want to buy. • Surplus (Excess Supply): the condition where firms want to sell more than consumers want to buy

15. A Combined Supply and Demand Schedule

16. Figure 3 The Supply and Demand Model P $2.50 $2.00 $1.50 $1.00 $0.50 0 Supply Equilibrium Demand Q/t 0 10 20 30 40 50

17. All About Demand • The Law of Demand • The relationship between price and quantity demanded is a negative or inverse one.

18. Why Does the Law of Demand Make Sense? • The Substitution Effect • moves people toward the good that is now cheaper or away from the good that is now more expensive • The Real Balances Effect • When a price increases it decreases your buying power causing you to buy less. • The Law of Diminishing Marginal Utility • The amount of additional happiness that you get from an additional unit of consumption falls with each additional unit.

19. The Law of Supply • The Law of Supply is the statement that there is a positive relationship between price and quantity supplied.

20. Why Does the Law of Supply Make Sense? • Because of Increasing Marginal Costs firms require higher prices to produce more output.

21. Determinants of Demand • Taste • Income • Normal Goods • Inferior Goods • Price of Other Goods • Complement • Substitute • Population of Potential Buyers • Expected Price

22. Movements in the Demand Curve

23. Figure 4 The Effect of an Increase in Demand P $2.50 $2.00 $1.50 $1.00 $0.50 0 Supply New Equilibrium Old Equilibrium New Demand Demand Q/t 0 10 20 30 40 50

24. Figure 5 The Effect of a Decrease in Demand P $2.50 $2.00 $1.50 $1.00 $0.50 0 New Equilibrium Supply Old Equilibrium New Demand Demand Q/t 0 10 20 30 40 50

25. The Determinants of Supply • Price of Inputs • Technology • Price of Other Potential Output • Number of Sellers • Expected Future Price

26. Movements in the Supply Curve

27. Figure 6 An Increase in Supply P $2.50 $2.00 $1.50 $1.00 $0.50 0 Supply New Supply Old Equilibrium New Equilibrium Demand Q/t 0 10 20 30 40 50

28. Figure 7 A Decrease in Supply New Supply P New Equilibrium $2.50 $2.00 $1.50 $1.00 $0.50 0 Supply Old Equilibrium Demand Q/t 0 10 20 30 40 50

29. Elasticity • Elasticity: the responsiveness of quantity to a change in another variable • Price Elasticity of Demand: the responsiveness of quantity demanded to a change in price • Price Elasticity of Supply: the responsiveness of quantity supplied to a change in price • Income Elasticity of Demand: the responsiveness of quantity demanded to a change in income • Cross Price Elasticity of Demand: the responsiveness of quantity demanded of one good to a change in the price of another good

30. The Mathematical Representation of Elasticity ΔQ %ΔQ Q Elasticity = = %ΔP ΔP P Because the demand curve is downward sloping and the supply curve is upward sloping the elasticity of demand is negative and the elasticity of supply is positive. Often these signs are implicit and ignored.

31. Elasticity Labels • Elastic : the condition of demand when the percentage change in quantity is larger than the percentage change in price • Inelastic: the condition of demand when the percentage change in quantity is smaller than the percentage change in price • Unitary Elastic: the condition of demand when the percentage change in quantity is equal to the percentage change in price

32. The Graphical Explanation Alternative Ways to Understand Elasticity

33. The Relationship Between Slope and Elasticity • Elasticity and the slope of the demand curve are not the same but they are related. • At a given price level, elasticity is greater with a flatter demand curve. • With a linear demand curve (meaning a demand curve that has a single value for the slope) elasticity is greater at higher prices

34. Figure 1 12.5% change (9-8)/8 P 13 12 11 10 9 8 7 6 5 4 3 2 1 0 25% change (4-3)/4 D1 1 2 3 4 5 6 7 8 9 10 11 12 13 Q/t

35. Figure 2 50% change (12-8)/8 P 13 12 11 10 9 8 7 6 5 4 3 2 1 0 D2 25% change (4-3)/4 1 2 3 4 5 6 7 8 9 10 11 12 13 Q/t

36. Figure 3 Higher Prices Means Greater Elasticity 12.5% change (9-8)/8 P 13 12 11 10 9 8 7 6 5 4 3 2 1 0 50% change (3-2)/2 A B Demand 25% change (4-3)/4 C 9.1% change (11-10)/11 D 1 2 3 4 5 6 7 8 9 10 11 12 13 Q/t

37. Alternative Ways to Understand Elasticity • A good for which there are no good substitutes is likely to be one for which you must pay whatever price is charged. It is also likely to be one for which a lower price will not induce substantially greater consumption. Thus, as price changes there is very little change in consumption, i.e. demand is inelastic and the demand curve is steep. • Inexpensive goods that take up little of your income can change in price and your consumption will not change dramatically. Thus, at low prices, demand is inelastic. The Verbal Explanation

38. Seeing Elasticity Through Total Expenditures • Total Expenditure Rule:if the price and the amount you spend both go in the same direction then demand is inelastic while if they go in opposite directions demand is elastic.

39. Determinants of Elasticity • Number of and Closeness of Substitutes • The more alternatives you have the less likely you are to pay high prices for a good and the more likely you are to settle for something that will do. • Time • The longer you have to come up with alternatives to paying high prices the more likely it is you will shift to those alternatives.

40. Extremes of Elasticity • Perfectly Inelastic: the condition of demand when price changes have no effect on quantity • Perfectly Elastic: the condition of demand when price cannot change

41. How the Elasticity of Demand Affects Reactions to Price Changes Elasticity and the Demand Curve

42. Figure 4 Perfectly Inelastic Demand P S2 P2 S1 P1 D Q1=Q2 Q/t

43. Figure 5 Perfectly Elastic Demand P S2 S1 P1=P2 D Q2 Q1 Q/t

44. Figure 6 Inelastic Demand(at moderate prices) P S2 S1 P2 P1 D Q2 Q1 Q/t

45. Figure 7 Elastic Demand(at moderate prices) P S2 S1 P2 P1 D Q2 Q1 Q/t

46. Elasticity Examples

47. Price Elasticity Supply • Identical in concept to elasticity of demand. • Formula is the Same • It is also related to the slope of the supply curve but is not simply the slope of the supply curve. • Terminology is the same

48. Perfectly Inelastic Supply P S P2 P1 D2 D1 Q1=Q2 Q/t

49. Inelastic Supply P S P2 P1 D2 D1 Q1 Q2 Q/t

50. Elastic Supply P S P2 P1 D2 D1 Q1 Q2 Q/t