Why do prices change?

1. Why do prices change? • Inflation/Deflation (times of generally rising/declining prices) reflect the changes • Change in market conditions for a particular product/service • change in factors that affect consumers’ demand for the good • change in factors that affect producers’ supply of the good

2. Consumer Demand • Households get less satisfaction from later units of a product/service than they get from earlier units -- diminishing marginal utility (declining marginal value) • why the first run of the season down the ski slope is more exciting than the second • why the second donut doesn’t taste as good as the first • Implies that consumers are only willing to buy more of a good if the price declines

3. Consumer Demand (cont.) • Demand Curve - depicts the relationship between the price of the product and the quantity of the product that consumers will purchase. • For this class, Demand Curves will always have a negative slope

4. Demand for Donuts Price/donut D1 Quantity of Donuts (in 1,000’s)

5. What affects the shape/position of the demand curve? • Household income • as income rises families increase their demand for “normal” goods and decrease their demand for “inferior” goods • Household preferences • some people don’t like to eat sweet things in the morning while others do • The availability and price of substitutes • e.g., bagels vs. donuts • The availability and price of complements • e.g., coffee and donuts

6. Defining Terms • Normal Goods: a good for which consumption increases as an individual’s income rises. • Inferior Goods: a good for which consumption decreases as an individual’s income rises

7. Producer Supply • Producers’ willingness to provide a product or service is dependent on the price they can get for the good/service in the market… • the higher the price, the more they are willing to produce • Producers’ supply is a positive function of price • For this class, Supply Curves will always have a positive slope

8. Supply of Donuts Price/donut S1 Quantity of Donuts (in 1,000’s)

9. What affects the shape of the supply curve? • Production technology • e.g., must donuts be made by hand or can a machine do it? • Cost of inputs (a.k.a Input Costs) • e.g., price of labor, machines, space

10. Supply & Demand Intersect to Determine Market Price Price/donut S1 E1 P1 D1 Q1 Quantity of Donuts (in 1,000’s)

11. Let’s draw some curves! • How does an income increase affect demand for a normal good? • How does an income decrease affect demand for a normal good? • How does an income increase affect demand for an inferior good? • How does an income decrease affect demand for an inferior good?

12. Examples... • Oprah Effect: Households become aware of the perceived negative health consequences of eating beef • shifts demand to the left and the market price for beef declines. • ABC Factory moves it’s manufacturing plant to Veracruz, Mexico. What will happen to the price of ABC’s products? • shifts supply to the right and the market price for ABC’s products decrease.

13. Examples... • California has the best strawberry crop in years. What will happen to the price of chocolate and whipped cream? • May shift demand for chocolate and whipped cream to the • right (increasing both equilibrium quantity and price). • Strike of union workers may • raise employee costs and shift supply curve to the left (raising equilibrium price and decreasing quantity).