Unit 2 Supply and Demand

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1 Unit 2 Supply and Demand Microeconomics - analyzes the Small Unit economic behavior of Individuals, Households and Firms to understand their decision-making process. -America s Free Enterprise- An economy is the way goods and services are produced and consumed. Everyone is involved in the economy both by producing goods or services and by consuming them. America s economic success can be attributed to its open land, natural resources, a flow of immigrants with different backgrounds & experiences. But the major contributor is America s system of FREE ENTERPRISE {Capitalism or Market Economy}.The Back bone of Free Enterprise is Supply and Demand. -Features of a Free-Enterprise system- Business operates with little government involvement. In this economic system, producers are free to decide what to produce, and consumers are free to buy whatever they need and want. This selling and buying takes place in the market, which is not a physical place, but instead refers to the entire activity of buying and selling that takes place out in the world. -Individuals have a right to: Own property. Enter into Free contracts{people make their own agreements} Make Voluntary Exchanges{choices to buy or sell} based on self-interest. The free enterprise system rewards efficiency and innovation{something new or Different}. Engage in competition {rivalry between companies}. Competition gives the consumer choices. -Role of Supply and Demand- The principle role of supply and demand is to act like a kind of motor for this economic type of system, they keep the system running. It works by creating interaction between those who wish to earn money by selling goods or services and those who wish to buy those goods and services. Supply and demand are called market forces because they act to make the market function well or poorly. The Consumer{someone who acquires goods and services} creates the demand. The Free-enterprise system{capitalism or Market Economy} allows consumers the freedom to make their own economic decisions: a) How to make use of their money. b) Communicate their wants & needs to producers. The Producer {someone who makes goods or offers services for others} creates the supply. Producers look to Profit Motive - A force that encourages people and organizations to improve their standard of living. Producers are motivated by the profits {Financial gain received by selling something for more than it cost to make it } they expect to gain from the goods or services they offer.

2 -Laws of Demand- Demand is the amount of goods & services consumers are willing or are able to buy. To measure demand economists create a demand curves or demand Schedules. A Demand Curve graph measures the number of goods bought and at what price. Quantity Demanded (QD) Refers to how much of a product a consumer will buy at a particular price. -The Demand Curve Shifts- The demand Curve is only accurate as long as there are no changes other than price. When (D) for a product changes for reasons other than price, the (D) curve shifts left or right. If the Demand curve shifts right, there is an increase in (D) at any prices. The (D) curve shifts left, Demand decreases at all prices. -The Law of Demand- an Increase in price = a decrease in the Quantity Demanded at that price. a Decrease in price = an increase in the quantity demanded at that price Demand Schedule is a table of prices and how much quantity is demanded at that price. - Elasticity of Demand- Elasticity of Demand how consumers react to changes in price. Producers look at elasticity to determine whether to raise prices or not. The Two Types: 1. In-elastic Demand the change in price of a product has little effect on demand for it * The product is a necessity * Few substitutes are available * The price is a small part of consumer income 2. Elastic Demand- a change in price can cause a major change in demand: * The product is not a necessity. * Substitutes are available. * The price is a large part of consumer Income. -What explains the Laws of Demand?- Purchasing power - the amount of goods & services consumers can buy with their available income. Income effect- a change in consumption resulting from a change in consumer income or a product price. Substitution effect a change in price of the product causes a consumer to react by buying a different good (must be comparable to the original). - Other influences of Demand- Reasons for changes in (D)emand- other than the price of an item: Income of consumers Price of related goods Number of consumers Tastes & preferences Expectations of consumers -Diminishing Marginal Utility- The more a product is used, the less value it has to the consumer & (D)emand decreases. Demand is not unlimited- at some point usefulness or desire for the product decreases.

3 -Supply- Supply - the amount of goods and services producers are willing & able to offer at various prices during a given period. Supply deals with the Producer s behavior. Profit is the incentive behind why producers choose to make a product. -The Law of Supply- Producers will supply more of a product as prices increase. Producers will supply less at as prices decreases. -Why Law of Supply Happens- Producers want to maximize profits When consumers are willing to pay the higher price, producers will charge it. Higher prices encourage sellers to produce and offer more products. New firms will be encouraged to enter the industry & increase overall supply -THE SUPPLY CURVE- Supply Curve Illustrates the supply of a product at all price levels at a given period. The (S) curve shifts right when supply increases. The (S) curve shifts left when supply decreases. -Taxes Take Away Profits & Decrease Supply- If business have their taxes decreased, it moves the supply curve to the right If business have their taxes increased, it moves the supply curve to the left. Other influences of Supply- reasons for changes in (S)upply: -Taxes -Resource costs -Technology -Prices of related goods -Subsidies - gov t welfare to businesses -Number of Sellers -Expectations of producers

4 Cost of Production Elasticity of Supply- Elastic supply - a change in resource prices have an effect on the quantity supplied. In-Elastic supply a change in resource prices has no effect on the quantity supplied. 1) Elastic Supply- (production of the product is flexible and can be adjusted as resource prices change) The product in relatively inexpensive to produce. The production can be changed quickly. Few resources need to be adjusted in production. 2) In-elastic Supply- It is more difficult to change production or supply when resource prices change The product cannot be made quickly. There is greater expense in production. Additional resources are not readily available. -Productivity- Productivity -The Value of the output of what you produced. It drives businesses/firms to supply goods or services. The Product is the output. Resources (Factors of Production - land, labor, capital) are the input. -Revenue Costs & Profits- Revenue is the amount of money received in sales{business income}. Costs of production - the expenses incurred in making the product{overhead}. Profit - the revenue earned after all costs of production have been paid. -Costs of Production- Fixed costs do not change no matter what the level of production example: rent, insurance, taxes, loans. (these expenses must be paid no matter what) Variable costs these costs change as output levels change. ex: wages, utilities, costs of materials Fixed and Variable costs added together equals Total costs. Marginal costs In economics, the term marginal means just one more - changes in total cost with the addition of producing 1 more product.. (3 cars total cost is $300,000. For 2, it s $200,000. $300,000 $200,000 = $100,000 -Diminishing Marginal Returns- When in production, whenever you add one more variable input to a fixed input, producing goods and services will become less and less productive or become more costly. (You could actually end up producing less with more workers) -Law of Diminishing Returns- 3 stages of production predicted by the Law of Diminishing Returns: Increasing marginal returns: increased input supply equal to increased output. Diminishing marginal returns: increased input peaks at a certain level. Negative marginal returns: too much input lowers the level of output (decreasing productivity). -Externalities- An economic Spillover of a good or service, that generates benefits or costs to those not involved. A side effect of a transaction that affects people other than the producer or consumer. Example: factory dumps chemical waste into a river polluted water affects health of people living downstream. Example: neighbor plants new flower garden; the results please you. Negative externality- generate unintended cost or negative effects. Positive externality- produces a benefit to third parties.

5 -Market Equilibrium- CH 6 -PRICES- Price serves an important role in a free market. It moves land, labor and capital into the hands of the producers and the finished goods into the consumer s hands. Prices are how producers and consumers communicate to each other. -Market Equilibrium- The point at which quantity demanded & quantity supplied are equal at the same price. At this point the market is stable. -Disequilibrium- The market price of a product is not at the same point of the quantity demanded. - Excess demand: creates a shortage - (QD > QS )- - Excess supply: creates a surplus - (QS > QD) - How to change this: a decrease in price, which may cause Demand to increase &/or Supply to decrease until equilibrium is again reached. -Government Intervention- When markets are in disequilibrium, the government may get involved in order to restore equilibrium by controlling prices through: Price Ceilings & Price Floors -Price ceiling- A government regulation setting a maximum price for a good or service. Producers cannot charge above the set price level. A common example is RENT CONTROL In some cities, in order to provide housing for lower income people, landlords cannot charge above a certain rent price. Pro= lower income people can afford housing. Con= housing shortages & landlords have no incentives to make improvements to property. -Price Floor- The government sets a minimum price for a good or service. The most common example is minimum wage. -Minimum wage- Inflation- prices increase because producer s costs increase. Unemployment- employers hire fewer workers to keep costs low. Affects less educated or lower skilled workers.

6 -The Role of Prices- Producers tell customers at what price they are willing to offer goods & services Consumers let producers know what they are willing to pay for goods & services when they do or do not purchase -Prices provide INCENTIVES- Incentives: cause people to behave in a certain way. higher prices encourage producers to supply more. lower prices encourage consumers to buy more -Prices allow for CHOICES- producers: low costs for resources can allow for adjustments to a variety of products. consumers: producers adjustments & competition offers product variety -Prices encourage EFFICIENCY Producers attempt to find the least expensive methods of production to keep costs down & increase profit margin Consumers search for the easiest & least expensive products & aim to get the most for their money with the least effort. -Prices provide FLEXIBILITY- price changes allow producers to deal with changes in resources & consumer demand. consumers preferences are not limited & we can change our demand. -Rationing- a system by which the government (or other authority) decides how to distribute goods when there are shortages. - Rationing is unwise - rationing is UNFAIR- ~ products are not distributed equally ~ prices do not reflect demand rationing is EXPENSIVE ~ costs involved in enforcement rationing creates BLACK MARKETS- ~ illegal buying & selling usually at higher prices