9/23/2010. The individual demand curve shows the quantity demanded at each price by one consumer.

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1 When the price of a good is high, consumers and businesses will buy less and substitute other goods. They economize on the use of scarce goods or resources. Therefore, scarce goods are used most efficiently. No announcement on radio or TV has to be made. Individuals find out about the relative scarcity of a good through its price. Individuals and firms then decide what to do; decision making is decentralized. Price changes can be puzzling. Price movements are in the news and are important topics of national debate. The price of housing in San Francisco increases. The effective, or quality-adjusted, price of computers falls. Average real wages of workers in the United States remain roughly constant. The inflation adjusted price of gasoline in the U.S. has remained approximately constant since the mid-1980s. Demand is the quantity of a good or service purchased at a given price. The demand curve shows the quantity of the good demanded at each price. The individual demand curve shows the quantity demanded at each price by one consumer. Demand curves are downward sloping. As price falls, consumers buy more of the good. The position of an individual s demand curve (but not its slope) also depends on: Income Social trends The price of related goods Expectations about the future 1

2 The market demand curve is the horizontal sum of the demand curves of all individuals. A change in price is represented by a movement along the demand curve. All other changes that affect demand will shift the demand curve. Tastes Prices of related goods Income Demographics Information Availability of credit Changes in expectations Tastes: If one day everyone in the United States woke up and liked Britney Spears CDs, the demand curve for Britney Spears CDs would shift to the right. Prices of related goods Complementary goods: Peanut butter and jelly When the price of peanut butter rises, there is movement along the demand curve for peanut butter. When the demand for jelly falls, the demand curve for jelly shifts to the left. Price of related goods Substitute goods When the price of coffee rises, there is movement along the demand curve for coffee. When the demand for tea increases, the demand curve for tea shifts to the right. 2

3 An increase in income increases the demand for most goods. The demand curve shifts to the right. A change in expectations If consumers believe the price will increase in the future, demand increases today (when the good is cheaper); this shifts the demand curve to the right. A change in expectations about the future affects current variables. A change in expectations may be self-fulfilling. Supply is the quantity of goods and services offered in the market at a given price. The supply curve shows the quantity of the good offered for sale at each price. The supply curve is upward sloping. When the price of a good or service rises, the quantity supplied to the market rises. Suppliers find it more profitable to produce more goods or services when prices are higher. A higher price allows firms to cover the higher costs of producing more goods. The market supply curve is the horizontal sum of the supply curves of all the suppliers. Just as individual supply curves have a positive slope, so do market supply curves. A change in price is represented by a movement along the supply curve. All other changes that affect supply shift the supply curve. 3

4 A change in the price of inputs A change in technology A change in the natural environment A change in the availability of credit A change in expectations A rise in the price of coffee increases the costs of making espresso. The supply of coffee decreases and the supply curve for coffee shifts left or up. If a new technology improves coffee bean harvesting, the costs of producing coffee fall. This increases the suppliers desire to sell at each price. The supply increases and the supply curve shifts right. In equilibrium, there are no forces or reasons for change. A marble in a bowl is in stable equilibrium. It remains at the bottom if there are no external changes to the system. In a market in equilibrium, neither demanders nor suppliers have an incentive to change their actions. The equilibrium price is the market clearing price that equates quantity demanded with quantity supplied. Equilibrium occurs where the demand curve intersects the supply curve Qd = Qs. The law of supply and demand predicts that prices will move to equilibrium values. Excess supply causes prices to fall. Suppliers cannot sell all they wish, so they the cut price. Quantity demanded increases along the demand curve to point E 0. Quantity supplied decreases along the supply curve to point E 0. 4

5 Excess demand causes prices to rise. Consumers cannot buy as much of the item as they want. They bid up the price. As the price rises, the quantity supplied increases along the supply curve. As the price rises, the quantity demanded decreases along the demand curve. Price is related to marginal value not to total value. The price of water can be very low, even though its initial value is immense. The marginal value is why the price of water is relatively low in Alaska and relatively high in New Mexico. Price does not reflect importance. Price only reflects supply and demand. Water and diamond paradox 5