Unit 2: Microeconomics
What is Demand?
Demand is made up of two elements:
– Desire for Goods and Services
– Means to purchase those Goods and Services
Demand Schedule - a table showing the relationship between
the price of a good and the quantity demanded per period of
time, ceteris paribus.
– ceteris paribus: means "assuming all else is held
constant". The attempt to distinguish an effect of one kind
of change from any others.
Law of Demand - the price of a product (or service) is inversely
related to the quantity demanded, ceteris paribus.
Market Demand Curve
•
The demand curve we just drew was the Demand for CDs by
one person.
•
Market Demand Curve - a curve showing total quantity
demanded by all consumers in the market per period of time,
ceteris paribus.
Change in Quantity Demanded
•
Change in Quantity Demanded (Qd) - movement along a
demand curve
• A change in quantity demanded can only be caused by a change
in the price of the good.
•
Changes in Quantity Demanded
• Increase in Qd - a movement to the right along a demand curve
• Decrease in Qd - a movement to the left along a demand curve
Change in Demand
•
Change in Demand - a change in the desire or means to purchase
the good, thus there is a change in quantity demanded at EVERY
price. A change in demand is a shift of the demand curve.
• Increase in demand - demand curve shifts to the right
• Decrease in demand - demand curve shifts to the left
Factors Which Cause a Change in Demand
1. Number of Buyers
2. Tastes and Preferences
3. Income
P ($)
Qd
$20
5
$15
7
$10
15
4. Price of Other Goods
5. The Availability of Credit
6. Expectations about Future Prices
Change in Demand - Number of Buyers
The more buyers in the market for a good, the greater the total quantity demanded (by the whole
economy) of the good at a given price. Since the quantity demanded is higher at every given price, the
demand has increased.
Likewise, if there are less buyers in the market there is less quantity demanded at every price, so demand
has decreased.
Normal and Inferior Goods
•
•
Normal Good - any good which increases in demand as income increases (and vice-versa)
Inferior Good - any good which decreases in demand as income increases (and vice-versa)
Change in Demand - Price of Other Goods
•
Substitute - a good which can be consumed in place of another good
– Thus an increase in the price of a substitute will increase the demand for the good
– And a decrease in the price of a substitute will decrease the demand for the good
•
Complement - a good which is consumed along with the consumption of another good
Change in Demand - Price of Other Goods
Thus, either of the following will increase Demand
• Price of a substitute good increases
• Price of a complement good decreases
And either of the following will decrease Demand
• Price of a substitute good decreases
• Price of a complement good increases
Supply
Supply is the quantities of a product offered for sale at all possible prices.
The Supply Schedule provides information on supply in chart form; the supply curve offers the same
information in graph form.
Quantity Supplied is the change in the amount of a product offered for sale in response to price change.
Factors that cause a change in supply are:
1. costs of inputs
2. productivity
3. technology
4. number of sellers
5. taxes and subsidies
6. expectations
7. government regulations.
Prices as Signals
Five advantages of using prices to allocate goods and services:
1. neutral
2. flexible
3. offer freedom of choice
4. have no administrative costs
5. work efficiently
Describe the way in which prices act as signals to help you make your decisions?
High prices will signal that they should probably delay their purchase or look for a cheaper alternative.
Low prices will signal that they should buy.
How Prices are Determined
Economic Model- a set of assumptions that can be listed in a table, illustrated with a graph, or even
stated algebraically- to help analyze behavior and predict outcomes.
Market Equilibrium- a situation in which prices are relatively stable, and the quantity of goods or services
supplied is equal to the quantity demanded.
Equilibrium Price “Clearing Price”- the price that “clears the market” in that there is neither a surplus nor
a shortage at the end of the trading period.
Draw an Economic Model
and label the Equilibrium
Surplus- a situation in which the quantity supplied is greater then the quantity demanded at a given price.
Shortage- a situation in which the quantity demanded is greater then the quantity supplied at a given
price.
How do surpluses and shortages help the market find the equilibrium price?
Surpluses indicate that prices should be lowered; shortages indicate that prices should be
increased. Through this process, equilibrium eventually will be reached.
What do merchants usually do to move items that are overstocked?
What does this tell you about the equilibrium price for the product?
They lower the price of the items. The equilibrium price for the product is lower than the present
price.
The Price System at Work
Price Ceiling- the maximum legal price that can be charged
Price Floor- the lowest legal price that can be paid for a good or service
Ex. Minimum Wage- the lowest legal wage that can be paid to most workers
What are two effects of having a fixed price other than the equilibrium price forced on a market?
1. Shortages are created if price ceilings are set below the equilibrium price.
2. Surpluses are created if price floors are set higher than the equilibrium price.
Draw an Economic Model with a Price Ceiling – show where the shortage would be.
Draw and Economic Model with a Price Floor – show where the surplus would be.
Elasticity of Demand
Elastic – the quantity demand changes inversely to a change in price.
Inelastic – the quantity demand does not change due to a change in price.
Unit Elastic – the degree of the quantity demand change due to a change in price does not result in a
change in total revenue.
Elastic
Inelastic
Unit Elastic
Price
Increase/Decrease
Increase/Decrease
Increase/Decrease
Total Revenue
Decrease/Increase (Opposite)
Increase/Decrease (Same)
No Change
Why are price changes more moderate when demand is highly elastic?
Buyers can delay their purchase or find alternates.
How do markets speak collectively for buyers and sellers?
Prices will move up or down significantly, signaling the collective decisions of buyers and sellers.
Competition and Market Structure
Market structure- the nature and degree of competition among firms operating in the same industry.
There are four basic Market Structures:
1. Pure competition- market situation including independent and well-informed buyers and sellers of
identical products. (Ex. Wheat, Corn, Fruit)
Conditions for Pure Competition:
1. A large number of buyers and sellers exist.
2. Buyers and sellers deal in identical products.
3. Each buyer and seller acts independently.
4. Buyers and sellers are reasonably well informed about items for sale.
5. Buyers and sellers are free to enter into, conduct, or get out of business.
Imperfect Competition - all market situations that lack one or more of the conditions of pure
competition.
2. Monopolistic competition- market situation including independent and well-informed buyers and
sellers of Similar products. (Ex. Candy Bars, Shampoo)
Product differentiation- the product being sold is similar from one firm to another, but it is not
identical. This is done on purpose by the seller.
Nonprice competition- takes the place of price competition; advertising or other promotional
campaigns try to convince the consumer that the product is somehow better than another brand.
3. Oligopoly- few very large sellers of a product dominate the market. The exact number of firms in the
industry is not as important as the ability of any single firm to cause a change in output, sales, and prices
in the industry as a whole. (Ex. Coke and Pepsi, TV options, Cell Phone Providers)
Collusion- a formal agreement to set prices or to otherwise behave in a cooperative manner. This
is Illegal in the United States.
Price Fixing- one type of collusion; agreeing to charge the same or similar prices for a product.
4. Monopoly – market structure where there is only one seller for a particular product.
(Ex. Local Water Company)
Types of Monopolies:
Pure Monopoly - a market situation with only one seller of a particular economic product that has no
close substitutes.
Natural Monopoly- where costs are minimized by having a single firm produces the product.
Geographic Monopoly- no other business in the immediate area offers any competition.
Technological Monopoly- a firm or individual has discovered a new manufacturing technique or has
invented or created something entirely new.
Patent- an exclusive right to manufacture, use, or sell any new and useful art, machine, manufacture, or
composition of matter, or any new and useful improvement thereof.
Copyright- gives authors or artists the exclusive right to publish, sell, or reproduce their work for their
lifetime plus 50 years.
Government monopoly- a business the government owns and operates.
Business Structures
1. Sole Proprietorships – Owned and managed by An Individual. (Ex. Lawn mower business)
Advantages:
Disadvantages:
1. easy start-up
1. unlimited liability
2. full control
2. sole responsibility
3. exclusive rights to profits
3. lack of longevity
2. Partnerships – Two or more owners. (Ex. Law Firm)
Advantages—
Disadvantages—
1. easy start-up
1. unlimited liability
2. specialization (different duties)
2. potential for conflict
3. shared losses
3. Lack of longevity
3. Corporations – A business owned by Stockholders who share in the profits and losses.
Advantages—
Disadvantages—
1. limited liability
1. heavily regulated by the government
2. management is separate from ownership;
2. slow decision making
3. easy to raise money
3. double taxation (profits and dividends)
4. longevity
Business Growth and Expansion
Merger – two companies become one.
 Horizontal – companies that produce the Same types of products.
Ex. Two Cell Phone Companies or Two Airlines
 Vertical – companies that produce products that Depend on each other.
Ex. Ebay buying Paypal, Wal Mart buys a shipping company
Other Organizations and Institutions
1. Nonprofit Organizations –Companies that operate for a reason other than making a profit
2. Cooperative (Co-op) – companies that are based on member groups for more efficiency.
Consumer – to help buy goods for individuals or companies in bulk for a lower price.
Service - to provide service for members and a better price. (Insurance and Credit Unions)
Producer – to help sell products for members. (Farmers markets)