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DEMAND, SUPPLY, and MARKET EQUILIBRIUM

DEMAND, SUPPLY, and MARKET EQUILIBRIUM. The Basic Decision-Making Units. Firms are the primary producing units in a market economy. Households are the consuming units in an economy. Input Markets and Output Markets: The Circular Flow input or factor markets

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DEMAND, SUPPLY, and MARKET EQUILIBRIUM

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  1. DEMAND, SUPPLY, andMARKET EQUILIBRIUM

  2. The Basic Decision-Making Units Firms are the primary producing units in a market economy. Households are the consuming units in an economy.

  3. Input Markets and Output Markets: The Circular Flow input or factor markets The markets in which the resources used to produce products are exchanged. outputorproduct markets The markets in which goods and services are exchanged.

  4. Input markets Input markets include: • The labor market, in which households supply work for wages to firms that demand labor. • The capital market, in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods. • The land market, in which households supply land or other real property in exchange for rent.

  5. The circular flow of economic activity shows the connections between firms and households in input and output markets. • Here goods and services flow clockwise: Labor services supplied by households flow to firms, and goods and services produced by firms flow to households. • Payment (usually money) flows in the opposite direction: Payment for goods and services flows from households to firms, and payment for labor services flows from firms to households.

  6. Demand in Output in Product/Output Markets • A household’s decision about what quantity of a particular output, or product, to demand depends on a number of factors, including: • The price of the product in question. • The income available to the household. • The household’s amount of accumulated wealth. • The prices of other products available to the household. • The household’s tastes and preferences. • The household’s expectations about future income, wealth, and prices.

  7. Price and Quantity Demanded quantity demanded The amount (number of units) of a product that a household would buy in a given period if it could buy all it wanted at the current market price.

  8. Price and Quantity Demanded: The Law of Demand Thelaw of demand says that when the other determinants of demand remain constant, there is a negative (or inverse) relationship between the quantity demanded of a good and its price.

  9. Demand Schedules and Demand Curves • demand curve • A graph illustrating how much of a given product a household would be willing to buy at different prices. • demand schedule • A table showing how much of a given product a household would be willing to buy at different prices.

  10. Properties of Demand Curves • To summarize what we know about the shape of demand curves: • They have a negative slope. An increase in price is likely to lead to a decrease in quantity demanded, and a decrease in price is likely to lead to an increase in quantity demanded. • They intersect the quantity (X-) axis, a result of time limitations and diminishing marginal utility. • 3. They intersect the price (Y-) axis, a result of limited incomes and wealth.

  11. Other Determinants of Household Demand In addition to price, factors such as income and wealth are important determinants of the quantity demanded.

  12. Changes in demand can be caused by changes in: • incomeand wealth • the prices of related products • tastes and preferences • expectations

  13. Changes in demand can be caused by changes in:incomeand wealth Income is the sum of all households wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure. Wealth, or net worth, is the total value of what a household owns minus what it owes. It is a stock measure.

  14. Changes in demand can be caused by changes in:incomeand wealth • For most goods, if income increases, the demand for the good will increases. Such goods are called normal goods. • Goods for which an increase in income results in a decrease in demand are referred to as inferior goods.

  15. Changes in demand can be caused by changes in:income Higher income decreases the demand for an inferior good Higher income increases the demand for a normal good

  16. Changes in demand can be caused by changes in:wealth Wealth is a stock measure: It is measured at a given point in time. If, in a givenperiod, you spend less than your income, you save. When you spend more than yourincome, you dissave—you reduce your wealth. An increase in wealth causes an increase in demand, and a decrease in wealth causes a decrease in demand.

  17. Changes in demand can be caused by changes in: prices of related products Substitutes are goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. Perfect substitutes are identical products. Complements are goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa.

  18. Changes in demand can be caused by changes in: prices of related products

  19. Changes in demand can be caused by changes in: tastes and preferences An increase in a consumer’s taste or preference for a good will cause an increase in demand (think of a fad, for example). But if the taste or preference for the good diminishes, demand will decrease (examples would be the end of a fad or an announcement that a product might cause harm or disease).

  20. Changes in demand can be caused by changes in: expectations • Consumers have expectations about future prices, future income, and whether or not a product will be available in the future. • All of these can affect demand in the present: • expecting higher prices in the future will increase demand in the present and vice versa; • expecting higher income in the future will increase demand in the present and vice versa; • and expecting a future shortage will increase demand in the present and vice versa.

  21. From Household Demand To Market Demand Demand for a good or service can be defined for an individual household, or for a group of households that make up a market. Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

  22. From Household Demand To Market Demand

  23. Supply in Product/Output Markets Successful firms make profits because they are able to sell their products for more than it costs to produce them. profit The difference between revenues and costs.

  24. Price and Quantity Supplied quantity supplied The amount of a particular product that a firm would be willing and able to offer for sale at a particular price during a given time period.

  25. Price and Quantity Supplied: The Law of Supply supply schedule A table showing how much of a product firms will sell at different prices. supply curve is a graph illustrating how much of a product a firm will supply at different prices.

  26. Price and Quantity Supplied: The Law of Supply • law of supply • The positive relationship between price and quantity of a good supplied: An increase in market price will lead to an increase in quantity supplied, and a decrease in market price will lead to a decrease in quantity supplied. This means that supply curves typically have a positive slope.

  27. Determinants of Supply: Assuming that its objective is to maximize profits, a firm’s decision about what quantity of output, or product, to supply depends on: 1. The price of the good or service. 2. The cost of producing the product, which in turn depends on: • The price of required inputs (labor, capital, and land). • The technologies that can be used to produce theproduct. 3. The prices of related products.

  28. Determinants of Supply: costs of production Cost of production depends on a number of factors, including the available technologies and the prices and quantities of the inputs needed by the firm (labor, land, capital, energy, and so on).Decreasesin production costs will cause supply to increase. This is shown by a shift of the supply curve to the right. Increaseswill cause a decrease in supply, shown by a shift to the left. technologies Improvements in technology will cause supply to increase. This is shown by a shift of the supply curve to the right. Decreasesin technology, will cause a decrease in supply, shown by a shift to the left.

  29. From Individual Firm to Market Supply market supply The sum of all that is supplied each period by all producers of a single product.

  30. From Individual Firm to Market Supply

  31. Market Equilibrium equilibrium The condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for price to change.

  32. Market Disequilibria excess demand or shortage The condition that exists when quantity demanded exceeds quantity supplied at the current price.When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored. excess supply or surplus The condition that exists when quantity supplied exceeds quantity demanded at the current price.When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored.

  33. Changes In Equilibrium When supply and demand curves shift, the equilibrium price and quantity change. Before the freeze, the coffee market was in equilibrium at a price of $1.20 per pound. At that price, quantity demanded equaled quantity supplied. The freeze shifted the supply curve to the left (from S0 to S1), increasing the equilibrium price to $2.40.

  34. Increases in Demand and Supply Higher demand leads to higher equilibrium price and higher equilibrium quantity. Higher supply leads to lower equilibrium price and higher equilibrium quantity.

  35. Decreases in Demand and Supply Lower supply leads to higher price and lower quantity exchanged. Lower demand leads to lower price and lower quantity exchanged.

  36. REVIEW TERMS AND CONCEPTS law of demand law of supply market demand market supply movement along a demand curve movement along a supply curve normal goods perfect substitutes product or output markets profit quantity demanded quantity supplied shift of a demand curve shift of a supply curve substitutes supply curve supply schedule wealth or net worth capital market complements, complementary goods demand curve demand schedule entrepreneur equilibrium excess demand or shortage excess supply or surplus factors of production firm households income inferior goods input or factor markets labor market land market

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