Basic Concepts Unit 2

The Law of Demand

The Law of Demand

All other factors equal, there is a negative relationship between the price of a good and the quantity of it demanded, meaning that when price increases consumers demand less of the good and when it decreases they buy more.

The Law of Supply

The claim that, other things equal, the quantity supplied of a good rises when the price of the good rises

Normal good

a good that consumers demand more of when their incomes increase

Examples of normal goods

Gasoline, housing, clothes, candy, jewelry (most goods are normal goods, either only that or in addition to something else.)

Examples of inferior goods

First price products (all low price chains), economy class tickets, second-hand clothes or other second-hand products, ramen noodles, bus tickets (depends)

Inferior good

a good that consumers demand less of when their incomes increase

Examples of substitute goods

Fanta and Solo, Coke and Pepsi, a degree from Oxford and the same degree from Cambridge, Apple and Samsung, McDonalds and Burger King

Substitute good

Products or services that satisfy the same or similar needs and can be used in place of each other.

What happens when the price of substitute good A increases?

The demand for substitute good B increases (and when A's price decreases, B's demand decreases)

Examples of complementary goods

Cars and gasoline, knives and forks, bow and arrow, device and charger, ski and poles, helmet and motorcycle, pencil and pencilcase

Complementary goods

Products and services that are often used or bought together (you don't NEED both, but they work best together)

Cetris Paribus

the assumption that nothing else is changing; all else being equal

Positive economics

Fact providing economics that describe, explain and predict the economy through methods, models and hypothesis

Examples of positive economics statements

The unemployment rate is 5% (describe), if the price of strawberries increases the demand will go down (explain), the unemployment rate will go up next year (prediction)

Normative economics

The part of economics that focuses on what we think should happen or be done based on our morals and values, often focuses on politics and environment

Examples of normative economics statements

Healthcare should be available and free for everyone (opinion)

What are the three economic questions?

What to produce? How to produce? For whom to produce?

Market

Any kind of arrangement where buyers and sellers of a particular good, service, or resource are linked together to carry out an exchange.

Competitive market

A market in which there are many buyers and sellers of the same good or service, none of whom can influence the price at which the good or service is sold

Individual demand

The willingness and ability a consumer have to buy different quantities of a good at different prices, ceteris paribus

Demand curve

A graph of the relationship between the price of a good and the quantity demanded (does not have to be an actual curve)

Market demand

The sum of all the individual demands for a particular good or service, often displayed through a demand curve

Non-price determinants of demand

The unchanging variables that can influence demand other than price itself, ceteris paribus (causes a shift in the demand curve)

A rightward shift in the curve means

An increase (of demand/supply)

A leftward shift in the curve means

A decrease (of demand/supply)

Examples of non-price determinants on demand

Preferences and tastes (including trends), income of consumer (demand goes up for normal goods and down for inferior goods), prices of substitute goods (if one's price goes up, the other's demand goes up too), prices of complementary goods (if one's prices go up, both their demands go down), the number of consumers (how many are actually buying this?)

A movement along the curve

Is a change in quantity, caused by a change in price

A shift in the curve

Is a change of demand/supply and is caused by non-price determinants

The law of diminishing marginal utility

The principle consumers experience diminishing additional satisfaction as they consume more of a good or service during a given period of time (partly explains the law of demand and the negative relationship between price and quantity demanded) The satisfaction consumers get from consuming more and more units of a good decreases.

Utility

The subjective satisfaction, usefulness, value or happiness the consumers gain from consuming something

Util

the assumed measurement of utility for the purposes of discussing economics (however it does not actually exist)

Total utility

The total satisfaction consumers gets from consuming a product

Marginal utility

The additional satisfaction consumers get when they consume one more unit of a good (it falls the more you buy)

How is marginal utility calculated?

The total utility of the second product minus the total utility of the first product

Marginal in economics

Additional/extra

Real income

Purchasing power; it increases as prices fall and decreases as prices rise even if the income/amount of money remains the same

To explain the law of demand we can divide it into two concepts

The income and substitution effects

The substitution effect

Quantity demanded increases when prices fall because consumers buy more of the less-expensive products, therefore always a negative relationship between price and quantity demanded

The income effect

The consumption changes because the real income changes (you can buy more for the same or less for the same)