TAX: Supply, Demand, & Elasticity

The circular flow of economic activity

shows the connections between firms and households in input and output markets (micro to macro economics)

demand

• WILLING TO BUY

• the relationship between quantity demanded and price within a specific period

• the relationship between the maximum willingness to pay in return for something of value

output markets

markets in which goods and services are exchanged

input markets

markets in which resources (labor, capital, and land—used to produce products,) are exchanged

what is the flow of the circular flow of economic activity

payments flow in the opposite direction as the physical flow of resources, goods, and services

labor market

households supply work for wages to firms that demand labor

capital market

households supple their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods

market demand

• horizontal sum of individual demands

• market demand that commands our interest

• a competitive market offers homogenous (identical) products

quantity demanded

the amount (number of units) of a product that a household would buy in a given time period if it could buy all it wanted at the current market price

demand in output markets

demand schedule and demand curves

input markets include:

labor market, capital market, land market

demand schedule

a table showing how much of a given product a household would be willing to buy at different prices

demand curves

• usually derived from demand schedules

• a graph illustrating how much of a given a product a household would be willing to buy at different prices

the law of demand

• states that there is a negative (inverse) relationship between price and the quantity of a good demanded and its price

• this means that the demand curves slope downward

• Price goes up ; Quantity Demanded goes down

• Price goes down ; Quantitiy Demanded goes up

the law of demand graph

demand schedule (a listing that shows the quantity demanded at all prices)

what causes a shift in demand?

non-price determinants

demand equation

qD = f

where F = price, income, prices of related goods, tastes, expectations

determinants of household demand

a household’s decision about the quantity of a particular output to demand depends on different determinants

the price of the product in question

as the price of a good or service increases, consumers typically demand less of it

the income available to the household

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.

the household’s amount of accumulated wealth

• Wealth, or net worth, is the total value of what a household owns minus what it owes.  It is a stock measure.

• wealth - liability = net worth

the prices of related products available to the household

• “no choice”

• you need to buy the product since it is related to products

the household’s taste and preferences

the household’s expectations about future income, wealth, and prices

Property of demand curves (x-axis)

Demand curves intersect the quantity (X)-axis, as a result of time limitations and diminishing marginal utility

Property of demand curves (y-axis)

Demand curves intersect the (Y)-axis, as a result of limited incomes and wealth

Inferior good (YED<0)

• opposite of a normal good

• increased income leads to fall in demand (ex. cheap substitutes)

• demand drops when consumer’s income rise

• when incomes are low or economy contracts, inferior goods become a more affordable substitute for a more expensive good

normal goods (YED>0)

• also called necessary goods

• increased income leads to higher demand

luxury good (YED>1)

• increased income leads to bigger percentage increase in demand (ex. sports cars)

• not essentials

• demand rises when consumer’s income also rises

• depends on consumer’s wealth or assets

what is the shift in demand curve for normal goods?

increase in income causes forward shift in demand curve

what is the shift in demand curve for inferior goods?

increase in income causes backward shift in demand curve

substitutes (goods and services)

• goods that can serve as replacements for one another

• when the price of one increases, demand for the other goes up

perfect substitutes (goods and services)

• identical products

• can be used in exactly the same way as the good or service it replaces. This is where the utility of the product or service is pretty much identical

• ex. different brands of bread

complements (goods and services)

• are goods that “go together”

• a decrease in the price of one results in an increase in demand for the other, and vice versa

• ex. toothpaste and toothbrush

what causes movement along a demand curve?

• changes price determinant

• ex. higher price causes lower QUANTITY DEMANDED

what causes shift along a demand curve?

• changes in determinants other than price

• causes a change in DEMAND or shift to the RIGHT

individual household

Demand for a good or service

market demand

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

how is the market demand derived from the households in the market?

• plot the graph for all households

• then get the sum of the quantity (x-axis)

Supply and demand relationship

• demand falls; supply rises

• demand rises; supply falls

supply

the total amount of a specific good or service that is available to consumers

the law of supply

• states that there is a positive relationship between price and quantity of a good supplied

• This means that supply curves typically have a positive slope

supply schedule

a table showing how much of a product firms will supply at different prices

quantity supplied

quantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period.

supply curve

a graph illustrating how much of a product a firm will supply at different prices

the price of the good or service

when the price of a good increases, the quantity supplied for that good also increases, holding everything else equal

the cost of producing the good, which in turn depends on:

• The price of required inputs (labor, capital, and land),

• The technologies that can be used to produce the product

the prices of related products