Market Forces of Demand

1. Firms

2. Entrepreneurs

3. Households

The basic decision-making units:

Firm

It is an organization that transforms resources (inputs) into products (outputs). The primary producing units in a market economy.

Entrepreneur

A person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.

Households

The consuming units in an economy.

circular flow of economic activity

The ___ ___ _ ___ ___ shows the connections between firms and households in input and output markets.

Output or product markets

The markets in which goods and services are exchanged.

Input markets

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

• 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.

Types of Input Markets:

Market

A group of buyers and sellers of a particular product.

Competitive Market

One with many buyers and sellers, each has a negligible effect on price.

• All goods are exactly the same

• Buyers & sellers are so numerous that no one can affect market price – each is a “price taker”

Traits of a perfectly competitive market:

Law of Demand

It is the claim that the quantity demanded of a good fall when the price of the good rises, other things equal. It states that there is a negative or inverse relationship between price of the good itself and the quantity of the good demanded.

downward

The demand curves slope (upward/downward).

quantity demanded

The ___ ___ of any good is the amount of the good that buyers are willing and able to purchase.

Demand

It is the willingness and the ability of buyers to purchase goods and services.

Demand Schedule

A table that shows the relationship between the price of a good and the quantity demanded.

Demand Curve

A graph illustrating how much of a given product a household would be willing to buy at different price.

Income

The sum of all household’s wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time.

True

T or F: If income will increase, demand for some goods will increase but not the demand for all goods.

Normal Goods

Goods for which demand goes up when income is higher and for which demand goes down when income is lower.

Inferior Goods

Goods for which demand falls when income rises.

positively

Demand for a normal good is (positively/negatively) related to income.

right

Increase in income causes increase in quantity demanded at each price, shifts D curve to the (left/right).

negatively

Demand for an inferior good is (positively/negatively) related to income.

Substitutes

Goods that can serve as replacements for one another; when the price of one product increases, demand for the other goes up.

Complements

Goods that “go together”; a decrease in the price of one product results in an increase in demand for the other, and vice versa.

substitutes

Two goods are (substitutes/complements) if an increase in the price of one causes an increase in demand for the other.

complements

Two goods are (substitutes/complements) if an increase in the price of one causes a fall in demand for the other.

True

T or F: Product quality affects consumers’ buying decisions.

True

T or F: Massive advertisement will lead to an increase in the demand for the good or service.

price elasticity of demand

The ___ ___ __ ___ is a measure of how much the quantity demanded of a good respond to a change in the price of that good.

1. Elastic demand

2. Inelastic demand

3. Unit Elastic demand or Unitary demand

Kinds of demand elasticity:

Elastic Demand

• Quantity demanded responds strongly to changes in price.

• Demand is elastic if the percentage change in quantity demanded is greater than the percentage change in price.

• Price elasticity of demand is greater than one.

Inelastic Demand

• Quantity demanded does not respond strongly to price changes.

• Demand is inelastic if the percentage change in quantity demanded is less than the percentage change in price.

• Price elasticity of demand is less than one.

Unit Elastic Demand

Demand is unit elastic if the percentage change in quantity demanded is equal to the percentage in price.

Cross Price Elasticity of Demand

The responsiveness of demand of one good to changes in the price of a related good – either a substitute or a complement.

Inverse relationship

Goods which are complements: Cross Elasticity will have negative sign. (inverse relationship/positive relationship)

Positive relationship

Goods which are substitutes: Cross Elasticity will have a positive sign (inverse relationship/positive relationship between the two)

• the larger the number of close substitutes.

• if the good is a luxury.

• the longer the time period under consideration.

• The greater the proportion of income is spent on the good.

Factors when demand tends to be more elastic:

• the lesser the number of close substitutes or if the good or service has no substitute at all

• if the good is a necessity.

• the shorter the time period under consideration.

• The smaller the proportion of income is spent on the good.

Factors when demand tends to be more inelastic: