Chapters 3-7 Class Notes:

Chapter 3: Demand, Supply, and Market Equilibrium 

• Demand and supply are the basics of economics 

• How do competitive markets lead to efficient use of resources? They’re concern is maximizing profit (only focusing on competitive markets). Producing more resources can create more things, which can lead to the price of things lowering because there are more things to sell. You are forced to be efficient

• Sellers can’t make themselves better off without producing something that makes the buyers better off

• Markets:

  • Interaction between buyers and sellers

  • Can be virtual or in store 

  • Price is determined between the interactions of the buyers and sellers

• Demand: (how much of a product is wanted in a society, easy definition)

  • The different quantities of goods that consumers are willing and able to buy at different prices (actual definition)

    • Ex: You are able (you are able to buy them) to purchase diapers, but if you aren’t WILLING to buy them (you don’t necessarily want them), there is no demand for them

• Law of Demand: an inverse relationship between price and quantity demanded. If the price goes down, people will demand more because they want it more. If the price goes up for a product, fewer people will demand it because less people can afford it

  • Why does it happen? The law is the result of three separate behavior patterns that overlap

    • The substitution effect: change in quantity demanded because of a change in the relative price. If the price goes up for a product, consumers buy less of that produce and more of another substitute product (vice versa)

    • The income effect: the change in quantity demanded because of a change in price that alters the consumer’s real income. If the price goes down for a product, the purchasing power increases of consumers—allowing them to purchase more

    • The law of diminishing marginal utility: the idea that as you consume additional units of the same thing, you will eventually get less and less satisfaction from the good. 

      • Utility = satisfaction 

      • We buy goods because we get utility from them 

      • What does this have to do with the Law of Demand? As price decreases, consumption increases (vice versa). This gives the marginal utility a negative slope because these laws are inversely related 

      • How does this affect the pricing of businesses? Consumers will be willing to buy more of a product if the price is lower 

  • Graphing demand:

    • Price and cost is the y-axis label (even though it is independent)

    • Quantity is on the x-axis 

    • Demand curve: a graphical representation of a demand schedule 

      • Downward sloping

      • Shows the inverse relationship between price and quantity

      • Price increase with quantity decrease 

      • Price decrease with quantity increase

      • Assume every other factor is constant

• Demand review:

  • What are the two key aspects in the definition of demand? Willingness and able 

  • What is the law of demand?

  • Give an example of income, substitution, and law of diminishing marginal utility 

  • Explain how the law of diminishing utility causes the law of demand. Gives the marginal utility a negative slope since both laws are inversely related 

  • How do you determine the market demand for a particular good? Add up all of the quantity demanded of everyone in the society 

• Shifts (change) in demand:

  • Use arrows to show the shift of demand 

  • Ceteris paribus ** (assume everything is constant)

  • When the ceteris paribus assumption is dropped, the movement is no longer along the demand curve. Rather, the entire demand curve shifts. 

  • If there is a shift in demand, is it NEVER because of price 

  • A shift means that at the same prices, more people are willing and able to purchase that good

  • Change in quantity demanded: a shift in the demand curve BECAUSE of price (never anything else)

  • Price causes movement ALONG the demand curve

• Shifters/determinants of demand: (MEMORIZE)

  • Tastes and preferences

  • Number of consumers

  • price of related goods: Substitutes are goods used in place of others. Complements are two goods that are bought together normally. (Ex: bagels and cream cheese. If the price of bagels goes down, the demand for cream cheese will go up. 

  • income

  • future expectations of price 

• Tastes and preferences:

  • the consumer prefers something (want more of it), or it’s a taste of theirs 

  • ex: if a celebrity wears a certain brand, many fans would want to be like them. So, the demand for that certain brand will increase because people would prefer to dress like her

• Number of consumers:

  • if there are more consumers in the marketplace, then the demand for the product will go up (more people who want a certain thing)

• Price of related goods:

  • complements (two goods that are normally bought together) or substitutes (goods used in place of others 

• Income:

  • You get a raise (more money) - you can buy more stuff

  • You lose your job, you demand less

  • the income of consumers change the demand, but how depends on the type of goods

    • Normal goods: as income increases, demand decreases. As income falls, demand falls (ex: luxury cars, jewelry, homes, etc)

    • Inferior goods: as income increases, demand falls. As  income falls, demand increases (ex: Top Ramen, used clothes, anything used)

• Future expectations (of price):

  • Has to be price related

  • ex: consumers that are expecting the price of swimwear to cost less during the fall, so the consumer would expect to buy more during the fall. 

  • If someone think that the price will go down in the future **

Supply:

• Law of supply: a positive relationship between price and quantity supplied

  • Price increases, the quantity producers make increases (vice versa) 

• Shifters of supply:

  • Price/availability of inputs (resources)

  • Number of sellers

  • Technology 

  • Expectations of future profit 

  • Government action: taxes and subsidies

    • Taxes will always decrease the supply

    • Subsidies will always increase the supply 

Efficient allocation:

A competitive market achieves two types of efficiency that results at equilibrium price and quantity.

• Productive efficiency: firms produce goods in a least costly way to maximize profit. This is achieved by using the best technology and the right mix of resources (deals with cost)

• allocative efficiency: firms produce the right combination of goods most highly valued by society (required production efficiency to occur

Price ceiling: the maximum legal price a seller can charge for a product

• Goal - make affordable by keeping price from reaching the equilibrium 

• Decreases the price

• Ex: rent control in NYC

  • Average rent: 5,000 a month for rent. If the mayor says “it’s too expensive”, and they want people to live there and contribute, they want the rent to be controlled. The N.Y. Government might “cap it” (price ceiling) at 3,000 a month (*the MOST you can charge for an apartment) 

    • Landlords would be furious 

    • Solution for landlords: they would just sell their apartment 

    • Designed to make renting more affordable, didn’t increase the supply, but people who are allowed to stay in their apartments and pay less for it now (they were paying 5000 a month and are now paying 3000) benefit from it

• Set below the equilibrium oric 

• Black markets 

• Rationing problem  

Price floor: minimum legal price a seller can sell a product

• goal: keep price high by keeping the price from falling to equilibrium 

• Increase the price 

• prices are set above the market price 

  • Price go below a certain price 

• chronic surpluses 

• Ex: minimum wage law 

  • Minimum wage is set at 20 an hour, government wants to increase it to 30 because people have families to take care of 

Chapter 4: 

• Efficiently Functioning Markets:

  • Demand curves must reflect the consumer's full willingness to pay

  • supply curve must reflect all of the costs of production (the producers willingness to sell)

  • If both of these are occurring then by producing at the equilibrium quantity is efficient 

  • the market is producing the amount of output that society desires, maximizing benefit to consumers and producers (total surplus)

• Consumer surplus - the area below the demand curve and above the market price 

  • “Is the buyer getting a good deal?”

  • shows that the buyer getting a good deal 

• Producer surplus - the area above the supply curve and below the market price

  • “Is the seller getting a good deal?”

  • difference between the actual route a producer receives and the minimum price they would accept

  • difference between they wanted to sell something compared to what they actually sold it for **

  • extra benefit from receiving a higher price 

• Deadweight loss - efficiency loss

  • inefficiency**

  • Not all resources are used up, being wasteful 

  • not good for a society

  • Can be overallocation OR underallocation of resources  

• Marginal benefit is known as demand, marginal cost is known as supply

• If inside of the graph when labeling consumer and producer surplus, put addition signs between the letters to show addition. 

Chapter 6: 

Elasticity of demand - the measure of how responsive buyers are to a change in price 

• price elasticity of demand: knowing what the response will be to a change in price 

  • Why does elasticity matter? elasticity matters because it helps firms decide what to change and when, if ever, to have sales

  • it helps firms determine how many substitutes are in the market 

  • it is also used by the government to decide when and how much to tax (they always tax Inelastic goods) 

• price elasticity of supply: 

• cross-price elasticity 

• Income elasticity of demand 

• Inelastic demand: insensitive to price chances, small changes in quantity. Price increase: quality demanded will fall a little. Price decrease: quantity demanded increases a little. Inelastic demand = quantity is insensitive to a change in price. People will continue to buy it even though the price changes!

• Elastic demand: sensitive to price changes, large change in quantity. Quantity is sensitive to a change in prices. Price increase: quantity demanded will fall a lot. Price decrease: quantity demanded will increase a lot. The amount people buy is sensitive to price 

• Total revenue test - uses elasticity to show how changes in price will affect total revenue (the easiest way to determine elasticity unless you are asked to find the coefficient)

• Inelastic demand: price increase can cause total revenue to increase. Price decrease can cause total revenue to decrease

  • Moving in the same direction

• elastic demand: big response to a change in price. Price goes up, the total revenue will decrease a lot (vice versa)

  • Moving in opposite directions

• Unit elastic: price changes, but the total revenue stays the same

Chapter 7: Utility Maximization 

• Law of diminishing marginal utility: states that the more someone consumes of a good/service, the additional satisfaction will eventually start to decrease 

  • How does this explain the downward slope of the demand curve? It represents the diminishing marginal utility law (consumers will only want to purchase more as long as the price falls because they won’t get the same satisfaction as before)

• Utility: satisfaction 

  • NOT usefulness

  • Subjective

  • Difficult to quantify 

  • Util: one unit of satisfaction 

  • Total utility: the total amount of satisfaction

  • Marginal utility: the extra satisfaction from consuming an additional unit of a good**

    • Formula: MU = change in TU/change in Q (memorize)

• Rational behavior: the consumer will use their money to derive the greatest satisfaction from it

• Preferences: each consumer has different preferences

• Budget (income) constraint - at any point in time a consumer has a limited/fixed amount of money to spend

• Prices - every good has a price on it and the prices do not change based on the amount purchased 

• Consumer equilibrium - consumer allocates their incomes so that the last dollar spend on each product yields the same amount of the marginal utility (the extra satisfaction)

  • If you get more satisfaction from option A, you will keep doing that until the utils per dollar are less than option B and then you will choose option B