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Supply Demand


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TOPIC Lesson Summary FUNDAMENTALS OF DEMAND LESSON 1 In economics, demand is the desire to own something and the ability to p

TOPIC Lesson Summary SHIFTS IN DEMAND LESSON 2 The law of demand relates to how price affects demand when all other factors s

TOPIC Lesson Summary ELASTICITY OF DEMAND LESSON 3 Economists use the term elasticity of demand to describe the way people re

TOPIC Lesson Summary FUNDAMENTALS OF SUPPLY LESSON 4 Supply is the amount of a good or service that is available to consumers

  

TOPIC 3 Lesson Summary COSTS OF PRODUCTION LESSON 5 Economists divide a producers costs into fixed costs and variable costs.

TOPIC 3 Lesson Summary COSTS OF PRODUCTION (continued) LESSON 5 Marginal cost is the cost of producing one more unit of a goo

TOPIC 3 Lesson Summary CHANGES IN SUPPLY LESSON 6 The law of supply explains how supply changes in response to price changes

TOPIC Lesson Summary EQUILIBRIUM AND PRICE CONTROLS LESSON 7 In a market, equilibrium is the point at which quantity supplied

TOPIC 3 Lesson Summary CHANGES IN MARKET EQUILIBRIUM LESSON 8 Free markets tend to seek equilibrium. If a price for a good or

TOPIC 3. Lesson Summary PRICES AT WORK LESSON 9 In a free market, prices serve several important functions. Prices are like s

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We were unable to transcribe this image
TOPIC Lesson Summary FUNDAMENTALS OF DEMAND LESSON 1 In economics, demand is the desire to own something and the ability to pay for it. The law of demand states that the lower a good's price, the more consumers will buy, and the higher a good's price, the less consumers will buy. For example, people will demand less pizza if its price goes from $3 a slice to $4. And, they will demand more pizza if the price drops from $3 to $2. People who study economics use two tools to illustrate how price affects the quantity demanded. A demand schedule is a table that shows how much of a good consumers will buy at different prices. A demand curve plots the data from a demand schedule on a graph. The law of demand helps produce two patterns of behavior. The first, known as the substitution effect, says that as the price of one good rises, people are likely to choose a substitute good. When the price of pizza goes up, people are likely to choose a less expensive substitute when they order food. In the same way, if the price of pizza were to drop, diners might substitute pizza for other more expensive menu items. Sometimes, an increase in the price of a pizza may cause consumers to simply buy less pizza without increasing purchases of other goods. This behavior is known as the income effect. It occurs because when the price for pizza and other goods rise, people can no longer afford to buy the same combination of goods. In response, they cut back on their purchases. Lesson Vocabulary demand the desire to own something and the ability to pay for it law of demand consumers will buy more of a good when its price is lower and less when its price is higher demand schedule a table that lists the quantity of a good that a person will purchase at various prices in a market demand curve a graphic representation of a demand schedule substitution effect when a consumer reacts to a rise in the price of one good by consuming less of that good and more of a substitute good income effect the change in consumption that results in response to changes in price
TOPIC Lesson Summary SHIFTS IN DEMAND LESSON 2 The law of demand relates to how price affects demand when all other factors stay the same. In fact, many other factors besides price can affect demand. These factors are called non-price determinants of demand. For example, if the weather became very hot, people may desire less hot pizza. Consumers buy less pizza at all price levels. This change in demand at all price levels is called a demand shift, or a change in demand. On the demand curve, a demand shift moves the entire curve to the right or left. Many factors can shift the demand curve. Changes in income is one example. Higher income causes people to buy more of most goods at every price level. Similarly, a decrease in income causes demand for most goods to fall. Changes in demographics, or the makeup of the population, will affect demand. For example, the aging of the population is likely to increase the demand for medical care. Advertising and fashion trends can also have a big effect on consumer demand. A change in demand for one good can shift demand for other goods. Complements are two goods that are bought and used together. People who buy skis are likely to buy ski boots, so a change in one will affect the other. Substitutes are goods used in place of one another. When people buy more snowboards they will buy fewer skis. Lesson Vocabulary non-price determinant factors other than price that can affect demand for a particular good or service demographics the statistical characteristics of populations and population segments, especially when used to identify consumer markets complements two goods that are bought and used together substitutes goods that are used in place of one another
TOPIC Lesson Summary ELASTICITY OF DEMAND LESSON 3 Economists use the term elasticity of demand to describe the way people respond to price changes. If you keep buying despite a price increase, your demand is inelastic. If you buy a lot less after a small price increase your demand is elastic. Demand tends to be inelastic for goods that have few substitutes, like medicines, or for goods that are considered essential, like milk. Demand is often elastic for luxury items. Economists have a mathematical formula they use to measure elasticity of demand. The formula calculates the ratio of change in demand to change in price. If there is less than a one-to-one ratio of change in demand to change in price, demand is inelastic. If there is a greater than one-to-one ratio, demand is elastic. Elasticity is an important tool for business owners. It helps them to determine how a change in prices will affect their business's total revenue, or the amount of money the company receives by selling its goods. If a business faces elastic demand for its good or service, then raising prices will result in a sharp drop in demand. This may decrease total revenue. However, when a good has an inelastic demand, a business might be able to increase prices and sell the same quantity of its good or service. In that case, the business would enjoy an increase in total revenue. Lesson Vocabulary elasticity of demand a measure of the way quantity supplied reacts to a change in price inelastic describes demand that is not very sensitive to price changes elastic describes demand that is very sensitive to a change in price total revenue the total amount of money a company receives by selling goods or services
TOPIC Lesson Summary FUNDAMENTALS OF SUPPLY LESSON 4 Supply is the amount of a good or service that is available to consumers. As the price of a good rises, firms will increase the quantity supplied, or the amount of the good or service they offer to the market. New firms will have an incentive to enter the market. The tendency of suppliers to offer more of a good at a higher price is called the law of supply. This law states that the higher the price, the larger the quantity supplied. If the price of a good falls, less of a good will be supplied. Economists record data about how price affects supply on a table called a supply schedule. They also create supply curves, which are graphs that show how changes in price affect quantity supplied. For example, a supply curve could show the quantity of pizza supplied at different prices. A supply curve always rises from left to right. That is because higher prices encourage producers to supply more of that good or service to the market. Elasticity of supply is a concept that describes how suppliers react to price changes. Industries that cannot easily alter quantity supplied in response to price changes have inelastic supply. Orange growers, for example, cannot quickly grow more oranges when prices for oranges rise. They need to purchase more land and plant more trees in order to increase output. A barbershop, however, may have a more elastic supply, meaning it can alter its supply quickly in response to price changes. If the price of a haircut rises, barbershops and salons can hire new workers or increase hours quickly. Lesson Vocabulary supply the amount of a good or service that is available quantity supplied the amount of a good or service that a producer is willing and able to supply at a specific price law of supply producers offer more of a good or service as its price increases and less as its price falls supply schedule a chart that lists how much of a good or service a supplier will offer at various prices supply curve a graph of the quantity supplied of a good or service at various prices elasticity of supply a measure of the way quantity supplied reacts to a change in price
TOPIC 3 Lesson Summary COSTS OF PRODUCTION LESSON 5 Economists divide a producer's costs into fixed costs and variable costs. A fixed cost is a cost that does not change, no matter how much the business produces. Examples of fixed costs include rent and the purchase of machinery. A variable cost is a cost that rises or falls depending on the quantity of good produced. These include the costs of raw materials and some labor. Fixed and variable costs together add up to produce the total cost. Businesses can increase output by hiring more workers or purchasing more machinery. The change in output from adding one more worker is called the marginal product of labor. Often, adding one new worker will result in increasing marginal returns, meaning the output of goods per worker goes up. This happens because adding more workers may allow people to specialize and fully use tools or machinery. But at some point, adding new workers may no longer increase output per worker, and the business will experience diminishing marginal returns. For example, workers may need to wait to use a tool or machine. As more workers are added and they begin to get in each other's way, there can eventually be negative marginal returns, in which each new worker actually lowers total output (Continues on the next page.) Lesson Vocabulary fixed cost a cost that does not change no matter how much of a good or service is produced variable cost a cost that rises or falls depending on the quantity produced total cost the sum of fixed costs and variable costs marginal product of labor the change in output that results from hiring one additional unit of labor increasing marginal return the level of production in which the marginal product of labor increases as the number of workers increases diminishing marginal return the level of production in which the marginal product of labor decreases as the number of workers increases negative marginal return when the addition of a unit of labor actually reduces total output
TOPIC 3 Lesson Summary COSTS OF PRODUCTION (continued) LESSON 5 Marginal cost is the cost of producing one more unit of a good. Marginal revenue is the revenue gained from producing one more unit of a good, and it is equal to the market price of the unit on the market. When marginal cost is less than marginal revenue, a producer has an incentive to increase output, since it will earn a profit on the next unit produced. When marginal cost is more than marginal revenue, a producer has an incentive to decrease output, since it will lose money on the next unit produced. That is why profits are maximized when marginal cost equals marginal revenue. Lesson Vocabulary marginal cost the cost of producing one more unit of a good or service marginal revenue the additional income from selling one more unit of a good or service; sometimes equal to price
TOPIC 3 Lesson Summary CHANGES IN SUPPLY LESSON 6 The law of supply explains how supply changes in response to price changes when all other factors are constant. But all other factors are not always constant. Many non-price determinants can affect supply and cause it to change at all price levels. For example, any change in the cost of inputs, such as raw materials, machinery, or labor, will affect supply at all price levels. A cost increase for inputs causes a drop in supply at all prices because the good has become more expensive to produce. A change of supply at all price levels is called a shift in supply. That is because a change in supply causes the entire supply curve to shift. On a graph, an increase in supply causes the supply curve to shift to the right. A decrease in supply causes the curve to shift to the left. The government has the power to cause supply shifts. A subsidy is a government payment to support a business or market. Since the subsidy lowers producers' costs, it is likely to cause an increase in supply. The government can also reduce the supply of some goods by placing an excise tax on them. An excise tax is a tax on the production or sale of a good, making it more expensive to produce. Regulation, or steps the government takes to control production, may also affect supply. Producers' expectations are another influence on supply. If sellers expect the price of a good to rise in the future, they will store goods now and sell more in the future. But if the price of the good is expected to drop, sellers will put more goods on the market immediately. Lesson Vocabulary subsidy a government payment that supports a business or market excise tax a tax on the production or sale of a good regulation government intervention in a market that affects the production of a good
TOPIC Lesson Summary EQUILIBRIUM AND PRICE CONTROLS LESSON 7 In a market, equilibrium is the point at which quantity supplied and quantity demanded are equal. It is the price at which buyers are willing to buy the same quantity of a good or service that the sellers are willing to sell. On a graph, equilibrium is the point where the supply curve and the demand curve meet. A market is said to be in disequilibrium when the quantity supplied does not equal the quantity demanded. When disequilibrium occurs, market forces push the market back toward equilibrium. When quantity demanded is more than quantity supplied, there is excess demand, or a shortage. Shortage occurs when prices somehow fall lower than the equilibrium price, which encourages buyers and discourage sellers. When a shortage occurs, sellers are likely to raise their prices so they can earn more profits. In time, the price increase will lower demand, and the market will again reach an equilibrium point, where supply and demand are the same. When quantity supplied is more than quantity demanded, there is excess supply, or a surplus. Prices will fall because sellers need to sell their supply. Sometimes governments attempt to control prices in a market. Governments may set a price ceiling, a maximum price that can be charged for a good or service. For example, some cities have price ceilings on rental apartments. If the price ceiling is lower than the equilibrium price, a shortage will result. Property owners will offer fewer apartments than people want to rent. Governments may also set a price floor, a lowest price that can be paid. An example is the minimum wage, the lowest hourly rate a business can pay workers. When a minimum wage is higher than the equilibrium rate, a surplus of labor may occur. Lesson Vocabulary equilibrium the point at which the demand for a product or service is equal to the supply of that product or service disequilibrium any price or quantity not at equilibrium; when quantity supplied is not equal to quantity demanded in a market shortage a situation in which consumers want more of a good or service than producers are willing to make available at a particular price surplus when quantity supplied is more than quantity demanded price ceiling a maximum price that can legally be charged for a good or service price floor a minimum price for a good or service minimum wage a minimum price that an employer can pay a worker for an hour of labor
TOPIC 3 Lesson Summary CHANGES IN MARKET EQUILIBRIUM LESSON 8 Free markets tend to seek equilibrium. If a price for a good or service leads to excess supply or demand, market forces push the price up or down until supply and demand are again equal. Sometimes, however, changes in market conditions lead to the shift of an entire demand curve or supply curve. This means that the quantity demanded or supplied changes at all price levels. Such changes also create disequilibrium. When this occurs, market forces seek to establish a new equilibrium point, a price where the new supply and demand meet. Technology, for example, can make a good cheaper to produce. The earliest digital cameras cost many hundreds of dollars. Then technology improved, lowering the cost of making the cameras. The price of cameras also dropped. The supply curve shifted to the right as producers were willing to offer greater quantities of cameras at all prices. However, quantity supplied was now greater than quantity demanded, leading to a surplus. Producers reacted to the surplus by lowering prices, and eventually price and quantity reached a new equilibrium. A shift in demand can be caused by a fad, such as the surge in popularity of a new toy. The demand curve shifts, reflecting the fact that buyers are willing to buy more toys at every price. At the old equilibrium price, demand is now greater than supply, creating a shortage. Producers respond by raising prices and increasing supply, until once again the quantity supplied equals the quantity demanded and a new equilibrium is established. Lesson Vocabulary free market A market in which individuals determine what gets made, how it is made, and how much people can consume of goods and services produced
TOPIC 3. Lesson Summary PRICES AT WORK LESSON 9 In a free market, prices serve several important functions. Prices are like signals that send information to buyers and sellers. For producers, a high price is a signal to increase supply. A low price is a signal to reduce the supply or leave the market. For buyers, a low price is a signal and an incentive to buy. A high price is a signal to think before buying Another key feature of prices is that they are flexible. Prices can usually change more quickly than production levels. Consider the example of a supply shock, which is a sudden shortage of a good. If a natural disaster destroys a crop, for example, supply cannot be quickly restored. But prices can change quickly, helping reduce excess demand. There are options to the price system. Rationing is a system for allocating goods and services using tools other than price. When rationing is in place, people are told what and how much of a good they can consume. Centrally planned economies use rationing, not price, to distribute goods and services. Rationing is expensive to administer. There is generally little variety of goods available, as producers have little incentive to respond to the demands of consumers. Rationing also leads to the appearance of black markets, which are illegal markets for the exchange of goods outside the rationing system. Prices do not always work efficiently in markets in which there is not much competition, or in which buyers and sellers do not have enough information. Another inefficiency in markets involve negative externalities, such as air and water pollution. These are side effects of production that producers do not have to pay and that are not reflected in the prices consumers pay. Lesson Vocabulary supply shock a sudden shortage of a good rationing a system of allocating scarce goods and services using criteria other than price black market a market in which goods are sold illegally, without regard for government controls on price or quantity
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