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Law of Demand - all else constant, as price falls, the quantity demanded rises.
Similarly, as price increases, the corresponding quantity demanded falls. This
relationship leads to the downward sloping demand curve.
Rationale:
1.) Common sense and simple observation seems to substantiate this assertion
3.) The income effect - a decline in the price increases the purchasing power of a
buyer's money, enabling him or her to buy more of the product than before.
4.) The substitution effect - at a lower price, buyers have the incentive to
substitute the cheaper good for similar goods which are now relatively more
expensive. For example, at a lower price, beef is relatively more attractive and is
substituted for pork, mutton, chicken, etc.
Determinants of Demand
The determinants of demand are also known as demand shifters. They result in the
leftward (decrease) or rightward (increase) shifts in the demand curve.
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* As income increases, a superior good's demand increases
* As income decreases, a superior good's demand decreases
* Superior goods are most common goods
Inferior Goods
Substitute Goods
Complementary Goods
Independent Goods
Terminology Clarification
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Price Determination
A surplus occurs when there is too much supply and not enough demand at a
particular price
*
A shortage occurs when there is too much demand and not enough supply at a
particular price.
Eventually, the market will shift toward equilibrium. The ability of the competitive
forces of supply and demand to establish a price where selling and buying decisions
are synchronized or coordinated is called the rationing function of prices.
Demand Curve
Supply Curve
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All else constant, an increase in supply causes a decrease in equilibrium price
and an increase in equilibrium quantity supplied.
Complex Cases
If both supply and demand curves change, the result is indeterminate - the changes
on equilibrium price and quantity depend on how much each curve has changed.
The Equilibrium Price is 4.0 per bushel at the Equilibrium Quantity of 75,000
bushels. With these price and quantity, the supply surplus is 0.
B. GRAPH THE DEMAND FOR WHEAT AND THE SUPPLY OF WHEAT. BE SURE
TO LABEL THE AXIS OF YOUR GRAPH CORRECTLY. LABEL EQUILIBRIUM
PRICE P AND EQUILIBRIUM QUANTITY Q.
C. WHY WILL 3.40 NOT BE THE EQUILIBRIUM PRICE IN THIS MARKET? WHY
NOT 4.90? “SURPLUSES DRIVE PRICES UP; SHORTAGES DRIVE THEM
DOWN.” DO YOU AGREE? EXPLAIN?
The 3.40 price results to a shortage of 13,000 bushels and the price of 4.90 a
surplus of 21,000 bushels. We agree that consumer demand for wheat with a
supply shortage of 13,000 would drive prices up while surplus of 21,000 would
eventually drive prices down. Supply shortages, on the one hand, would result to
more and more people competing to buy such supply items resulting to a natural
increase in prices. On the other hand, when demand is below supply levels
resulting to supply surpluses, prices will tend to go down.
D. SUPPOSED THAT THE GOVERNMENT ESTABLISHES A PRICE CEILING OF
3.70 FOR WHEAT. WHAT MIGHT PROMPT THE GOVERNMENT TO ESTABLISH
THIS PRICE CEILING? EXPLAIN CAREFULLY THE MAIN EFFECTS.
DEMONSTRATE YOUR ANSWER GRAPHICALLY. NEXT, SUPPOSED THAT THE
GOVERNEMNT ESTABLIHSED A PRICE FLOOR OF 4.60 FOR WHEAT. WHAT
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WILL BE THE MAIN EFFECTS OF THE THIS PRICE FLOOR. DEMONSTRATE
THE ANSWER GRAPHICALLY.
The government regulation to impose a Price Ceiling 3.70 (which is still below the
Equilibrium Price of 4.00) is intended to allow consumers to enjoy lower
priceshopefully within a manageable supply shortage of 7,000 bushels. This respite
on the part of consumers will be shortlived unless the shortage is addressed.
The Price Floor of 4.60 which is above the Equilibrium Price of 4.00 does in any way
serve the interests of both consumers and suppliers. The impending supply surplus
would marginalize many consumers. As consumer demand plunges, supply surplus
would accumulate as wheat sellers will not be able to sell their wheat stocks—
driving them out of business.
Both of these situations lead to market failures.
Prices of US Corn behaved unpredictably over the past three years (2007-2009). In
2007, corn prices was at US$ 2.00, then it rose to US$ 3.50 in 2008 and further rose
to US$ 4.00 in 2009 (after reaching an all time high of US$ 5.50 in mid-2008).
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However, the increase in demand was short lived as demand dwindled at the close
of 2008 and continued up this time.
On the other hand, US Corn production in 2006 was at 10.5 billion bushels which
further rose to 13.1 billion bushels in 2007. However, in 2008 corn production
shrunk to 12.1 billion bushels.
It was more likely that the increase in demand drove corn prices up from US$ 2.00
in 2007 to US$5.50 in 2008.
US Hog Prices and Production Volume
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Prices of US Hogs ahave reamined on the averaged of US$ 43.00 with production
volume remaining fundamentally unchanged since 2000 up to the present at around
25 billions pounds annually.
US Milk Prices and Production Volume
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US Milk prices began an increasing trend: from US$ 12.00 in 2006, US$ 16.00 2007,
US$ 18.00 in 2008. The trend is broken 2009 when milk prices droppedto below
2006 level at US$ 11.00.
On the other hand, US milk production as has been on the increase since 2001. By
2005, the US has produced 177 billion pounds. This further increased in 2006 at
187 billion pounds and in 2007, 190 billion pounds.
In unprecedented production volume capacity beginning 2007 (since Us data is only
up to 2007), milk supply must have yielded a surplus.
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