Chapters 4 & 5: Supply and Demand

4-1: What is Demand?

Microeconomics is the part of economic theory that deals with the behavior and decision making by individual units, such as people and firms.
Microeconomic concepts help explain how prices are determined.

Demand is the desire, ability, and willingness to buy a product.

Demand is a concept specifying the different quantities of an item that will be bought at different prices.

The Law of Demand: There is an inverse relationship between the price of an item and the quantity demanded.
As price goes up, the quantity demanded will go down. As price goes down, the quantity demanded will go up.

Marginal Utility is the additional satisfaction or usefulness a consumer gets from having one more unit of a product. Diminishing Marginal Utility states that the extra satisfaction we get from using additional quantities of the product begins to decline. How many cars do you really need?

Demand Schedule table that lists how much of a product consumers will buy at all possible prices
Price $30 $25 $20 $15 $10 $5 Quantity Demanded 0 1 1 3 5 8

Demand Curve a graph showing the quantity demanded at each and every price that might prevail in the market
(graphs in motion)

4-2: Factors Affecting Demand

When it comes to demand, there are two types of changes
When the price of a product changes while all other factors remain the same, there will be a change in the quantity demanded. Price of hamburger decreases at McDonalds, people will buy more hamburgers.
Sometimes when other factors change while the price remains the same, there will be a change in demand. If McDonalds redesigns its restaurants to appeal to more people, they will have more customers.

Change in Quantity Demanded

Caused by a change in price Graphically represented by a move along the demand curve Income effect the change in quantity demanded due to the change in a buyers real income
Price goes down, you spend less, you feel richer, you buy more.

Change in Demand
Caused by a change in factors other than price Consumers decide to buy different amounts of the product at the same prices Graphically represented by a shift of the demand curve, giving an entirely new demand curve (graphs in motion) Can be caused by changes in: consumer income consumer tastes (trends) cost of substitutes cost of complements consumer expectations number of consumers

Substitution effect the change in quantity demanded due to a price change that makes other products more or less costly

4-3: Elasticity of Demand

Elasticity is a measure of responsiveness. cause and effect how much does a dependent variable respond to a change in the independent variable How much does the quantity demanded respond to an increase or decrease in price? Depends on its elasticity. Demand is elastic when a change in price results in a relatively larger change in quantity demanded. (m<-1) Demand is inelastic when a change in price results in a relatively smaller change in quantity demanded. (m>-1) A product is unit elastic when a change in price results in a proportional change in quantity demanded. (m=-1)

Type of demand
Change in Price Change in quantity demanded Change in expenditures (price times quantity)

Elastic
Down Up Up

Inelastic
Down Up Down

Unit Elastic
Down Up Same

Some determinants of Elasticity Can the purchase be delayed? Are adequate substitutes available? Does purchase use a large portion of income?

5-1: What is Supply?

Supply is the amount of a product that would be offered for sale at all possible prices that could prevail in the market The Law of Supply: There is an direct relationship between the price of an item and the quantity supplied.
As price goes up, the quantity supplied will go up. As price goes down, the quantity supplied will go down. (graphs in motion)

Change in Quantity Supplied

Caused by a change in price Graphically represented by a move along the supply curve

Change in Supply
Caused by a change in factors other than price Producers offer different amounts of the product to sell at the same prices Graphically represented by a shift of the demand curve, giving an entirely new demand curve Can be caused by changes in: cost of resources, productivity, technology, expectations taxes and subsidies, government regulations number of sellers

Supply is elastic when a change in price results in a relatively larger change in quantity supplied. (m<+1) Supply is inelastic when a change in price results in a relatively smaller change in quantity supplied. (m>+1)

A product is unit elastic when a change in price results in a proportional change in quantity supplied. (m=-1)

5-2: Theory of Production

The production function shows how total output changes when the amount of a single Stages of Production variable (usually labor) I. Increasing marginal returns changes over the short run. The marginal product is the extra output or change in total product caused by adding one more unit of variable input.

- Each additional worker adds more to the total output than the worker before.

Can be illustrated with a production schedule or graph

. (graphs in motion)

II. Decreasing marginal returns - Each additional worker is making a diminishing, but still positive, contribution III. Negative marginal returns - Each additional worker decreases total output

5-3: Cost, Revenue, and Profit Maximization

Fixed Costs or Overhead - costs that an organization incurs even when the is little or no activity, usually machinery and capital resources Variable Costs costs that change when the businesss rate of production or output changes, usually labor and raw materials Total Costs sum of the fixed and variable costs Break-Even Point level of production that generates just enough income to cover its total operating costs Total Revenue all the revenue that a company receives Marginal Revenue additional revenue a company receives from the production and sale of one additional unit of output