Unit 2 Notes

I. Demand a. The willingness and ability to buy/consume something b. The Law of Demand i. As price goes up, quantity demanded goes down. As price goes down, quantity demanded goes up. ii. 3 Factors that influence demand 1. Substitution Effect a. As the price of one good/service goes up, quantity demanded for all of its substitutes goes up. As the price of one good/service goes down, quantity demanded for all its substitutes goes down. 2. Real Income Effect a. As prices rise and your incomes stays the same, quantity demanded for all goods/services goes down. As prices decrease and your income stays the same, quantity demanded for all goods/services goes up. 3. Diminishing Marginal Utility a. getting smaller, additional, satisfaction b. Assuming all things stay the same (ceteris paribus), with each additional unit consumed, we receive less satisfaction then the previous unit consumed. c. The Demand Curve i. The graphical representation of a demand schedule ii. ALWAYS goes top-left to bottom-right iii. Only shows how we respond to changes in price d. Market Demand i. Sum of all individual demands in the market Shifts in Demand a. Ceteris Paribus i. all thing held constant b. Change in price =Change in quantity demanded c. Change in anything else=Shift in demand d. Causes of Shifts i. Income 1. normal goods a. goods that people buy more of as income increases 2. inferior goods a. goods that people buy less of as income increases ii. Expectations 1. If you expect price to rise in the future, your demand will increase today 2. If you expect prices to decrease in the future, your demand will decrease today Copyright 2008 theboylefactor Fall 08

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iii. Population 1. As the population increases, demand for all goods/services increases 2. As population decreases, demand for all goods/services decreases iv. Tastes/Advertising 1. trends, fads, Super Bowl ads v. Prices of related goods 1. Complements a. Two goods that are bought and sold together i. Peanut butter and jelly 1. as the price of peanut butter goes down, demand for jelly will increase (regardless of price) 2. Substitutes a. Goods used in place of one another i. Hamburgers or Hot dogs 1. as the price of hamburgers goes up, demand for hot dogs will increase (regardless of price) Elasticity of Demand a. Measures the way consumers react to a price change b. The How Much? c. Calculating Elasticity i. % change in demand / % change in price (% cd / % cp) ii. Unitary Elastic 1. % cd / % cp = 1 iii. Elastic Demand 1. consumers ARE responsive to price changes (BIG) 2. % cd / % cp > 1 iv. Inelastic Demand 1. consumers are NOT responsive to price changes (small) 2. % cd / % cp < 1 d. Factors affecting Elasticity i. Availability of Substitutes 1. more subs = more elastic 2. less subs = more inelastic ii. Relative Importance (% of budget) 1. more expensive = more elastic 2. less expensive = more inelastic iii. Necessities vs Luxuries 1. more necessary = more inelastic 2. more luxury = more elastic Copyright 2008 theboylefactor Fall 08

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iv. Time (to Adjust) 1. more time = more elastic 2. less time = more inelastic e. Elasticity and Revenue i. Revenue = price * quantity sold ii. Elastic demand = lower price to increase revenue iii. Inelastic Demand = raise price to increase revenue Supply a. Law of Supply i. As price goes up, quantity supplied goes up. As price goes down, quantity supplied goes down ii. Factors influencing Supply 1. Incentive for greater profit a. As prices rise, suppliers believe they will make more profit, therefore, they become more willing and able to increase their supply. 2. Market Entry (# of Suppliers) a. As prices rise, suppliers believe they will make more profit, therefore, more suppliers will enter the marketplace. iii. Supply schedule (see demand) iv. Market Supply (see demand) v. Supply curve-Graphical representation of supply schedule vi. Elasticity of Supply 1. Time is the largest factor influencing elasticity a. In the short run (today), supply tends to be inelastic b. In the long run (future), supply can become more elastic b. Costs of Production i. Labor and Output 1. Marginal Product of Labor a. additional output from one more worker 2. Specialization (Division of Labor) a. allows marginal output to increase as resources are added 3. Increasing Marginal Returns a. Marginal Product of Labor is increasing as workers are added b. The next worker adds more to total output than the previous worker 4. Diminishing Marginal Returns a. Marginal Product of Labor is decreasing as workers are added Copyright 2008 theboylefactor

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b. The next worker adds less to total output than the previous worker 5. Negative Marginal Returns a. The next worker added decreases total output ii. Production Costs 1. Fixed Costs a. Does not change according to the number of units produced b. Examples i. Rent, property taxes, regularly scheduled maintenance ii. Salaried Employees 2. Variable Costs a. Costs that change according to the number of units produced b. Examples i. Raw materials, utility bills ii. Hourly Employees 3. Total Costs a. Fixed Costs + Variable Costs 4. Marginal Cost a. Additional cost of producing one more unit iii. Setting Output 1. Profit = Total Revenue Total Cost 2. Marginal Revenue = Marginal Cost iv. Shutting Down 1. If Revenue is > operating costs (variable costs) = stay open a. Lose less 2. If revenue is < operating costs = close c. Changes in Supply i. Input Costs 1. costs go up, supply goes down (left) 2. costs go down, supply goes up (right) 3. Technology a. Tends to lower costs ii. Governments Influence 1. Subsidies a. Government payments that support an industry b. Often used to keep prices low c. Impacts farmers in other countries negatively i. Cotton 2. Taxes a. Excise tax i. Tax on the production, distribution or sale or a good ii. Increases costs Boyle Copyright 2008 theboylefactor Fall 08

3. Regulation a. Tends to increase costs b. Example i. Pollution control iii. Expectations 1. If you expect prices to go up in the future, supply is decreased today 2. If you expect prices to go down in the future, supply is increased today iv. Number of Suppliers 1. more suppliers = increase in supply 2. fewer suppliers = decrease in supply

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Fall 08