Post on 28-Dec-2015
Setting an Econom y ’s Price SystemTo understand how a nation’s economy
functions it is important to understand the nation’s price system
The forces that determine price are called the forces of supply and demand
The place where these two forces meet is called the marketplace
Basic factsConsumers have a great influence on
the price of goods and services. Why?
Market: Represents the freely chosen action between buyers and sellers.
Voluntary exchange: Buyers and sellers work out a deal that suits both sides.
DemandDemand shows how many of a product
consumers are willing and able to buy at a particular price during a specified time period.e.g. Swimming suits have a different
price and quantity demanded in summer vs. winter
How many of you would like a new car?How many of you are able?
Law of Demand Explains the amount people are willing
to buy as prices change. Demand can only occur if a buyer is
willing and able to buy. Three factors that affect what and how
much people buy are diminishing marginal utility, real income, and substitution.
Price goes up – Demand goes down
Price goes down – Demand goes up
Diminishing Marginal Utility (DMU)Utility: Power of a good or service
to satisfy.Total satisfaction rises with
additional units purchased, but additional satisfaction diminishes.
People will buy until price exceeds satisfaction.
Price decreases, people will buy more.
Real Income Effect Income limits the amount of money
people can spend.People cannot keep buying the same
amount if price increases and income stays the same. (Real income effect).
People are forced to trade-off if price increases.
If price decreases and you buy the same amount, your real income has increased.
Demand CurveDemand Curve is a line graph that
shows the amount of a product that will be purchased at each price; it shows an inverse relationship and is always downsloping
p
DQd
Remember:
A change along the curve indicates a change in price and a change in quantity demanded
A change of the curve (right or left) indicates an across the board change in demand
Law of Demand As price decreases, the quantity demanded
increases. As the price rises, the quantity demanded decreases
P QD
Price per gallon of water
Bottles per week
$ Jo Pat
.75 90 50
.50 130 70
.35 180 100
.25 290 130
Demand for hot chocolate in December at the skating rink
PriceQuantity
Demanded$.50 30
$1.00 25$1.50 20$2.00 15$2.50 10$3.00 5$3.50 0
Demand Determinants
Characteristics that will affect the amount people will buy. Includes changes in population, income, and personal preferences.
Prices of related goods, income, preference/taste, consumer expectations, population change
Demand DeterminantsPrices of Related Goods
Substitutes: Goods that are related in such a way that an increase in the price of one leads to an increase in the demand for the other [goods that can be consumed in place of one another] (Pepsi and Coke)
Compliments: Goods that are related in such a way that an increase in the price of one leads to a decrease in the demand for the other [goods that are normally consumed together] (hamburgers and french fries)
Determinants cont.Income
Normal Good: a good for which demand increases as consumer incomes rise (milk)
Inferior Good: A good for which demand decreases as consumer incomes rise (ground chuck, bus rides)
As income rises consumers tend to switch from consuming these inferior goods to consuming normal goods (ex. steak, car/plane)
Determinants cont.
Preference/TasteLikes and dislikes in consumption
Consumer ExpectationsChange in future price of goodsChange in future income
Population ChangeAs the number of consumers in a market
changes the demand will change
Law of Supply The amount producers are willing to provide
at various prices.As price increases, supply increases.As price decreases, supply decreases.
Law of diminishing returns: Adding units of a factor of production will increase output for a time. Eventually output will decrease.
Supply Schedule & CurvesA Supply Schedule displays the
quantity of a product supplied at each price
Price Per Bottle
Bottles Supplied
.75 200
.50 130
.35 75
.25 50
Supply of shovels before a large snowstorm sold at Lowes
PriceQuantity Supplied
$4.00 5$8.00 10$12.00 15$14.00 20
Determinants of SupplyTechnology
If more efficient technology is discovered production costs will fall
So suppliers will be more willing and able to supply more of the good at each price
Price of Relevant ResourcesThose resources employed in the
production of a good.
Determinants con’tPrices of Alternative Goods
Price of a good that uses some of the same resources as used to produce the good in question
Producer ExpectationsShift production according to future
pricesNumber of Producers
# of Prod. Increases # of supplyGovernment Restrictions
Taxes, quotas, licenses, etc.
Supply and Demand If price falls, demand will increase and supply will
decrease. If price rises, demand will decrease and supply will
increase. Equilibrium price: Point where supply and
demand meet. Shortage and surplus:
When demand is greater than supply, a shortage occurs.
When supply is greater than demand, a surplus occurs.
Prices will rise in a shortage and fall in a surplus.
Price ControlsPrice Ceiling – Gov’t set
maximum price that can be charged for a good or service
Price Floor -- Gov’t set minimum price that can be charged for a good or service
Price Elasticity
How consumers react when prices change.
Elasticity is determined by:Existence of substitutes.Percentage of income spent on a
good or service.Time allowed to adjust to a
change.
Elastic:Many competing brands.Price increases, people choose a substitute.
Inelastic:Not much competition.Price increases, demand does not change.
Types
Steak: Elastic or Inelastic ?
ElasticWhy? People as
a whole can do without steak and will substitute chicken or other protein for expensive steak
Milk: Elastic or Inelastic ?InelasticWhy?The population as a
whole can do without steak….but can not do as easily without milk…especially families with children
What Products are Subject to Elastic Demand ?Luxury Items – Most customers want luxuries and
will consider buying them if price drops If Price Represents a Large Portion of Family Income
e.g. Mortgage Rates drop from 6.5 to 5.5% people will “refinance”
Availability of Substitute Itemse.g. Steak /chicken
Durable GoodsComputers, cars, washers, dryers will be in greater
demand if the price drops
What Products are Subject to “Inelastic Demand”?
Necessities (milk, gasoline)Drugs
Legal (heart medicine antibiotics) Illegal (heroin, cocaine)
Products with no good substitute insulin, cancer drugs, etc. salt in Middle Ages (preservative)
Why is Elasticity of Demand Important ?
What happens if a florist increases the price of roses 400 % in October ? Will sales go up or down ?
A. Probably, down What happens if a florist increases the
price of roses on February 14th? Will sales go down or up?
A. Probably up Why ? Frantic husbands and boyfriends will pay exorbitant prices for a dozen roses on Valentine’s Day.
Competition Competition will exist if different
businesses produce similar products. Perfect Competition
1. Large Market2. Similar Product3. Easy entry and exit4. Information obtainable5. No control over price
Market Price is equilibrium price. (decided by supply and demand)
Imperfect CompetitionOne group can have an impact on price.
MonopolyOligopolyMonopolistic Competition
Barriers to entry:Government regulations: Some goods and services
are protected from duplication by the government.Cost of getting started: Large amount of capital is
needed to begin.Ownership of raw materials: Companies control
materials and do not sell to competitors.
Monopoly One group controls the market.
1. Single seller2. No substitutes3. No entry4. Complete control over price
Suppliers can raise prices without losing business.
Types of Monopoly1. Natural: Control of resources. Water
company
2. Geographic: Control of location Dick’s is the only sports store in the area
3. Technological: Patent on technology4. Government: Created by the
government. Illegal to enter. Post office
5. Cartel: International form of monopoly (OPEC).
Oligopoly A few businesses in competition.
1. Domination of a few sellers2. Barriers to entry3. Identical or slightly different products4. Some control of price
Price wars are common place.
Oligopoly ExamplesMovie Studios
Columbia, 20th Century Fox, Warner Bros., Paramount, Universal, and MGM
TelevisionDisney/ABC, CBS Corp., NBC Universal, Time
Warner, and News CorporationFood Processing
Kraft Foods, PepsiCo, and NestleTelecommunications
AT&T, Verizon, Sprint, and T-Mobile
Monopolistic Competition
1. Numerous sellers2. Easy entry3. Different products4. Competition5. Some control of price
Substitution and advertising are factors.
Mergers One company joins with another.
Horizontal: Companies in the same business.
Vertical: Company joins with one it buys from.
Conglomerate: Buying of un-related businesses.
Vertical or Horizontal?Google and Bing
HorizontalPaper Company and Saw Mill
VerticalTostitos and Corn Fields
VerticalHarris Teeter and Ace Hardware
ConglomeratePepsi and Coke
Horizontal