chapterthree - Ch.3 Demand and Supply Markets and Prices -...

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Ch.3 Demand and Supply Markets and Prices - A market has two sides: buyers and sellers. There are markets for goods, services and other manufactured inputs. - Some markets are physical places where buyers and sellers meet. Ex. NYSE, produce and meat markets. Some are groups of people spread around the world. Ex. E-commerce and currency markets. Most markets are unorganized collections of buyers and sellers. - Competitive market : a market that has many buyers and many sellers, so no single buyer or seller can influence the price. - Producers offer items for sale only if the price is high enough to cover their opportunity cost. And consumers respond to changing opportunity cost by seeking cheaper alternatives to expensive items. - In everyday life, the price of an object is the number of dollars that must be given up in exchange for it, or the money price . - The ratio of one price to another is called a relative price , and a relative price is an opportunity cost. o The normal way of expressing a relative price is in terms of a “basket” of all goods and services. To calculate this relative price, we divide the money price of a good by the money price of a “basket” of all goods (called a price index ). The resulting relative price tells us the opportunity cost of the good in terms of how much of the “basket” we must give up to buy it. o The theory of demand and supply determines relative prices. When we predict that a price will fall, we mean that the price will fall relative to the average price of other goods and services. Demand - If you demand something, then you want it, can afford it, and plan to buy it. - Scarcity guarantees that many of our wants will never be satisfied. Demand reflects a decision about which wants to satisfy. - Quantity demanded : the amount that consumers plan to buy during a given time period at a particular price. The quantity demanded is not necessarily the same as the quantity actually bought. o Measured as an amount per unit of time. o How, other things remaining the same, does the quantity demanded of a good change as its price changes? - THE LAW OF DEMAND: Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded. o Why does a higher price reduce the quantity demanded? o Substitution Effect: When the price of a good rises, its relative price rises. Although each good is unique, it has substitutes , other goods that can be used in its place. As the opportunity cost of a good rises, people buy less of that good and more of its substitutes. o Income Effect: When a price rises and all other influences on buying plans remain unchanged, the price rises relative to people’s incomes. With a higher price and unchanged income, people cannot afford to buy all the things they previously
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bought. They must decrease the quantities demanded of at least some goods and services, and normally, the good whose price has increased will be one of the
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This note was uploaded on 02/17/2008 for the course ECON 51 taught by Professor Leachman during the Spring '08 term at Duke.

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chapterthree - Ch.3 Demand and Supply Markets and Prices -...

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