CHAPTER 3 notes - Understanding Individual Markets Demand...

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Understanding Individual Markets: Demand and Supply CHAPTER THREE INDIVIDUAL MARKETS: DEMAND AND SUPPLY CHAPTER OVERVIEW This chapter provides a basic, but rather detailed introduction to how markets operate as well as an introduction to demand and supply concepts. Both demand and supply are defined and illustrated; determinants of demand and supply are listed and explained. The concept of equilibrium and the effects of changes in demand and supply on equilibrium price and quantity are explained and illustrated. The chapter also includes brief discussions of supply and demand factors in resource markets and the importance of the ceteris paribus assumption. LECTURE NOTES I. Markets Defined A. A market is an institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of particular goods and services. 1. A market may be local, national, or international in scope. 2. Some markets are highly personal, face-to-face exchanges; others are impersonal and remote. 3. This chapter concerns purely competitive markets with a large number of independent buyers and sellers. 4. A product market involves goods and services. 5. A resource market involves factors of production. B. The goal of the chapter is to explain the way in which markets adjust to changes and the role of prices in bringing the markets toward equilibrium. II. Demand A. Demand is a schedule that shows the various amounts of a product that consumers are willing and able to buy at each specific price in a series of possible prices during a specified time period. 1. Example of a demand schedule for corn is Table 3-1. 2. The schedule shows how much buyers are willing and able to purchase at five possible prices. 3. The market price depends on demand and supply. 4. To be meaningful, the demand schedule must have a period of time associated with it. B. Law of demand is a fundamental characteristic of demand behavior. 1. Other things being equal, as price increases, the corresponding quantity demanded falls. 2. Restated, there is an inverse relationship between price and quantity demanded. 3. Note the “other-things-equal” assumption refers to consumer income and tastes, prices of related goods, and other things besides the price of the product being discussed. 4. Explanation of the law of demand 35
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Understanding Individual Markets: Demand and Supply a. Diminishing marginal utility: The decrease in added satisfaction that results as one consumes additional units of a good or service, i.e., the second “Big Mac” yields less extra satisfaction (or utility) than the first. b. Income effect: A lower price increases the purchasing power of money income, enabling the consumer to buy more at a lower price (or less at a higher price). c. Substitution effect: A lower price gives an incentive to substitute the lower-priced good for now relatively higher-priced goods.
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