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03sg - Chapter 3 DEMAND AND SUPPLY Key Concepts Markets and...

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45 3 DEMAND AND SUPPLY K e y C o n c e p t s Markets and Prices A competitive market is one that has so many buyers and sellers so that no single buyer or seller can influ- ence the price. The ratio of the money price of one good to the money price of another good is the relative price . The relative price of a product is the product’s opportunity cost. The demand for and supply of a product depend, in part, on its relative price. Demand The quantity demanded of a good is the amount that consumers plan to buy during a time period at a par- ticular price. The law of demand states that “other things remaining the same, the higher the price of a good, the smaller is the quantity demanded.” Higher prices decrease the quantity demanded for two reasons: Substitution effect — a higher relative price raises the opportunity cost of buying a good and so people buy less of it. Income effect — a higher relative price reduces the amount of goods people can buy. Usually this effect decreases the amount people buy of the product that rose in price. Demand is the entire relationship between the price of a good and the quantity demanded. A demand curve shows the inverse relationship between the quantity demanded and price, everything else remaining the same. For each quantity, a demand curve shows the highest price someone is willing to pay for that unit. This highest price is the marginal benefit a consumer receives for that unit of output. Demand Curves FIGURE 3.1 Price (dollars per street hockey ball) Quantity (thousands of street hockey balls per week) 0 3 1 4 5 2 6 1 2 3 4 5 D 1 D 2 Demand curves Demand curves are negatively sloped, as illustrated in Figure 3.1. A change in the price of the product leads to a change in the quantity demanded and a movement along the demand curve . The higher the price of a good, the lower is the quantity demanded. This re- lationship is shown in Figure 3.1 with the move- ment along , 1 from 4,000 to 2,000 street hockey balls demanded per week in response to a rise in price from $2 to $4 for a street hockey ball. A change in demand and a shift in the demand curve , occur when any factor that affects buying plans, other than the price of the product changes. An increase in demand means that the demand curve shifts rightward, such as the shift from , 1 to , 2 in Figure 3.1; a de- C h a p t e r
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4 6 C H A P T E R 3 crease in demand refers to a shift leftward. The demand curve shifts from changes in the following: prices of related goods — a rise in the price of a sub- stitute increases demand and the demand curve shifts rightward; a rise in the price of a complement decreases demand and the demand curve shifts left- ward. expected future prices — if a product’s price is ex- pected to rise in the future, the current demand for it increases and the demand curve shifts rightward.
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