E-201.Study Guide Chapter3.Key Terms and Questions

E-201.Study Guide Chapter3.Key Terms and Questions -...

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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 money price of a good is the num- ber of dollars that must be given up for a good. The ratio of one price to another is the relative price . The relative price of a good is the good’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 good that rose in price. Demand is the entire relationship between the price of a good and the quantity demanded. A demand curve shows the relationship between the quantity demanded of a good and its price, everything else remaining the same. Demand curves are negatively sloped, as illus- trated in Figure 3.1. 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. A change in the price of the good or service leads to a change in the quantity demanded and a move- ment along the demand curve . The higher the price of a good or service, the lower the quantity de- manded. In Figure 3.1, along demand curve D 0 when street hockey balls rise in price from $2 to $4, the quantity demanded decreases from 4,000 to 2,000 street hockey balls per week. 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 D 0 to D 1 in Figure 3.1; a decrease in demand refers to the demand curve shifting leftward. The demand curve shifts with changes in: prices of related goods — a rise in the price of a sub- stitute increases demand and shifts the demand curve rightward; a rise in the price of a complement de- creases demand and shifts the demand curve leftward. C h a p t e r
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4 6 C H A P T E R 3 expected future prices — if the price of a good is ex- pected to rise in the future, the current demand for it increases and the demand curve shifts rightward. income — for a normal good , an increase in in- come increases demand and shifts the demand curve rightward; for an inferior good an increase in in- come decreases demand and shifts the demand curve leftward.
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