Chapter 07 _Demand _ Supply_

Chapter 07 _Demand _ Supply_ - Chapter 7 Supply and Demand...

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1 Chapter 7 Supply and Demand Introduction and Review In Chapter 2 we discussed the concept of rational economic behavior. Each decision maker strives to maximize satisfaction by carrying out economic activities up to the point where their marginal benefits just equal their marginal costs. In Chapter 4 we saw that a typical consumer would consume the quantities of a good up to the point where the benefit derived from the last unit just equals its price. So a consumer’s marginal benefit function for a good is in fact that consumer’s demand function. It shows the quantities of the good the consumer is willing and able to buy. The consumer will be ―willing‖ to buy the quantity of the good that will give him or her maximum satisfaction. The consumer, though, should have enough money to be ―able‖ to buy that quantity. Adding the individual demand functions over all the consumers would result in the market demand function. The market demand function would give the quantities of a good the market would be willing and able to buy at different prices. Chapters 5 and 6 analyzed producer behavior in a perfectly competitive market. A firm in such a market environment would maximize profit by producing a level of output at which the marginal cost of production just equals the market price. This point should be in the upward sloping portion of the marginal cost function above the shut-down point. The marginal cost function above the shut-down point, therefore, is the producer’s supply function. It shows the quantities of a good that the producer is willing and able to supply –―willing‖, in terms of maximum profit and ―able‖ in the sense of having enough resources and technology. Adding these individual supply functions over all the producers gives us the market supply function. The market supply function would give the quantities of a good the market would be willing and able to sell at different prices We see that both consumers and producers consider the market price of a good in making their consumption or production decisions. What we have not told you yet is how that market price is determined. This chapter will answer that question. Keep in mind that we are still working in an environment of perfect competition. In this chapter we will make two assumptions: 1. There are a large number of small but well-informed buyers and sellers. This assumption will help us avoid the complications that may arise if one or two large producers or consumers have enough power in the marketplace to be able to affect prices. Such power is called market power and is the subject of later chapters. 2. The period of time we are dealing with is too short for business firms to be able to change the size and amount of their plants and equipment. This period of time in economics is called the short run . Later we will relax this assumption.
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2 The Market We will look at a market for a particular good or service and will find out why that market actually produces the amount it does and how it determines the market price of
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This note was uploaded on 11/08/2010 for the course ECN ECN 001A taught by Professor Scottcarrell during the Spring '10 term at UC Davis.

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Chapter 07 _Demand _ Supply_ - Chapter 7 Supply and Demand...

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