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Unformatted text preview: UNIT 2 What is a market? o A group of buyers and sellers of a particular good or service o Farmers market, NYSE, etc o Uncoordinated negotiation gives us the most efficient outcome (Invisible hand) No third party; consumer enters market and makes purchase if price is right; producer does same and decides to produce more/ less of good or service Gives us production, consumption, and resource allocation decisions that provide the most efficient outcome possible for society o Demand represents consumers (buyers) ; Supply represents firms (sellers) o Buyers and sellers negotiate to determine the market price of a product Demand o The demand for a product is the relationship between price and quantity demanded holding income, preferences, prices of related goods, constant! o The demand curve only provides the change in the relationship between price and quantity, keeping all other factors constant o Law of Demand: inverse relationship between the price of a product and the amount of the product that consumers are willing and able to purchase, ceteris paribus For example, ppl are more willing and able to buy gas when prices are low and less willing and able to buy gas when price is high How many units of that good/service are consumers willing (and able) to buy Ceteris paribus: everything else held constant (latin term) Substitution/ income effects o Income Effect Explanation for the law of demand Consumers feel poorer as prices rise bc their income cannot buy as much as previously, so they have to reduce purchases Income is very important for consumption service An increase in the price of a good/service Leaves consumer w/ fewer resources to buy the same bundle of goods/services as previously Consumer is relatively/ feels poorer o Substitution Effect Another explanation for law of demand Consider goods that provide almost the same satisfaction As prices of one good increases It becomes relatively more expensive Consumers substitute to the other good Relation between the prices of 2 goods, good 1 is the one in which concerns us and there is a substitute for good 1, assuming the substitute price is not changing; nothing else is changing except the particular good 1 Substituting away from a more desired option to a less desired option o Demand Schedule and Curve Price is on y axis; quantity is on x axis Curve should have downward slope (law of demand) o The Price Elasticity of Demand A measure of how much the quantity demanded of a good responds to a change in the price of that good Changes are measure in percentage terms Determinants are things that Demand tends to be more elastic (consumers are going to be more responsive in changes in prices when these conditions are met) The larger the number of close substitutes If the good is a luxury (vs. a necessity) The more narrowly defined the market/ the good (ex. vanilla ice cream vs dessert)...
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- Spring '08