Supply, Demand and Competition

Essential Question: How are prices set?

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Setting an Econom y ’s Price SystemTo understand how a nation’s economy

functions it is important to understand the nation’s price system

The forces that determine price are called the forces of supply and demand

The place where these two forces meet is called the marketplace

Basic factsConsumers have a great influence on

the price of goods and services. Why?

Market: Represents the freely chosen action between buyers and sellers.

Voluntary exchange: Buyers and sellers work out a deal that suits both sides.

DemandDemand shows how many of a product

consumers are willing and able to buy at a particular price during a specified time period.e.g. Swimming suits have a different

price and quantity demanded in summer vs. winter

How many of you would like a new car?How many of you are able?

Law of Demand Explains the amount people are willing

to buy as prices change. Demand can only occur if a buyer is

willing and able to buy. Three factors that affect what and how

much people buy are diminishing marginal utility, real income, and substitution.

Price goes up – Demand goes down

Price goes down – Demand goes up

Diminishing Marginal Utility (DMU)Utility: Power of a good or service

to satisfy.Total satisfaction rises with

additional units purchased, but additional satisfaction diminishes.

People will buy until price exceeds satisfaction.

Price decreases, people will buy more.

Real Income Effect Income limits the amount of money

people can spend.People cannot keep buying the same

amount if price increases and income stays the same. (Real income effect).

People are forced to trade-off if price increases.

If price decreases and you buy the same amount, your real income has increased.

Demand CurveDemand Curve is a line graph that

shows the amount of a product that will be purchased at each price; it shows an inverse relationship and is always downsloping

p

DQd

Remember:

A change along the curve indicates a change in price and a change in quantity demanded

A change of the curve (right or left) indicates an across the board change in demand

Law of Demand As price decreases, the quantity demanded

increases. As the price rises, the quantity demanded decreases

P QD

Price per gallon of water

Bottles per week

$ Jo Pat

.75 90 50

.50 130 70

.35 180 100

.25 290 130

Demand for hot chocolate in December at the skating rink

PriceQuantity

Demanded$.50 30

$1.00 25$1.50 20$2.00 15$2.50 10$3.00 5$3.50 0

Demand Determinants

Characteristics that will affect the amount people will buy. Includes changes in population, income, and personal preferences.

Prices of related goods, income, preference/taste, consumer expectations, population change

Demand DeterminantsPrices of Related Goods

Substitutes: Goods that are related in such a way that an increase in the price of one leads to an increase in the demand for the other [goods that can be consumed in place of one another] (Pepsi and Coke)

Compliments: Goods that are related in such a way that an increase in the price of one leads to a decrease in the demand for the other [goods that are normally consumed together] (hamburgers and french fries)

Determinants cont.Income

Normal Good: a good for which demand increases as consumer incomes rise (milk)

Inferior Good: A good for which demand decreases as consumer incomes rise (ground chuck, bus rides)

As income rises consumers tend to switch from consuming these inferior goods to consuming normal goods (ex. steak, car/plane)

Determinants cont.

Preference/TasteLikes and dislikes in consumption

Consumer ExpectationsChange in future price of goodsChange in future income

Population ChangeAs the number of consumers in a market

changes the demand will change

Law of Supply The amount producers are willing to provide

at various prices.As price increases, supply increases.As price decreases, supply decreases.

Law of diminishing returns: Adding units of a factor of production will increase output for a time. Eventually output will decrease.

Supply Schedule & CurvesA Supply Schedule displays the

quantity of a product supplied at each price

Price Per Bottle

Bottles Supplied

.75 200

.50 130

.35 75

.25 50

Supply of shovels before a large snowstorm sold at Lowes

PriceQuantity Supplied

$4.00 5$8.00 10$12.00 15$14.00 20

Determinants of SupplyTechnology

If more efficient technology is discovered production costs will fall

So suppliers will be more willing and able to supply more of the good at each price

Price of Relevant ResourcesThose resources employed in the

production of a good.

Determinants con’tPrices of Alternative Goods

Price of a good that uses some of the same resources as used to produce the good in question

Producer ExpectationsShift production according to future

pricesNumber of Producers

# of Prod. Increases # of supplyGovernment Restrictions

Taxes, quotas, licenses, etc.

Supply and Demand If price falls, demand will increase and supply will

decrease. If price rises, demand will decrease and supply will

increase. Equilibrium price: Point where supply and

demand meet. Shortage and surplus:

When demand is greater than supply, a shortage occurs.

When supply is greater than demand, a surplus occurs.

Prices will rise in a shortage and fall in a surplus.

Price ControlsPrice Ceiling – Gov’t set

maximum price that can be charged for a good or service

Price Floor -- Gov’t set minimum price that can be charged for a good or service

Price Elasticity

How consumers react when prices change.

Elasticity is determined by:Existence of substitutes.Percentage of income spent on a

good or service.Time allowed to adjust to a

change.

Elastic:Many competing brands.Price increases, people choose a substitute.

Inelastic:Not much competition.Price increases, demand does not change.

Types

Steak: Elastic or Inelastic ?

ElasticWhy? People as

a whole can do without steak and will substitute chicken or other protein for expensive steak

Milk: Elastic or Inelastic ?InelasticWhy?The population as a

whole can do without steak….but can not do as easily without milk…especially families with children

Gasoline: Elastic or Inelastic ?

What Products are Subject to Elastic Demand ?Luxury Items – Most customers want luxuries and

will consider buying them if price drops If Price Represents a Large Portion of Family Income

e.g. Mortgage Rates drop from 6.5 to 5.5% people will “refinance”

Availability of Substitute Itemse.g. Steak /chicken

Durable GoodsComputers, cars, washers, dryers will be in greater

demand if the price drops

What Products are Subject to “Inelastic Demand”?

Necessities (milk, gasoline)Drugs

Legal (heart medicine antibiotics) Illegal (heroin, cocaine)

Products with no good substitute insulin, cancer drugs, etc. salt in Middle Ages (preservative)

Why is Elasticity of Demand Important ?

What happens if a florist increases the price of roses 400 % in October ? Will sales go up or down ?

A. Probably, down What happens if a florist increases the

price of roses on February 14th? Will sales go down or up?

A. Probably up Why ? Frantic husbands and boyfriends will pay exorbitant prices for a dozen roses on Valentine’s Day.

Competition Competition will exist if different

businesses produce similar products. Perfect Competition

1. Large Market2. Similar Product3. Easy entry and exit4. Information obtainable5. No control over price

Market Price is equilibrium price. (decided by supply and demand)

Imperfect CompetitionOne group can have an impact on price.

MonopolyOligopolyMonopolistic Competition

Barriers to entry:Government regulations: Some goods and services

are protected from duplication by the government.Cost of getting started: Large amount of capital is

needed to begin.Ownership of raw materials: Companies control

materials and do not sell to competitors.

Monopoly One group controls the market.

1. Single seller2. No substitutes3. No entry4. Complete control over price

Suppliers can raise prices without losing business.

Types of Monopoly1. Natural: Control of resources. Water

company

2. Geographic: Control of location Dick’s is the only sports store in the area

3. Technological: Patent on technology4. Government: Created by the

government. Illegal to enter. Post office

5. Cartel: International form of monopoly (OPEC).

Oligopoly A few businesses in competition.

1. Domination of a few sellers2. Barriers to entry3. Identical or slightly different products4. Some control of price

Price wars are common place.

Oligopoly ExamplesMovie Studios

Columbia, 20th Century Fox, Warner Bros., Paramount, Universal, and MGM

TelevisionDisney/ABC, CBS Corp., NBC Universal, Time

Warner, and News CorporationFood Processing

Kraft Foods, PepsiCo, and NestleTelecommunications

AT&T, Verizon, Sprint, and T-Mobile

Monopolistic Competition

1. Numerous sellers2. Easy entry3. Different products4. Competition5. Some control of price

Substitution and advertising are factors.

Mergers One company joins with another.

Horizontal: Companies in the same business.

Vertical: Company joins with one it buys from.

Conglomerate: Buying of un-related businesses.

Vertical or Horizontal?Google and Bing

HorizontalPaper Company and Saw Mill

VerticalTostitos and Corn Fields

VerticalHarris Teeter and Ace Hardware

ConglomeratePepsi and Coke

Horizontal

Government policies Late 1800’s the railroad industry was

the biggest in the United States.Theodore Roosevelt set out to stop

monopolies with his “trust-busting” policy, which would break up large businesses.

All mergers must be approved by the Government.