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Chapter 3 Notes Equillibrium Price

Chapter 3 Notes Equillibrium Price

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Published by smz1978

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Categories:Types, Business/Law
Published by: smz1978 on Jun 08, 2010
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08/19/2010

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1 Demand Compiled By: Saima Munawar 
Chapter 3 Notes
DEMAND ............................................................................................................................................................... 1
 
SUPPLY
.................................................................................................................................................................. 5
 
MARKET EQ 
UILIB
R
IU
M .......................................................................................................................................... 8
 
Demand
Q
uantity Demanded refers to the quantity of a product that buyer is willing and able to buy at given price during a particular period of time, other things being equal.
Effective demand
means demand that is backed up with a
willingness
and
ability
to pay.The
law of demand
states that other things remaining the same, the higher the price of a good, thesmaller is the quantity demanded; and the lower the price of a good, the greater the quantitydemanded.
The law of demand occurs for two reasons:
 
Substitution Effect 
:
(choice between two substitutes) When the relative price of good changes,the opportunity cost of the good changes. An increase in the price increases the opportunitycost of buying the good and people respond by buying less of the good and buying more of itssubstitutes.
 
ncome Effect 
:
(Purchasing Power) A change the price of a good changes the amount that aperson can afford to buy. When the price of a good rises, people cannot afford to buy the samequantities that they purchased before, so the quantities bought of some goods and servicesmust decrease. Normally the good whose price rises is one of the goods for which less ispurchased.The demand for a good refers to the entire relationship between the price of the good and the quantitydemanded of the good
 
2
Demand Compiled By: Saima Munawar 
You can see in the diagram above, the demand for CDs is fairly low at the relatively high price of fifteenpounds, but at the bargain price of five pounds demand is much higher.A
demand curve shows the relationship between the quantity demanded of a good and its price
, otherthings being equal. The figure illustrates the demand curve resulting from the demand schedule.The demand curve is a
willingness-and- ability-to-pay 
curvefor each quantity, the price along thedemand curve is the
highest price a consumer is willing to pay for that unit of output 
which means thata demand curve is a marginal benefit curve.
F
actors Influencing Demand
I
t is fairly obvious so far that the price of a good is a pretty strong determinant of its demand, but thereare many other things that will affect demand too.
 
Real income
.
I
f ones
r
eal income
rose (real means allowing for inflation), one should be ableto afford more CDs.
 
The p
r
ice of othe
r
goods.
 
I
f the price of CD players rose then one would expect demand for CDplayers to fall, and so would the demand for CDs. These goods are
complements
.
I
f the prices of rock concerts rose then one would expect the demand for these concerts to fall. Perhaps thosewho decided against the concert might buy a CD instead. These goods are
substitutes
. 
 
Tastes and p
r
efe
r
ences.
 
I
t is a slightly obscure but very important determinant. As you getolder, you may lose interest in the repetitive music currently in the charts and try some originalsounds from the 60s, 70s or 80s. Changing preferences will affect your demand for a productregardless of its price.
 
Expectations of futu
r
e p
r
ices
.
I
f you think that the price for CDs is likely to fall in the near future,perhaps because of reduced production costs or competition from the US, you may delay somepurchases which will reduce demand in the current time period. Alternatively, you may feel that
 
3
Demand Compiled By: Saima Munawar 
CD prices are likely to rise in the near future, perhaps due to the lack of competition in the retailmarket, so you may increase your demand in the current time period.
 
Adve
r
tising
. Although many of you probably doubt the effectiveness of some of the appallingadverts on the TV, one assumes that these companies would not spend fortunes on theseadverts if they did not expect to see a significant rise in demand for the product in question(Virgin and Our Price are always trying to sell you CDs via the TV).
 
P
opulation.
Quite obviously, a significant rise in the number of people in a given area or countrywill affect the demand for a whole host of goods and services. Note that a change in thestructure of the population (we have an ageing population) will increase the demand for somegoods but reduce the demand for others.
 
I
nte
r
est
r
ates and c
r
edit conditions.
 
I
f interest rates are relatively low then it is cheaper toborrow money that can then be spent. This is not so applicable to CDs, but will certainly affectthe demand for big ticket items such as cars and major electrical goods.
I
n boom time (like thelate 80s) it is often easier to obtain credit regardless of the rate of interest.Now that you understand that there are many things that affect the demand for a good other than itsprice,
I
hope you can see the importance of the
cete
r
is pa
r
ibus
assumption. The normal downward-sloping demand curve shows the relationship between the price of the good and its demand,
all othe
r
 things being equal
. Those all other things are the list above
:
incomes, prices of other goods, etc.
I
f youdo
not
make this assumption, then you could have a situation when the price of CDs falls, but at thesame time ones income falls by such a large amount that one actually demands
fewe
r
CDs.
I
n otherwords, one does not want to confuse
shifts in the demand cu
r
ve
and
movements along a demandcu
r
ve
.
M
ovements along a Demand Curve (Change in Quantity Demanded)
 A
movement along a demand curve only occurs when there is a change in the price of the good inquestion.
When the price of CDs falls (from P
1
to P
2
) there is a rise in demand (from Q 
1
to Q 
2
), ceteris paribus. Themovement along the curve is from point A to point B. When the price rises (from P
1
to P
3
) there is a fallin demand (from Q 
1
to Q 
3
), ceteris paribus. The movement along the curve is from point A to point C

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