Principles of Economics Chapter 3 Flashcards
Demand, Supply, and Market Equilibrium
firm
An organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy.
entrepreneur
A person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful
business.
households
The consuming units in an economy.
product or output markets
The markets in which goods and services are exchanged.
input or factor markets
The markets in which the resources used to produce goods and services are exchanged.
labor market
The input/factor market in which households supply work for wages to firms that demand labor.
capital market
The input/factor market in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods.
land market
The input/factor market in which households supply land or other real property in exchange for rent.
factors of production
The inputs into the production process. Land, labor, and capital are the three key factors of production.
Input and output markets are connected through
the behavior of both firms and
households. Firms determine the quantities and character of outputs produced and the types and quantities of inputs demanded. Households determine the types and quantities of products demanded and the quantities and types of inputs supplied.
A household’s decision about what quantity of a particular output, or product, to demand depends on a number of factors, including:
The price of the product in question.
The income available to the household.
The household’s amount of accumulated wealth.
The prices of other products available to the household.
The household’s tastes and preferences.
The household’s expectations about future income, wealth, and prices.
quantity demanded
The amount (number of units) of a product that a household would buy in a given period if it could buy all it wanted at the current market price.
The most important relationship in individual markets is that between market price and quantity demanded.
Changes in the price of a product affect the quantity demanded per period. Changes in any other factor, such as income or preferences, affect demand.
Thus, we say that an increase in the price of Coca-Cola is likely to cause a decrease in the quantity of Coca-Cola demanded. However, we say that an increase in income is likely to cause an increase in the demand for most goods.
demand schedule
Shows how much of a given product a household would be willing to buy at different prices for a given time period.
demand curve
A graph illustrating how much of a given product a household would be willing to buy at different prices.
law of demand
The negative relationship between price and quantity demanded: As price rises, quantity demanded decreases; as price falls, quantity demanded increases.
It is reasonable to expect quantity demanded to fall when price rises, ceteris paribus, and to expect quantity demanded to rise when price falls, ceteris paribus. Demand curves have a negative slope.
Properties of Demand Curves
- They have a negative slope.
- They intersect the quantity (X) axisa result of time limitations and diminishing marginal utility.
- They intersect the price (Y) axis, a result of limited income and wealth.
Other Properties of Demand Curves
The actual shape of an individual household demand curve—whether it is steep or flat, whether it is bowed in or bowed out—depends on the unique tastes and preferences of the household and other factors.
income
The sum of all a household’s wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure.
wealth or net worth
The total value of what a household owns minus what it owes. It is a stock measure.
normal goods
Goods for which demand goes up when income is higher and for which demand goes down when income is lower.
inferior goods
Goods for which demand tends to fall when income rises.
substitutes
Goods that can serve as replacements for one another; when the price of one increases, demand for the other increases.
perfect substitutes
Identical products.
complements, complementary goods
Goods that “go together”; a decrease in the price of one results in an increase in demand for the other and vice versa.
Tastes and Preferences
Income, wealth, and prices of goods available are the three factors that determine the combinations of goods and services that a household is able to buy.
Changes in preferences can and do manifest themselves in market behavior.
Within the constraints of prices and incomes, preference shapes the demand curve, but it is difficult to generalize about tastes and preferences. First, they are volatile. Second, tastes are idiosyncratic.
Expectations
What you decide to buy today certainly depends on today’s prices and your current income and wealth.
There are many examples of the ways expectations affect demand.
Increasingly, economic theory has come to recognize the importance of expectations.
It is important to understand that demand depends on more than just current incomes, prices, and tastes.
shift of a demand curve
The change that takes place in a demand curve corresponding to a new relationship between quantity demanded of a good and price of that good. The shift is brought about by a change in the original conditions.
movement along a demand curve
The change in quantity demanded brought about by a change in price.
Change in price of a good or service leads to
change in quantity demanded (movement along a demand curve).
Change in income, preferences, or prices of other goods or services leads to
Change in demand (shift of a demand curve).
market demand
The sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.
Firms build factories, hire workers, and buy raw materials because
they believe they can sell the products they make for more than it costs to produce them.
profit
The difference between revenues and costs.
quantity supplied
The amount of a particular product that a firm would be willing and able to offer for sale at a particular price during a given time period.
supply schedule
A table showing how much of a product firms will sell at alternative prices.
law of supply
The positive relationship between price and quantity of a good supplied: An increase in market price will lead to an increase in quantity supplied, and a decrease in market price will lead to a decrease in quantity supplied.
supply curve
A graph illustrating how much of a product a firm will sell at different prices.
The Cost of Production
For a firm to make a profit, its revenue must exceed its costs.
Cost of production depends on a number of factors, including the available technologies and the prices and quantities of the inputs needed by the firm (labor, land, capital, energy, and so on).
Assuming that its objective is to maximize profits, a firm’s decision about what quantity of output, or product, to supply depends on:
- The price of the good or service.
- The cost of producing the product, which in turn depends on:
■ The price of required inputs (labor, capital, and land).
■ The technologies that can be used to produce the product. - The prices of related products.
movement along a supply curve
The change in quantity supplied brought about by a change in price.
shift of a supply curve
The change that takes place in a supply curve corresponding to a new relationship between quantity supplied of a good and the price of that good. The shift is brought about by a change in the original conditions.
Change in price of a good or service leads to
Change in quantity supplied (movement along a supply curve).
Change in costs, input prices, technology, or prices of related goods and services leads to
Change in supply (shift of a supply curve).
market supply
The sum of all that is supplied each period by all producers of a single product.
equilibrium
The condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for price to change.
excess demand or shortage
The condition that exists when quantity demanded exceeds quantity supplied at the current price.
When quantity demanded exceeds quantity supplied,
price tends to rise.
When the price in a market rises,
quantity demanded falls and quantity supplied rises until an equilibrium is reached at which quantity demanded and quantity supplied are equal.
excess supply or surplus
The condition that exists when quantity supplied exceeds quantity demanded at the current price.
When quantity supplied exceeds quantity demanded at the current price,
the price tends to fall.
When price falls,
quantity supplied is likely to decrease and quantity demanded is likely to increase until an equilibrium price is reached where quantity supplied and quantity demanded are equal.
difference between demand and supply curves
A demand curve shows how much of a product a household would buy if it could buy all it wanted at the given price.
A supply curve shows how much of a product a firm would supply if it could sell all it wanted at the given price.
Quantity demanded and quantity supplied are always
per time period—that
is, per day, per month, or per year.
The demand for a good is determined by
by price, household income and wealth, prices of other goods and services, tastes and preferences, and expectations.
The supply of a good is determined by
price, costs of production, and prices of related products.
Costs of production are determined by
available technologies of production and input prices.
difference between movements and shifts
When the price of a good changes, the quantity of that good demanded or supplied changes—that is, a movement occurs along the curve. When any other factor changes, the curve shifts, or changes position.
Market equilibrium exists only when
quantity supplied equals quantity demanded at the current price.
Demand curves reflect
what people are willing and able to pay for products; demand curves are influenced by incomes, wealth, preferences, prices of other goods, and expectations.
Firms in business to make a profit
choose the best available technology—lower costs mean higher profits.
When a good is in short supply,
price rises. As it does, those who are willing and able to continue buying do so; others stop buying.
