PRINCIPLE OF ECONOMIC
6 EDITION
KARL CASE, RAY FAIR
PRENTICE HALL BUSINESS PUBLISHING
COPY RIGHT 2002
The Basic Decision-Making Units
•
A firm is an organization
that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a
market economy.
•
An entrepreneur is 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
are the consuming units in an economy.
The Circular Flow of Economic Activity
•
The circular flow of economic
activity shows the connections between firms and households in input
and output markets.
Input Markets and Output Markets
•
Output, or product, markets
are the markets in which goods and services are exchanged.
•
Input markets
are the markets in which resources—labor, capital, and land—used to produce
products, are exchanged.
Input Markets
Input markets include:
•
The labor market, in which
households supply work for wages to firms that demand labor.
•
The capital market, in
which households supply their savings, for interest or for claims to future
profits, to firms that demand funds to buy capital goods.
•
The land market, in which
households supply land or other real property in exchange for rent.
Determinants of Household Demand
A household’s decision about the quantity of a
particular output to demand depends on:
•
The price of the product
in question.
•
The income available to
the household.
•
The household’s amount of accumulated
wealth.
•
The prices of related products
available to the household.
•
The household’s tastes and
preferences.
•
The household’s expectations
about future income, wealth, and prices.
Quantity Demanded
•
Quantity demanded
is the amount (number of units) of a product that a household would buy in a
given time period if it could buy all it wanted at the current market price.
•
A demand schedule is a
table showing how much of a given product a household would be willing to buy
at different prices.
•
Demand curves are usually derived from
demand schedules.
The Demand Curve
•
The demand curve is a
graph illustrating how much of a given product a household would be willing to
buy at different prices.
The Law of Demand
•
The law of demand states
that there is a negative, or inverse, relationship between price and the
quantity of a good demanded and its price.
•
This means that demand curves slope
downward.
Other Properties of Demand Curves
•
Demand curves intersect the quantity (X)-axis,
as a result of time limitations and diminishing marginal utility.
•
Demand curves intersect the (Y)-axis,
as a result of limited incomes and wealth.
Income and Wealth
•
Income
is the sum of all households 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, is the total value of what a household owns minus
what it owes. It is a stock
measure.
Related Goods and Services
•
Normal Goods
are goods for which demand goes up when income is higher and for which demand
goes down when income is lower.
•
Inferior Goods
are goods for which demand falls when income rises.
•
Substitutes
are goods that can serve as replacements for one another; when the price of one
increases, demand for the other goes up.
Perfect substitutes are identical products.
•
Complements
are goods that “go together”; a decrease in the price of one results in an
increase in demand for the other, and vice versa.
Shift of Demand Versus Movement Along a Demand Curve
•
A change in demand is not
the same as a change in quantity demanded.
•
In this example, a higher price causes
lower quantity demanded.
•
Changes in determinants of demand, other
than price, cause a change in demand, or a shift of
the entire demand curve, from DA to DB.
A Change in Demand Versus a Change in Quantity
Demanded
•
When demand shifts to the
right, demand increases. This causes quantity demanded to be
greater than it was prior to the shift, for each and every price level.
A Change in Demand Versus a Change in Quantity
Demanded
To summarize:
Change in price of a good or service leads to Change
in quantity demanded (Movement
along the curve).
Change in income, preferences, or prices of other
goods or services leads to Change in
demand
(Shift of curve).
(Shift of curve).
The Impact of a Change in Income
•
Higher income decreases the demand for
an inferior good
•
Higher income increases the demand for a
normal good
The Impact of a Change in the Price of Related Goods
•
Price of hamburger rises
•
Quantity of hamburger demanded
falls
•
Demand for complement good
(ketchup) shifts left
•
Demand for substitute good
(chicken) shifts right
From Household to Market Demand
•
Demand for a good or service can be
defined for an individual household, or for a group of households
that make up a market.
•
Market demand
is 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.
From Household Demand to Market Demand
•
Assuming there are only two households
in the market, market demand is derived as follows:
Supply in Output Markets
•
A supply schedule is a
table showing how much of a product firms will supply at different prices.
•
Quantity supplied
represents the number of units of a product that a firm would be willing and
able to offer for sale at a particular price during a given time period.
The Supply Curve and the Supply Schedule
•
A supply curve is a graph
illustrating how much of a product a firm will supply at different prices.
The Law of Supply
•
The law of supply states
that there is a positive relationship between price and quantity of a good
supplied.
•
This means that supply curves typically
have a positive slope.
Determinants of Supply
•
The price of the good or
service.
•
The cost of producing the
good, 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.
A Change in Supply
Versus a Change in Quantity Supplied
•
A change in supply is not
the same as a change in quantity supplied.
•
In this example, a higher price causes higher
quantity supplied, and a move along the demand curve.
•
In this example, changes in determinants
of supply, other than price, cause an increase in supply, or a shift
of the entire supply curve, from SA to SB.
A Change in Supply
Versus a Change in Quantity Supplied
•
When supply shifts to the
right, supply increases. This causes quantity supplied to be
greater than it was prior to the shift, for each and every price level.
From Individual Supply to
Market Supply
•
The supply of a good or service can be
defined for an individual firm, or for a group of firms that make up a market
or an industry.
•
Market supply
is the sum of all the quantities of a good or service supplied per period by
all the firms selling in the market for that good or service.
Market Supply
•
As with market demand, market
supply is the horizontal summation of individual firms’ supply curves.
Market Equilibrium
•
The operation of the market depends on
the interaction between buyers and sellers.
•
An equilibrium is the
condition that exists when quantity supplied and quantity demanded are equal.
•
At equilibrium, there is no tendency for
the market price to change.
Market Equilibrium
•
Only in equilibrium is quantity supplied
equal to quantity demanded.
•
At any price level other than P0,
the wishes of buyers and sellers do not coincide.
Market Disequilibria
•
Excess demand,
or shortage, is the condition that exists when quantity demanded exceeds
quantity supplied at the current price.
•
When quantity demanded exceeds quantity
supplied, price tends to rise until equilibrium is restored.
•
Excess supply,
or surplus, is the condition that exists when quantity supplied exceeds
quantity demanded at the current price.
•
When quantity supplied exceeds quantity
demanded, price tends to fall until equilibrium is restored.
Increases in Demand and
Supply
•
Higher demand
leads to higher equilibrium price and higher equilibrium quantity.
•
Higher supply
leads to lower equilibrium price and higher equilibrium quantity.
Decreases in Demand and
Supply
•
Lower demand
leads to lower price and lower quantity exchanged.
•
Lower supply
leads to higher price and lower quantity exchanged.
Relative Magnitudes of
Change
•
Lower supply
leads to higher price and lower quantity exchanged.
Relative Magnitudes of
Change
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