Microeconomics Principles

Chapter 2: Review

Objectives:
After section II material, the student should
1. understand the importance of opportunity cost
and be able to calculate it for simple situations.
2. understand the meaning and importance of
comparative advantage.
3. understand the importance, use and reason for
the shape of the production possibilities curve
(PPC).
4. understand what efficiency means and why it is
important.
5. understand the importance of specialization,
and how it affects the economy.

Supply and Demand

Chapter 3

Objectives:
At the completion of this section, the student should
understand the meaning and use of demand and
supply.
be able to construct and manipulate a simple
demand and supply graph.
understand the dynamics of the demand and
supply model (surpluses, shortages, incentives,
& response to incentives)
understand and be able to show on a supply and
demand graph the effect of governmental
interventions in the market
understand the importance and measurement of
economic surplus.

Basic Questions in Economics

What?
What goods and services will be produced?
Ans: Those valued more than their opportunity cost.

How?
How will the goods and services be produced?
Ans: With the least cost in resources.

For Whom?
Who will get to consume the goods & Services?
Ans: Those willing and able to pay for them.

Demand
Price and quantity wanted combos
(p1 ,q1 ; p2 ,q2 )
menu of options

Reservation price = max price for me to buy

As price rises,
Each person wants fewer units
Fewer people willing to buy

Demand is
Maximum quantity demanded, given price
Maximum price for given quantity demanded
Curve is maximum boundary

Demand as Boundary
Price

Will not buy beyond the demand curve

Will not Buy

Will buy

Demand

Quantity

Supply
Price and quantity willing to sell combos
(p1 ,q1 ; p2 ,q2 )
menu of options

Reservation price = Min price for me to

sell
As price rises,
Each person wants to sell more units
More people willing to sell

Supply is price and quantity combinations

Maximum quantity supplied, given price
Minimum price for given quantity to be supplied
Curve is maximum boundary

Supply as Boundary

Price

Will not sell beyond Supply

Supply
Will
Sell

Will not Sell

Quantity

Equilibrium
A tendency not to change
Price such that Q demanded = Q supplied
What Price ___________
Quantity @ Equilibrium P
What Price___________
Only price both like is S & D intersection
Price

Will
Sell

Supply
Will not Buy

Pe
Both
willing

Will not Sell

Will buy
Qe

Demand

Quantity

10

Equilibrium
Desired Price and Quantity
Demanders willing to buy Qe at this price
Suppliers willing to sell Qe at this price

Process of getting to equilibrium

Excess Demand
Price too low Demanders want more than suppliers willing to sell
Demanders bid price up as they try to get what they want

Excess Supply
Price too high Suppliers willing to sell more than demanders want
Sellers drop price attempting to attract customers

Process of getting to equilibrium

P

Excess Supply

QD

QS

QS > Q D
Forcing P dn

P1

Excess Demand
QD > QS

D
Q

Q1

Forcing P up
QS

QD

Conclusion: Only at equilibrium price (P1) is price stable.*

Demand Changes
Demand Increase

Increases quantity demanded at each price

Shifts Demand curve out (more quantity)
Creates excess demand (shortage)
Forces equilibrium price up
Example: Demand for gasoline up now

Demand Decrease

Decreases quantity demanded at each price

Shifts Demand curve in (less quantity)
Creates excess supply (surplus)
Forces equilibrium price down
Example: Demand for suntan oil down now

Demand Shift
Demand for
houses up now
More customers,
same QS
Increasing P
Increasing Q
Along Supply
Curve

QD2

P2
P1

D2
D
Q1

Q2

Supply Changes
Supply Increase

Increases quantity supplied at each price

Shifts Supply Curve out (more quantity)
Creates excess supply (surplus)
Forces equilibrium price down
Example: More computing power is available

Supply Decrease

Decreases quantity supplied at each price

Shifts Supply Curve in (less quantity)
Creates excess demand (shortage)
Forces equilibrium price up
Example: Supply of oil is down

Supply shift
Supply of gasoline
down
Less Supply, same
QD
Increasing P
Decreasing Q
Along Demand
Curve

S2

P2
P1

QS2
D
Q 2 Q1

Demand Shift Factors

Income

more Q demanded @ each

Normal goods more income, _____
less
price
Inferior goods more income, _____Q demanded @ each price

Prices
of Substitutes

price
of pens affects
demand for pencils
_____________________________________________
Prices
Complements
price ofofspeakers
affects demand for stereo receivers
_____________________________________________
Preferences (tastes)
Fads affect demand for specific clothing
_____________________________________________
PriceExpected
expectations
futureprice affects demand for a stock
_____________________________________________
Number of Consumers
number of families in area affects demand for housing
_____________________________________________
Intel Inside, Have it your way
Advertising
_____________________________________________

Supply Shift Factors

Input Prices
labor cost affects supply of cars
______________________________________
Technological improvements
Technology
affects the supply of computer power
______________________________________
Weather (acts of nature)
______________________________________
Hurricane in Louisiana affects supply of gasoline
Expectations
Price expectations affects
______________________________________
willingness of oil companies to supply oil now
Number of suppliers Internet has increased
______________________________________
the number of suppliers in book market

Supply & Demand Example 1

C
P
Fdisaster decreases supply
B:natural
B
P2
A
I
P1
E
H
S
G
D
S
Q2

Q1

Assume that the above graph is for the market for gasoline,
and that the center dot marks the initial equilibrium.
When the BP well exploded the market likely moved to ____
(fill in the appropriate letter).

Supply & Demand Example 2

C
P
P2
P1

B
A
E
S

F:substitute
F
car that uses less gas
I
H
D
G
D
Q1 Q 2

Assume that the above graph is for the market for small, efficient
cars, and that the center dot marks the initial equilibrium.
When the BP well exploded the market likely moved to ____ (fill
in the appropriate letter).

Supply & Demand Example 3

C
P
P1
P2

B
A

I
E:complementary
E
H
good effect
G
D
S
D
Q2 Q1

Assume that the above graph is for the market for large
SUVs, and that the center dot marks the initial equilibrium.
When the BP well exploded the market likely moved to
____ (fill in the appropriate letter).

Supply & Demand Example 4

C
P
P3
P1
P2

F
B
A:new
A construction
I effect
E:potential
E
H buyer effect
S
G
D
S
D
Q3 Q Q1
Q
2

Assume that the above graph is for the housing market,

and that the center dot marks the initial equilibrium.
If interest rates rise, the market likely will move to ____
(fill in the appropriate letter).

Supply & Demand Example 5

P2

C:current
C
owner effect
P2
P
price expectations demand effect
B F: F
P2
A
II:new housing effect
P1
E
H
The size of the
S
G
D
D
effects will
S
S
determine the
Q1 Q2 Q 3 Q
actual outcome.
Q2

Assume that the above graph is for housing market, and that the
Center dot marks the initial equilibrium.
If the expectations are for housing prices to increase in the future,
the market will likely move to ____ (fill in the appropriate letter).

Supply & Demand Example 6

C
P
P1
P2

B
A

I
E
E:price
ofHcomplement effect
G
D
S
D
Q2 Q1

Assume that the above graph is for the market for half and half
(cream), and that the center dot marks the initial equilibrium.
When the price of coffee rises, the market will likely move to
____ (fill in the appropriate letter).

Supply & Demand Example 7

P
P2
P1

C
F
of complement effect
B F:Price
A
I
E
H
D
G
D
S
Q1 Q2

Assume that the above graph is for the market for cell phone
service, and that the center dot marks the initial equilibrium.
When cell phone companies give away free phones, the
market will likely move to ____ (fill in the appropriate letter).

Supply & Demand Example 8

C
P
P1
P2

B
A

I
E:Income
effect on a normal good
E
H
G
D
S
D
Q
Q2 Q1

Assume that the above graph is for the market for high quality
shoes, and that the center dot marks the initial equilibrium.
When the income in the area falls, the market will likely move to
____ (fill in the appropriate letter).

Supply & Demand Example 9

P

P2

P1

C
F
effect on inferior good
B F:Income
A
I
E
H
D
G
D
S
Q1 Q 2

Assume that the above graph is for the market for low quality
shoes, and that the center dot marks the initial equilibrium.
When the income in the area falls, the market will likely move
to ____ (fill in the appropriate letter).

Supply & Demand Example

10
C

P
P1
P2

B
A

I
E H:number
H
of suppliers effect
G
D
S
S
Q1

Q2

Assume that the above graph is for the market for airline travel to
Milwaukee, Wisconsin, and that the center dot marks the initial
equilibrium.
When Southwest Airlines started flying to Milwaukee, the market
likely moved to ____ (fill in the appropriate letter).

Price Ceiling
Rent control forces price below P
equilibrium
S

Does not change D or S!

Increases quantity demanded
Decreases quantity supplied
QD > QS => Excess Demand
Since price mandated, price
cannot adjust
Shortage permanent

P1

D
Q1

Q
QD

QS
Shortage

Price Floor9
Agricultural price supports forceP
price above equilibrium

Surplus
QD

QS

Does not change D or S!

Decreases quantity demanded
Increases quantity supplied
QS > QD => Excess Supply
Since price mandated, price
cannot adjust
Surplus permanent

P1

D
Q1

Comparative Advantage & Opportunity Cost

Using Cost rather than Output
Time to perform tasks (one unit of the activity takes slited
amount of time:
Clean Shop
George 1 hr 2 hr
Sarah
0.5 hr 1.5 hr
Opportunity Cost 1 Shop / 2 Clean
0.5 S/C
2 C/S
2 Clean / 1 Shop
George Clean__________
_______
0.33 S/C
1 Shop / 3 Clean
George Shop __________
_______
3 Clean / 1 Shop
Sarah Clean ___________
_______3 C/S
Sarah Shop ____________ _______
Georgeadvantage in Shopping?___________
Who has comparative