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Basic Microeconomics
Demand, Supply and Market
Equilibrium
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Firms and Households: Basic
Decision-Making Units Firm: primary producing unit in an economy
Exists when a person or group of people decide to
produce a good or service by transforming inputsinto outputs
Households: consuming unit in an economy
Is a large, heterogeneous group whose tastes find
expression in the marketplace A common constraint among consumers is that
they ultimately have limited income. Incomelevels are constrained by availability of jobs,current wages, capability and wealth.
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Input Markets and Output
Markets: Circular Flow Households and firms interact in both the
product and factor markets
Circular flow of economic activity Goods and services flow from firms to
households through the output market
Labor services flow from households tofirms through input markets.
Payment for goods and services flow in theopposite direction.
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Demand in Product/Output
Markets Households demand for a product depends on the ff:
Price of product
Income available to household Amount of accumulated wealth
Price of other products
Households taste or preferences
Expectation about future income, wealth andprices.
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Demand in Product/Output
Markets
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Demand in Product/Output
Markets
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Law of Demand A demand schedule shows the quantities of a good
that a household would be willing to buy at differentprice levels. These price and quantity coordinatescan be plotted to form a demand curve.
The Law of Demand states an inverse relationshipbetween quantity demanded and the price
Characteristics of the shape of a demand curve:
Negative slope
Intersects quantity axis as a result of time limitation
Intersects price axis as a result of limited income and wealth
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Other Determinants of Household
Demand Income and Wealth
Income sum of all wages, salaries and
profits, interest payments, rents and otherforms of earnings received by a householdwithin a given period of time
Wealth total value of what a householdowns minus what it owes (also known asnet worth). It is a stock measure (at agiven point in time).
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Other Determinants of Household
Demand Prices of Other Goods or Services
Households must apportion their income
over so many different goods and servicesthat the price of any one good will affectthe demand for other goods.
Substitutes and Complements: Substitutes related goods wherein the
increase in the price of one good leads to theincrease in quantity demanded of another good
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Other Determinants of Household
Demand Substitutes and Complements:
Complements related goods wherein the
increase in the price of one good leads to thedecrease in the quantity demanded of anothergood
Taste and Preferences
These are volatile and idiosyncratic Expectations
Expectations about the change in price, incomeand wealth affect present and future demand
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Demand in Product/Output
Markets Changes in Quantity Demanded vs. Changes
in Demand
Changes in the price of a product affect quantitydemanded per period. Changes in any otherfactor, such an income or preferences, affectdemand or essentially a shift in the demand curve.
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Demand in Product/Output
Markets
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Shift of Demand versus Movement
Along a Demand Curve Change in price leads to a change in quantity
demanded or a movement along the same demandcurve
Change in all other factors affecting demand leads toa change in demand or a shift of the entire demandcurve
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From Household Demand to market
Demand Market demand is the sum of all the quantities of a
good or service demanded per period by allhouseholds buying the good in the market
Graphically the market demand is a horizontalsummation of all individual demand curves.
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From Household Demand to marketDemand
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Supply in Product/Output Markets
Supply decisions depend on profit potential. It reactsto changes in revenues and costs
Costs, in turn, depends on other factors whichinclude the following:
Type of inputs necessary to produce the product
Amount of each input required
Prices of these inputs
Firms choose the production technique mostappropriate for product and the level of production.The method of production chosen is one thatminimizes cost within reasonable bounds.
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Supply in Product/Output Markets
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Law of Supply
Quantity supplied is the amount of a particularproduct that firms would be willing and able to offerfor sale at a particular price at a particular period of
time.
A supply schedule shows how much of a product afirm will sell at different levels of prices.
There is a positive relationship between the quantity
of a good supplied and the price.
Determinants of Supply
Cost of Production
Prices of Related Products
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Law of Supply
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Shifts in Supply versus MovementAlong a Supply Curve
A supply curve is derived holding everything constantexcept the price. When the price of a productchanges, ceteris paribus, a change in quantity
supplied follows and a movement along the samesupply curve takes place.
When factors other than the price changes , thesupply curve shifts resulting in a change in supply.
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Shifts in Supply versus MovementAlong a Supply Curve
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From Individual Supply to MarketSupply
Market supply is the sum of all that is supplied eachperiod by all producers of a product.
The market supply curve also depends on thenumber of firms that produce in the market. Profitsattract other firms to enter the same line of businessas other firms that have done so previously.
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From Individual Supply to MarketSupply
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Market Equilibrium
The operation of a market depends on the interactionbetween demand and supply.
Conditions that could prevail in the market:
Quantity demanded exceeds quantity supplied or a situationof excess demand
Quantity supplied exceeds quantity demanded or a situationof excess supply
Quantity demanded just equals quantity supplied or asituation of equilibrium in the market
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Market Equilibrium
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Market Equilibrium
Changes in equilibrium occur every time either thedemand or supply curves shift. Changes in quantity
demand, quantity supplied and price will all dependon how and by how much these curves shift.