Author: John Bouman

  The Difference Between Demand and Quantity Demanded We learned in an earlier section that as the price of a product increases, the amount purchased by buyers decreases, and vice versa. This illustrates the law of demand. In a more recent section, we noticed that as demand increases, the price of a product increases. When you look at these two statements together, it may appear confusing and contradictory. However, the two statements are both valid. It is merely a matter of what causes what; in other words, which is the cause and which is the effect? To understand the difference more clearly, we need to study the difference between demand and quantity demanded. Quantity Demanded If the market price of a product decreases, then the quantity demanded increases, and vice versa. For example, when the price of strawberries decreases (when they are in season and the supply is higher – see graph below), then more people will purchases strawberries (the quantity demanded increases). A quantity demanded change is illustrated in a graph by a movement along the demand curve. In the graph below we are moving along the demand curve from the first intersection point (Q = 800 and P = $3.99) to the second intersection point (Q = 1,000 and P = $2.99). Demand When one or more of the five demand determinants listed in Section 6 changes,...

Consumer Surplus  In the graph below, the supply and demand curves intersect at an equilibrium price of $5 and an equilibrium quantity of 120 products. If the price had been $6, buyers would have purchased 110 products. If the price had been $7, buyers would have purchased 100 products. If the price had been $8, buyers would have purchased 90 products, and so forth. This means that quite a few buyers would have been willing and able to pay more for the product than they are actually paying at the equilibrium price of $5. At the equilibrium price of $5 everyone pays that price, including the buyers who would have been willing to pay a higher price. The difference between how much consumers value a product and how much they actually pay for it at the equilibrium price is called consumer surplus. The consumer surplus in the graph below is illustrated by the shaded triangle. Video Explanation For a video explanation of consumer surplus, and how consumer surplus increases when demand and supply simultaneously increase, please watch: Producer Surplus Just like there is consumer surplus, there is producer surplus. Producer surplus is the difference between the minimum price at which producers would have been willing to produce the product and how much they are actually receiving at the equilibrium price. The producer surplus in the graph below is illustrated...

Categories of Products Prices of some categories of goods increase in the long run as demand rises, while others do not. Here we distinguish between products that are in limited supply, such as land, labor, raw materials, and sports and concert tickets, and manufactured products. Manufactured products, such as grocery items, clothes, cars, and electronics, are ones whose supply can be increased relatively easily in the long run. Products in Limited Supply In the long run, prices of products that are in limited supply fluctuate much more with changes in demand than products that are in abundant supply. Examples of limited supply goods and services include land, labor, natural resources such as oil, gas and minerals, tickets to major sporting events (the World Series, the Superbowl, or the World Cup Soccer final), and products supplied by a monopoly. If, for example, the demand for land in a certain area rises because of increased population and increased housing activity, the price of the land will increase. Because the supply of land is limited, the price of the land can remain high for a long period of time as long as the demand remains high. Products supplied by a monopoly are limited because the firm may be the sole owner of a resource, or the firm may have a patent, a license, or other government approval to be the only supplier....

The Free Market In a free market economy, prices of goods and services, wages, interest rates, and foreign exchange values are determined by supply and demand. There is no interference from a government in the form of price controls, labor laws, or other regulations affecting the market price of the product. A free market is economically efficient (from a production and cost point of view) and generally leads to higher overall standards of living. In a free market system, even though it doesn’t interfere with prices and wages, there is an important role for the government. The government must protect private property, provide essential services such as infrastructure (roads, highways, etc.), provide oversight of key industries, provide a legal system and defend the country. So in a free market system, the role of the government is limited, but important. The following are specific advantages of a free market system. Advantages of a Free Market System 1. Products are priced at their true worth. The most important advantage of a free market system is that products are priced at their true “worth.” The product’s true worth is based on how much buyers and sellers value the product. This is reflected in the demand and supply of the product (and not on a government-determined price). When consumers value a product highly, then the demand for this product is high and consequently,...

What’s in This Chapter? In Unit 2, we learned that if the price of a product increases, the amount demanded decreases. But how much does it decrease? The “how much” describes the concept of price elasticity of demand. If the price of a product increases and the amount demanded decreases by a lot, then the product is elastic. If it decreases by a little bit, or not at all, then the product is inelastic. Different products have different elasticities, and different people have different elasticities. Businesses use the various elasticities of people and products to make better decisions about how to maximize their profits. For example, airlines often charge more to business travelers than to tourists, because business travelers have lower price elasticities of demand. Airlines attempt to distinguish between business travelers and tourists by placing restrictions (for example, Saturday stay required) on when and how long people can fly for certain fares. Governments can also use elasticity in determining the amount of tax on a product. There are high taxes on low-elasticity products such as gasoline and cigarettes, because raising taxes on gasoline or cigarettes is expected to not significantly affect the amount of these products demanded. This unit will also discuss other types of elasticities, such as income elasticity of demand, cross price elasticity of demand, and price elasticity of...