Can you please help me solve these 10 Econ questions? I also attached the chapter just in case. Thanks so much!! :)

MARKETS AND HOW THEY WORK 177 9.0 CHAPTER 9 LEARNING GOALS After reading this chapter you should be able to: Define and give examples of a market and a market transaction. Describe the key institutions that make markets work and analyze how those institutions support markets. List and critically evaluate the assumptions upon which the supply and demand model rests. Using supply and demand curves, explain the concept of equilibrium and why markets tend toward an equilibrium price and quantity. Explain the theory of demand and the theory of supply. Analyze how changes in the determinants of demand and the deter- minants of supply shift demand and supply curves and affect equilib rium price and equilibrium quantity. 9.1 MARKETS AND MARKET TRANSACTIONS Markets are a central part of our lives, but they can be difficult to understand fully because so much of what makes markets work is hidden from plain sight. In simple terms, a market is an institution that organizes and facilitates transactions between buyers and sellers. A transaction is an agreement between eco- nomic agents-buyers and sellers-to exchange goods, services, or assets. Each market has a set of formal and informal rules that govern the behavior of economic agents. Economic agents can be individuals or groups such as corpora- tions or government agencies. There are many different types of markets in a capitalist economic system, each with its own characteristics. The market for food or clothing includes all of the stores and venders in your area and online that you could patronize to buy the food or clothes that you need or want. We can analyze the market for food at a local, national, or even a global level. Each level would have its own characteristics and dynamics. The market for stocks includes all the companies with publicly issued stocks and the investors and brokers who are interested in buying those stocks. The bin local market for labor includes all of the businesses in your area that are looking for employees and all of the people who want to find jobs. We usually subdivide the) ; P fe labor market into the market for particular skills because not everyone is qualified for every job. As you can see from the examples above, when analyzing a market, Value to the table178 MARKETS, SUPPLY AND DEMAND it is very important to specify the scope of the market you are describing to you can determine which factors are most important to incorporate into your analyst, The most common markets in capitalist economies are structured as follows. Retail markets are firms such as Walmart and Amazon (suppliers) that sell directly to consumers (demanders). Wholesale markets are retailers like Walmart and Amazon (demand- ers) that purchase the goods they sell from the companies that pro- duce them (suppliers). For example, Walmart buys food containers from Rubbermaid, which it then resells directly to consumers. Resource markets are the markets for labor, land, capital, and natural resources where producers purchase the inputs they need (producers are the demanders) from the owners of those resources (suppliers). Financial markets are where those wishing to borrow money (demand- ers) are matched with those with money to lend (suppliers). We also see informal markets and markets for illegal drugs and other illicit products in all economies. Informal markets have a different dynamic because most transac- tions take place in cash and are based on trust rather than established rules and laws, In each of these markets, the interaction of suppliers (sellers) and demanders (purchasers) will determine the market price, as we will study in some detail. In competitive markets the conditions affecting supply and demand are the primary determinant of prices. In less competitive markets, issues of monopoly power and bargaining power come into play. And government intervention can always play a role in determining prices. Markets are actually quite complicated in that they require a host of formal and informal institutions to make them work. The key institutions that make markets and market transactions work effectively are described in the next section. 9.2 THE INSTITUTIONS THAT MAKE MARKETS WORK Economists have identified a set of market-supporting institutions that must exist in order for markets to function effectively. Understanding these insti- tutions and how they work will give you a deeper understanding of markets. If you go to work for a private sector business, you will need to gain an intimate understanding of the institutions that affect the market in which your business operates. The key market-supporting institutions include property rights, laws to facilitate the aggregation of capital, trust, contract laws, competition, a lack of coercion, and infrastructure to lower transactions costs. The most important market institution, according to mainstream economists, is that of property rights.MARKETS AND HOW THEY WORK 179 9.2.1 Property rights In order to sell something to someone else, you must own it. Technically, this means you have been granted a property right to that thing by society. Property rights in a capitalist economic system stem from ownership of productive resources, and prop- erty can be owned by individuals, businesses, or governments. Most mainstream economists see property rights as the essential characteristic of capitalist markets. Property rights give the owners of resources the incentive to be as productive as possible with their property so they can make as much money as possible. Where property rights are unstable, such as places where property can be seized at any time, people are reluctant to make investments. In his classic book Tropical Gangsters, Robert Klitgaard describes how businesses owners in Equatorial Guinea would not invest in their businesses because as soon as their business became prof- itable, it would be seized by corrupt government officials. When cocoa was prof- They itable, the government nationalized cocoa farms. Government food inspectors stole chickens from the farms they inspected. And so on. These efforts completely protect undermined investment in the country. But where property rights are stable, own- ers are willing to build factories and invest in productivity enhancements because compare they are confident that they will reap the benefits of their investments. One fact noted particularly by progressive and radical political economists is that property rights confer power upon property owners. Owners of the means of production have the right to hire and fire workers, which gives them power and control over the lives of laborers, and their wealth gives them immense power over governments. Most property rights are inherited in capitalist countries (children inherit the businesses and properties owned by their parents), but there is no particular reason that property rights need to be associated so strongly with inheritance. Norway, France, Switzerland, and Spain have a wealth tax in order to reduce the amount of inequality that is caused by unequal property rights. Socialists argue that if prop- erty rights to society's productive resources were granted to workers, the result would be a much more equitable economic system. In a typical capitalist firm, workers do not own what they produce, so they cannot sell it-that right goes to the owner of the firm, and the owner gets to keep all of the profits from sales. But in a worker-owned firm, the people who do the work also get to sell the product because they collectively own the resources. As the worker-owned Mondragon Cooperative Corporation in Spain has demonstrated, workers running firms can make them efficient, productive, and profitable. Feminist economists note that property rights in most societies are distributed unequally by gender. Around the world, men are more likely to own property There and assets, which means that governments that strictly protect property rights and refuse to redistribute property cement existing gender inequality. The same is also is a true of the racial distribution of property. African Americans and Latino Americans Ce are much less likely to own property and businesses than whites. payas AND incausality180 MARKETS, SUPPLY AND DEMAND Given that property rights are the cornerstone of markets, the World Bank has made the establishment of clear property rights a key component of many of its development programs in poor countries. However, due to gender inequi- ties, this has had some significantly negative consequences. In several countries in Africa, efforts to establish secure property rights led to landownership being granted almost exclusively to men, taking the land away from women who had farmed it for decades under traditional land rights allocated by tribal elders. Sadly, taking access to the land from productive women and giving it to men with no farming experience led to declines in agricultural production. Property rights are therefore both the cornerstone of economic markets and a source of much dissatisfaction with markets on the part of those who have been historically excluded from having property rights. Laws facilitating the aggregation of capital are similarly divisive. 9.2.2 Laws to facilitate the aggregation of capital In the modern world, firms in many industries need to be large in order to achieve economies of scale to compete with other huge firms. Correspondingly, every country has laws that allow individuals or groups to pool their resources in order to form large businesses. Many economists see the law that established the limited liability corporation as an essential component of U.S. economic success because it facilitated the pooling of capital into huge trusts that became the first large manu- facturing companies. Other countries such as Japan and Germany allow banks to own a controlling interest in companies so that banks can directly use their vast financial resources for producing goods and services. larger, As with property rights, laws that foster huge corporations are controversial. By facilitating the pooling of financial resources, corporations grow larger and more powerful than they might otherwise, augmenting and centralizing the power Scale of property rights significantly. Economist E. F. Schumacher argued in his book is more Small Is Beautiful that once corporations became huge and impersonal, it was easier for them to exploit workers they did not know and ruin the environment in loca- likely tions the owners did not live in. The solution to problems of exploitation and environmental degradation was, to him, a return to local, small-scale production. to be The power of huge multinational corporations over workers, resources, and gov- corrupt. ernments is an issue we return to throughout the book as one of the defining issues in modern capitalism. smaller scale is more. 9.2.3 Trust and contract laws that foster trust Most transactions in markets are based on trust. Buyers have to trust that the seller will deliver a product of the expected quality at the expected time. Sellers have to trust that the buyer's payment will be made in the appropriate amount in the cor- rect currency at the required time. Both agents have to trust that the other partyMARKETS AND HOW THEY WORK 181 will not try to steal or cheat during the transaction. Because trust is so essential to transactions, personal relationships are a major facilitator of exchange. Another way to get people to trust you is to establish a solid reputation. Indeed, one of the reasons why marketers work so hard to establish a brand's reputation is because when people trust a particular brand, they are often willing to pay more for it and to purchase that brand over similar products that do not have as solid a reputation. It is hard to overstate how valuable reputation is. A survey by the World Economic Forum and Fleishman-Hillard, a public relations firm, found that "cor- porate reputation is a more important measure of success than stock market perfor- mance, profitability and return on investment, according to a survey of some the world's leading CEOs and organization leaders. Only the quality of products and services edged out reputation as the leading measure of corporate success." Most CEOs think that a corporation's brand and reputation are worth more than 40% of their company's value. Cultural norms can also facilitate or inhibit trust and particular types of trans- actions. For example, in countries adhering to strict Islamic law, religious beliefs prohibit charging interest. This makes banking very complex and inhibits numer- ous types of banking transactions. Instead of making traditional loans, Islamic banks have to engage in joint ventures and share in the profits of the ventures rather than charging interest. This requires a higher degree of trust on the part of the bank, and that makes it quite difficult for businesses to obtain funding. In countries that value honesty and transparency, such as Denmark and New Zealand, which rank as the least corrupt countries in Transparency International's Corruption Perceptions Index, market transactions are safer to engage in because it is less likely that some- one will try to cheat or steal. One of the ways in which large, impersonal, capitalistic markets achieve trust is via a system of contract laws. Contract laws specify the terms of a transaction. They are legally binding, so if one party violates the conditions of the contract, the other party has a legal right to seek compensation. Similarly, the Universal Commercial Code in the United States specifies the general rules governing transactions. With these laws in place, it is safe to assume that most transactions can be trusted. This makes people much more confident when engaging in mar- ket transactions. There are other government functions that also facilitate trust. One of the main reasons that people are willing to entrust their food supply and health to pri- vate firms operating in a market is because of laws, regulations, and regular inspec- tions by government regulators. Regulations protecting worker safety and the right to unionize ensure that workers participate in fair transactions with employers. Interestingly, macroeconomic stability also encourages market transactions. If consumers are secure in their jobs, they tend to spend more, and if businesses are secure in their sales expectations, they tend to invest more. Therefore, successful government stabilization policies also facilitate transactions by instilling trust in182 MARKETS, SUPPLY AND DEMAND e monopoly power and ensure the future of markets. Laws and regulations to red competition also make markets work more effectively 9.2.4 Competition and a lack of coercion ponents are competitive. In product markets, prices stay low and firms remain innovative when they face thuk Markets tend to work well when all of their come its get paid and treated is, workervices. In market sys- threat of significant competition. In labor markets, well when they have many employers bidding for these result is usually extreme rems dominated by huge firms with monopoly power. the resort, inequality. which causes people to lose faith in the market shares and demand discrimination with respect to gen- alternative. Similarly, in markets with rampant disc der, race, and ethnicity, excluded groups will see the market as inestimate and see changes, potentially destabilizing markets. 9.2.5 Infrastructure to lower transactions costs One of the biggest impediments to markets is the cost of engaging in a transac- tion. If transaction costs are too high. then no seller will participate in a market For example, this might happen if it costs a seller too much to transport goods to where consumers are. There are many different types of transactions costs. These include transportation costs, informatic mation costs incurred when actors identify and evaluate different opportunities, bargaining, monitoring and enforcement costs, and other costs associated with engaging in a transaction. extra cost. The government plays a primary role in reducing transactions costs. An effec tive transportation infrastructure of roads, rails, ports, and airports is crucial, as is a fast, efficient, and safe internet service. Establishing the market infrastructure itself is another key role of government. The government can create a local farmer's mar- ket by providing a place, parking, and information to buyers and sellers. It can cre- ate a stock market by creating rules, laws, and regulations governing transactions. By providing a stable currency, economic actors are more willing to engage in all types of transactions. An efficient postal service that can deliver bills and goods to any address is also essential. The government needs to provide physical infra- structure (roads, buildings, ports, airports, etc.), market infrastructure (information, rules, regulations, laws, and internet services), and financial infrastructure (a stable currency and banking system) to make markets work effectively. An understanding of market institutions is crucial for a business owner. It is very difficult to operate a business successfully unless you fully understand all of the key aspects of the markets in which you operate. You need to know the laws and regulations that affect all aspects of your operations, the competitive landscape, financial options for raising capital, the characteristics of consumers and consumer financing, and so much more. Details are important,MARKETS AND HOW THEY WORK 183 If we assume that the government has put all of the necessary characteristics of markets in place, then we can use the supply and demand model to analyze how prices and quantities of various goods are likely to change in response to shifts in consumer, producer, and government regulatory behavior. The supply and demand model is the cornerstone of mainstream economics. variables 9.3 THE ASSUMPTIONS OF THE SUPPLY AND DEMAND MODEL OF MAINSTREAM ECONOMICS Analysis of changes in prices and quantities is at the center of much mainstream economic analysis. Together, prices and quantities are the main mechanism by which resources are allocated in market capitalist economies. In markets that pursue maximum profits, prices provide crucial information, signaling whether companies should allocate more or less resources to the production of a particu- lar product and causing firms to change the quantity of the product they supply. Similarly, prices signal to consumers that an item is more or less expensive rela- tive to other commodities, which affects their purchasing decisions. Quantity is another crucial variable, indicating how many goods or services that busi- nesses produce, something that affects how many resources they need to pur- chase and how many workers they need to hire in order to produce those goods and services. Their demand for workers in turn affects workers, households, and communities. To analyze the forces that cause prices and quantities to change, economists developed the model of supply and demand. Like all economic models, the supply and demand model rests on a series of assumptions. Understanding these assump- tions helps you determine when the model is useful in understanding economic phenomena and when it is less likely to apply. The supply and demand model makes assumptions about what markets are like as well as assumptions about suppliers and demanders. Making these assumptions is what allows us to make systematic predictions about how supply and demand will change in response to a variety of factors and how these changes will likely affect prices and quantities. The supply and demand model is a simplified approximation of how markets work that focuses on a key set of characteristics present in most markets. This chapter focuses on markets for commodities like pizza, beer, gas, wheat, and clothing operating in the short run. Markets for inputs such as labor and mar- kets for financial assets work on slightly different principles. We will examine these markets later in the book. Also, different dynamics play out in the long run that cannot be captured by the supply and demand model alone. The supply and demand model of commodities markets is based on ten major assumptions.MARKETS, SUPPLY AND DEMAND 1. Transactions take place in a capitalist market system with privately owned firms and individual consumers. 2. Markets are perfectly competitive or at least competitive enough to mirror the behavior of perfectly competitive markets. In perfectly competitive markets, (a) suppliers sell an identical good or service and (b) no individual buyer or seller can influence the market price by themselves 3. Suppliers and demanders engage in optimizing behavior, with sup- pliers maximizing profits and demanders maximizing the satisfac tion, or "utility," that they get from purchases. 4. Markets tend toward a stable equilibrium, settling on an equilibrium price and quantity. The specific assumptions about demanders (consumers) are as follows: 5. Consumers are rational, calculating, fully informed, and self-inter- ested about their purchasing options. They engage in optimizing behay- for, carefully weighing their options. Note that this assumption eliminates purchases driven by impulse buying and by emulating one's peers. 6. Consumers prefer having more to having less, but they have a limited budget so they cannot buy all that they want, and they get less and less satisfaction from having more and more of the same good. This assumption implies that consumers have an insatiable demand for goods and services in general but they don't want too much of any one item. 7. There are substitutes for each good, and consumers can rank goods according to how much of each good they want at various prices. This leads them to want more of a good at lower prices and less of a good at higher prices. Consumers have a good idea about the quality of substitute goods and how much satisfaction they will get from each type of good. Consumers behave like mini-computers, tabulating how much satisfaction they will get from each dollar of spending on each good, choosing to purchase the items that give them the most satisfaction per dollar until they exhaust their budget. The rewik is that rational, fully informed consumers desire to purchase smaller quantities of a good at high prices and larger quantities of a good at low prices. The specific assumptions about suppliers are the following: 8. Firms pursue as much short-term profit as possible and, in doing so decide what to produce, how much to produce, and how to produce it. 9. Capital and technology are fixed in the short run. The short run is : period in which firms are stuck with the existing size of operations, usually a period of 1-12 months during which firms do not have time to dramatically expand the size of their business or develop new technologies. This means they cannot produce beyond their maximum capacity in the short run.MARKETS AND HOW THEY WORK 185 10. Firms are encouraged to increase the quantity of a good supplied when the price increases. With a fixed size of operations in the short run, it usually costs firms more to supply more. Thus, the only way to encourage firms to supply more is to offer them a higher price. If these assumptions hold reasonably well, then the supply and demand model can be a powerful tool to analyze markets. Let's consider the local market for pizza in the United States as it compares to the assumptions above. Most of the assumptions hold reasonably well: The pizza market in the United States is operated by private firms in a market capitalist sys- tem. Consumers are generally well informed about the quality of pizzas from dif- ferent pizzerias in their town, along with other options for quick food (substitutes) such as sandwich shops and Chinese restaurants. However, pizza is not a completely homogeneous product: There are quality and location differences. Nonetheless, most economists think that pizzas are close enough substitutes for each other that we can still talk about a local market for pizza. Pizza firms are not all small opera- tions, either. As Figure 9.2 shows, Domino's and Pizza Hut both have very large shares of the market. On the other hand, even small towns have lots of local com- petitors in addition to the national chains, so the pizza market is reasonably close to being a competitive market. The prices that different restaurants charge for a similar size and type of pizza in a particular location cluster together, varying only slightly. This makes sense, because no restaurant wants to charge significantly more than its competitors for fear of losing business. The price of a large cheese pizza in the Theater District in Manhattan was $13.50 in 2014, and there was remarkably little variation among various restaurants. In Lewisburg, Pennsylvania, a 14-inch cheese pizza went for $10 in 2018. Gourmet pizzerias can charge more, and some discount pizzerias charge less, but most pizzerias charge a price within $1 of each other. To mainstream economists, this means that the market for pizza has settled on an equilibrium Restaurant Name Market Share Domino's 30.10% Pizza Hut 27.14% Little Caesars Pizza 10.60% Papa John's 7.78% Papa Murphy's 1.80% California Pizza Kitchen 1.74% Marco's Pizza 1.42% Chuck E. Cheese/Peter Piper Pizza 1.11% Sbarro 1.07% Round Table Pizza 1.04% FIGURE 9.2 Table showing the ten largest pizza companies in 2019. Source: Pizza Today.186 MARKETS, SUPPLY AND DEMAND price, and we can safely analyze a market for a commodity like pizza using the sup. ply and demand model, even though there are some slight variations in the product and the price. 9.4 OVERVIEW OF THE SUPPLY AND DEMAND MODEL AND EQUILIBRIUM According to the supply and demand model, in competitive markets supply and demand interact to determine the equilibrium price and equilibrium quantity in the market. In this section we will briefly describe the model and how it works at a general level. In subsequent sections we go through each part of the model in detail. In studying the relationship between price and quantity, economists have iden- tified two major tendencies that dominate markets: (1) Firms tend to increase the amount of a good they want to sell as the price rises because it gets more and more profitable for the firm to supply a good as the price increases and (2) consumers tend to decrease the amount of a good that they want to purchase as the price increases, switching instead to lower priced goods or doing without the good altogether. If we plot out the positive relationship between price and the quantity firms want to supply, we get the positively sloped supply curve in Figure 9.3. The supply curve has a positive slope because the higher the price, the larger the amount of the good that firms want to supply. Similarly, if we plot out the inverse relationship between price and quantity demanded, we get the negatively sloped demand curve in Figure 9.3. The demand curve has a negative slope because the higher the price Price (P) of a pizza in $ Supply (S): The quantity of pizzas firms want to sell at each price Equilibrium Equilibrium Price (P.) Demand (D): The quantity of pizzas consumers want to purchase at each price Quantity (@) of pizzas Equilibrium sold per month Quantity (@.) FIGURE 9.3 A graph of the supply and demand model for pizzas.. .__.,' ._._-.._.L.-_.. MARKETS AND HOW THEY WORK 137 of the good. the smaller the quantity of the good consumers want to purchase. Where the supply and demand curves intersect we nd the equilibrium point, where the quantity supplied is exactly equal to the quantity demanded. which determines the equilibrium price and equilibrium quantity. Competitive markets always tend to move toward an equilibrium price and 1 quantity due to the innate characteristics of marketsthe invisible hand of the f market that Adam Smith identied. In fact. markets abhor surpluses and shortages. - and unless prevented by law. prices in markets will adjust to eliminate any surplus : or shortage and move the market into equilibrium. Consider graph (a) in Figure 9.4. We know that the equilibrium price (P) of . a large cheese pizza in Lewisburg, Pennsylvania. is 310. Now suppose that pizza restaurants in town try to charge a higher price than that. (PH). ofSI4. What will ' happen? Pizza restaurants want to sell more pizzas at a price of 314 than they do at SlO. Making pizzas would be so protable at that price that they could afford to hire more workers. buy more pizza delivery vehicles. and increase the quantity of pizzas they supply. The quantity they want to produCe increases substantially. i However. consumers have the opposite reaction. At $14 pizzas are too expensive for ' many people. who will cook for themselves or buy other types of fast food instead ' ofbuying a pizza. When the price increases from 510 (P) to 314 (PH). the quantity ' demanded decreases. The result in Figure 9.4(a) is that at the high price. (PH). the quantity of piz- 2n supplied is much greater than the quantity of pizzas demanded (Q5 > Q\"). This results in a surplus of pizzas: More pizzas are produced than are purchased. But for pizza producers, this is an unsustainable situation. As pizzas pile up. busi- nesses cut back on production and lower prices to get rid of the surplus. As prices ' fall. canSuniers buy more pizzas. This process continues until we returiaack to 'i/ OI W'C/ Mad Sc don/29 cwf'i Mammy. {a} High price (PH) above P, {b} Low price (PL) below P, p P Surplus to. --D_ l S 5 p. --------- Equilibrium PL ............. Sharing-ti EC 9.2 ,1 5.0.050 050.3% :iGiiaE 9.4 Prices adjusted to eliminate surpluses or shortages. 188 MARKETS, SUPPLY AND DEMAND equilibrium at P. where there is no longer any pressure for restaurants to cut Prices and production. Similarly, suppose pizza restaurants were to cut their prices below the equilibrium price of P. = $10 to a price of Py = $6 per pizza, which is depicted in Figure 9.4(6). That price is so low that many pizza restaurants would go out of business. and all firms would produce fewer pizzas because it is less profitable to do so. (They would probably start selling other types of food such as pasta and wings that are more prof- itable.) The quantity of pizzas supplied. (Q.). declines as the price falls. Consumers. on the other hand, want to purchase a lot more pizzas at the new. lower price P. Quantity demanded, (Q,), increases as the price falls. The result is a large shortage. consumers want a lot more pizzas than restaurants are willing to supply: Q, > Q,- How will the market respond to this shortage? Once businesses realize there is a shortage, they know they can increase prices and sell more pizzas. As they increase the price of pizza more and more in response to the shortage, the quantity of pizzas demanded falls steadily. Eventually we once again reach equilibrium at P, and Q, Next, we turn to how the supply and demand model works in more detail, analyzing the key factors that affect each curve. We can use this model to analyze how supply and demand interact to determine the price and quantity of goods and services and how price and quantity change in response to variations in key deter- minants of supply and demand. 9.5 THE THEORY OF DEMAND To use the supply and demand model you need to understand each of its com- ponents and the major factors that affect them. We will start with the theory of demand and the demand curve. According to the theory of demand in mainstream economics, consumers' willingness to pay for a product (demand) depends on the benefit (mar- ginal utility) they expect to get from consuming the product, the price of the product, disposable income and wealth, tastes and preferences, the prices of substitute and complementary goods, the number and size of buyers, expectations about the future, and the availability and cost of consumer credit. In order to determine the relationship between the factors that affect consumer demand and the prices and quantities of goods, economists developed the demand curve, which shows the precise relationship between the price of a good and the quantity of the good demanded at each price. Marginal utility and price determine the slope of the demand curve (whether it is steep or flat), and the other factors, known as the determinants of demand, affect the location of the demand curve (whether it shifts to the left or to the right). To begin, we will focus on the relationship between price and the quan- tity demand. Quantity demanded is the amount of a good or service thatMARKETS AND HOW THEY WORK 189 buyers are willing to purchase at each price in a particular time period. Neoclassical economist Alfred Marshall's law of demand states that, other things being equal, the quantity of a good demanded is inversely related to its price. When price increases, quantity demand decreases. When price decreases, quantity demanded increases. The law of demand focuses exclusively on the relationship between price and quantity demanded, whereas the theory of demand includes the effect of price and other factors on demand. Consider your own purchases of a product like a pizza. If pizza is extremely expensive-perhaps if it sells for a price of $30 per pizza-you would probably only purchase it on rare occasions as a treat. If pizza is really cheap-if the price is only $4 a pizza-you might buy it much more regularly. Note, however, that consumers tend to be less and less willing to purchase an item the more they have of it. If you have had pizza three nights in a row, on the fourth night you are much less likely to want pizza again. This means, in economic terms, that you are less willing to pay as much for pizza that night. Economists use the concept of utility to explain this phenomenon. Utility is the amount of satisfaction a person gains from consuming a product. The law of diminishing marginal utility reflects the fact that as a person betting consumes more and more of one product, while holding consumption of Sicle & other products constant, that person experiences a decline in the addi- tional (marginal) utility from each additional unit of that product con- a certain sumed. The law of diminishing marginal utility is the source of the negative prod at relationship between price and willingness to pay (quantity demanded). Consumers are willing to pay a lot for something that is scarce and that they want very badly. They are much less willing to pay for something that they have had a lot of and are sick of having. Economists construct a model of the demand curve based on such behavior. Figure 9.5 shows the quantity of large cheese pizzas demanded at each price every month by three consumers, Kate, Juan, and Bo. At a price of $14 per pizza, none of them want to buy any. At that price, they prefer to buy less expensive alternative forms of fast food. If the price falls to $12 per pizza, Kate will buy one pizza per Price Kate's Juan's Bo's Market quantity quantity quantity quantity demanded demanded demanded demanded (sum of all 3) $ 14.00 0 o 0 $ 12.00 6 $ 10.00 2 6 12 $ 8.00 w 9 18 $ 6.00 4 12 24 $ 4.00 un 10 15 30 $ 2.00 12 18 36 14 21 42 FIGURE 9.5 Table showing the quantity of pizza demanded per month at each price.MARKETS. SUPPLY AND DEMAND ntoiithjuan will buy two. and Bo will. buy three. At a Prize DfS'lD pm. pizza. Kate- will buy two pizzas per monthJuan will buy four. and {30 Will buy \"I. And ,0 on. To construct a market quantity demanded. we gimp}? add up the quantity demanded for all economic actors in the market. ll'we 3|.ul\"c that Kate. juan. and 130 are the only consumers. the market quantity demanded is found by adding up all of the individual quantities demanded at each price. The result is the marker quantity demanded in Figure 9.5. We can use the information in Figure 9.5 to construct a graph of the demand curves for Kate.Juan. Bo. and the market. A deruuhd curve shows the quantity ofn good buyers would like to purchase at each price within a particular period of rinse. Figure 9.6 plots out the demand curves for Kate. Juan. Bo. and the market (if Kate.Juan. and Bo make up the entire market) using the data from Figure 9.5. As you can see. all ofthe demand curves have a negative slope. in keep- ing with the law ofdemand. We can also use an equation to express a demand curve. In general. quantity demanded depends on price. In mathematical terms. Q, = P). Linear demand curves take the fonn Qd=a+bP. where a is the quantity demanded when P = 0 and I: is the inverse ofthe slope. The slope of the demand curve is the rise over the run. Slope = (AP / AQ4)=(1!b). b is always a negative number because when price increases, quantity demanded decreases and vice versa. In Figure 9.6, the equation for Kate's demand curve is Q, = 7 -(O.5)P . Th; equation for the market demand curve is Q; = 42 - 3P . The slope of the demand curve shows how quantity demanded changes when ever price changes. The location of the demand curve. whether it shifts to the Inf: or to the right. depends on the determinants of demand. 9.6 THE DETERMINANTS OF DEMAND THAT CAUSE SHIFTS IN THE DEMAND CURVE The demand curve is designed to show the direct relationship between price and the quantity demanded for a particular product (the law of demand). A changein price produces a change in the quantity demanded and causes a movement along the demand curve. For example. in Figure 9.6, if the price ofa pizza falls from $12 to $10, the quantity of pizzas demanded in the market will increase from 6 to 12 (the second and third points on the market demand curve). There are six factors that cause a shift in the entire demand curve. These are known as the determinants of demand: The six factors that determine the location of the demand curve and whether or not it shifts to the left or 192 MARKETS, SUPPLY AND DEMAND to t the right. The determinants of demand are (1) disposable income and wealth, (2) tastes and preferences, (3) the prices of substitute and com. plementary goods. (4) the number and size (buying Porosity "wer) of buyers , ( 5 ) Failability and cost of buyers' expectations about the future, and (6) the "man (the ceteris pan- consumer credit. The determinants of demand are held constant bus conditions) when we draw a particular demand curve. This also means that when the determinants of demand change. we have to ave to draw an entirely new demand curve reflecting the new information-the demand curve will have shift Before we proceed, we need to highlight some very 's specific and precise lan- guage economists use when they talk about changes in Vety find A change in the quantity demanded is a movement along the demand curve caused by a change in the price of the good being demanded. A change in demand refers to a shift in the demand curve to the left or to the to the right due to a change in one of the determinants of demand. We go through each of the determinants of demand below, starting with the most important one. disposable income and wealth. 9.6.1 Disposable income and wealth Disposable income is the income people have to spend after the govern- ment has taken out taxes (after tax income). Household wealth is the value of the assets held by individuals and households. In general, for all normal goods an increase in income or wealth will lead to consumers wanting to buy more of a good at each price than they used to. The entire demand curve shifts to the right. Suppose that incomes in Lewisburg. Pennsylvania, double because of a huge natural gas boom in the area that creates a lot of jobs and income. When people have more money, they tend to buy more goods in general, and they definitely tend to buy more pizzas. As you can see in Figure 9.7(a), when income or wealth increases, the demand curve moves further to the right at each price. For example, at a price of $10, consumers in Lewisburg wanted 30,000 pizzas per month before the increase in income (point A), but they want 50,000 pizzas per month after the increase in income. The entire curve has shifted to the right by 20,000 pizzas: At each price, people want 20,000 more pizzas than they used to as a result of the increase in income. (Note that we are depicting the full market for pizzas, rather than the market of three people we used earlier as an example. Now we have thousands of consumers in the market.) If we put the demand curve from Figure 9.7(a) together with a supply curve. we can see how a rightward shift in demand affects the equilibrium price and quan- tity of pizzas. The rightward increase in demand creates a shortage of pizzas at a price of $10: 50,000 people want pizzas (point B in Figure 9.7(b)), but suppliers only want to supply 30,000 pizzas (point A) at that price. Once pizza producers see that more people want their pizzas than pizzerias can provide, they will take advantage of the increase in demand to raise their prices and hire more workers so they canMARKETS AND HOW THEY WORK 193 (b) Change in Equilibrium from (a) Shift in Demand to the right a rightward shift in D P(S) Demand for Pizzas in Lewisburg, PA P($) Market for Pizzas in Lewisburg, PA $1 1 8 $10 - $10 - D, D2 D, D2 30 50 30 42 50 Q (Pizzas per month, in 1000s) Q (Pizzas per month, in 1000s) FIGURE 9.7 A shift in demand to the right (increase in demand). increase pizza production, moving from point A to point C along the supply curve. As the price of pizzas increases, consumers purchase fewer of them, reducing their quantity demanded from 50 to 42 and moving from point B to point C, which is the new equilibrium. A decrease in income or wealth would do the opposite. When the stock market crashed in 2008 and people saw the value of their assets decline by 60%, they pur- chased fewer goods of all types and the demand curves for most goods, including pizza, shifted to the left (decreased). The examples given above describe normal goods, which are defined as goods that consumers want to buy more of when their income or wealth increases and that they want to buy less of when their income or wealth decreases. But we do sometimes find inferior goods, which are goods that con- sumers want to buy less of as their income or wealth increases or more of as their income or wealth decreases. Examples of inferior goods include used clothing, used cars, inexpensive brands of all types, less desirable types of foods, and other goods that people would choose not to buy if they had more money. If peo- ple have more money, they tend to increase their demand for higher quality items and decrease their demand for lower quality items. For example, during economic booms when incomes and wealth increase, people buy more expensive brands of beer, including imported brands (Heineken, Stella Artois) and microbrews (Samuel Adams, Victory, Dogfish Head), while buying less bargain brands (Pabst Blue Ribbon, Natural Light, Old Milwaukee). The demand for premium beers increases when income increases, but the demand for bargain beers (inferior goods) decreases.194 MARKETS, SUPPLY AND DEMAND 9.6.2 Tastes and preferences Consumers' tastes and preferences can have a significant influence on the demand for a product when large numbers of consumers shift their buying habits. For example, as health concerns about obesity, diabetes, and arti reeteners grew and as anti-carbohydrate diets became prominent, demand for sodas (oft drinky) plummeted. From 2004 to 2017. U.S. consumers decreased their purchases of sodas from 10.2 billion cases to 8.6 billion cases, a drop of 15%. In Figure 9.8() you can see that the demand curve for sodas shifts to the left by 3.2 billion cases du es due to the decrease in consumers' interest in soda. Figure 9.8(b) shows how the leftward shift in demand creates a surplus of soda (the line between point A and point B). As surplus soda builds up in inventories, soda companies like Coca-cola and Pepsi cut back production and lower prices, moving the quantity supplied from point A to point C. the new equilibrium. As firms drop their prices, consumer demand moves from point B to point C. 9.6.3 The prices of substitute and complementary goods Demand curves also shift when the prices of closely related goods change. A sub- stitute good is a product that consumers are willing to purchase instead of another good; when the price of one good increases, many consumers will switch to buying the substitute good, increasing the demand for the substitute. A substitute for Coca-cola is Pepsi. A substitute for beef is chicken, A complementary good is a product that consumers tend to purchase along (a) Shift in Demand to the left (b) Change in Equilibrium from a leftward shift in D P (S) P (S) Demand for Sodas in the U.S. Market for Sodas in the U.S. $8 A B $8 C $6 D2 D2 7 10.2 7 8.6 10.2 Q (Cases of soda per year) Q (Cases of soda per year) FIGURE 9.8 A shift in demand to the left (decrease in demand).MARKETS AND HOW THEY WORK with another good: when the price of one good increases and consumers buy less of it. there will also be a decrease in the demand for any comple- mentary goods. Complements for peanut butter are bread and jelly. A comple- ment for a cell phone is a case for the phone. As an example of substitute goods. when deciding how to heat their homes. households choose between electric. coal. wood. oil. and natural gasthese goods are substitutes for each other. As you can see in Figure 9.9. the increase m the supply of natural gas from {racking has led to a dramatic drop in natural gas prices during the last decade. which has caused households to increase the quantity of natural gas demanded (moving along the natural gas demand curve dawn and to the right from point A to point B). There is a movement along the demand curve for natural gas because of the decrease in the price of natural gas. In the heating oil market. however. there is a shift in the demand curve for heat- ing oil to the left as households buy more gas and less heating oil. Equilibrium in the heating oil market moves from point C to point D. with a lower equilibrium price and quantity. Note that in these graphs we use Pl. P2. Q. and Q1 instead of putting in specic numbers. Economists are often interested in general trends tn markets. In this case. economiscs were able to predict that the decrease in the price of natural gas and the increase in the quantity of natural gas demanded in Figure 9.9(a) would be matched by a decrease in demand (leftward shift) for heat- ing oil that we see in Figure 9.9(b). There are also numerous examples of complementary goods. When someone buys a laptop computer. they also tend to buy a laptop bag, an external mouse. a monitor. and a printer. When you buy a printer. you will eventually need more in]: for it. When you buy a car, you will also need to buy gas. tires. and car insurance. {a} Ireraase in Supply 5. Quantity Dmnded (b) \"Tm\" hr '31:?" "'3 Pm\" ' Pm HarkallorNetural Gasln the HS) Market lorHeatingOilnlhe United States United States _.._-_. -_1.___ "\"'""""'- U: I.__._._..._._._.-_. 0. 02 0 [I'm at new Gas per year] 0 {Tons of Heating Oil per year) Fl-Cv'JRE is A dome in the price of a substitute good {935) causes a decrease in den-land tots). 195 196 MARKETS, SUPPLY AND DEMAND For another concrete example, there was a large increase in the market supply by more than 50% of gasoline from 2014 to 2015, which caused gas prices to f to fall by vehicles (SUVy) Gasoline is a strong complement for large trucks and sport utility SUV sales increased by 16% as gas prices fell. a significant increase in demand passenger cars are (rightward shift). However, sales of passenger cars fell by 2% Pay toward SUV's because of substitutes for SUVs. When consumers shift their tastes toward for passenger low gas prices, this causes a decrease (leftward shift) in the dem cars. (See if you can draw this situation on a set of three graphs of the gasoline mar- ket, the SUV market, and the passenger car market.) 9.6.4 The number or size of buyers The number of buyers, and especially the number of larger buyers, has a big influ- ence over the demand for a product. If there is an increase in the number or size of buyers, the demand for a product will increase (shift to the right). If there is a decrease in the number or size of buyers, the demand for a product will decrease (shift to the left). For example, when the government raised the national drinking age to 21 in 1984, this meant that fewer consumers could legally drink in bars. Many bars started losing money due to the decrease in demand for drinks at bars, causing some bars to close. Interestingly, most data indicate that the increase in the drinking age had no significant impact on alcohol consumption; there was just less alcohol consumption in public settings such as bars. The size of buyers also impacts demand significantly. If you manufacture a product and Walmart, the largest retailer in the United States, decides to stock your product to sell to consumers, you will experience a significant increase in demand because you have attracted a huge buyer. 9.6.5 Buyers' expectations about the future Expectations can affect the demand for a product in several ways. If consum- ers expect their incomes or wealth to increase, or if they are confident about the future, they tend to increase their demand for goods. If consumers worry that they might lose their job or that the value of their stock market portfolio might drop sig- nificantly, they will decrease their demand for goods. Ironically, if consumers expect a recession, they can help to cause one by reducing their purchases due to pessimism! Consumers might also change their demand for a particular good if they expect its price to change: If people expect home prices to drop, they often wait to purchase a home. People also shift their demand for a product if they think they might lose access to it. A mass shooting in San Bernardino in 2015 led President Obama to call for stricter background checks and gun regulations. This caused a significant increase in demand for guns by consumers who were worried they might not be able to buy guns in the future. Thus, consumer expectations of all types affect the demand for products.MARKETS AND HOW THEY WORK 197 9.6.7 The availability and cost of consumer credit The more access that consumers have to borrowing and the lower the interest pay- ments they have to make on their debt, the more purchases they can make. In 2017 consumer credit card debt reached $784 billion-that means consumers were able to buy over $700 billion more goods than they could have if they just relied on their income and wealth to make purchases. That amounts to a huge increase in demand for many products. Low interest rates on car loans and easier access to those loans increased the demand for cars in the 2010s. Now that we have discussed the factors that drive the behavior of the demand curve, it is time to turn to the supply curve and the behavior of sellers in more detail. 9.7 THE THEORY OF SUPPLY According to the theory of supply in mainstream economics, sellers' willing- ness to offer a product for sale (supply) in a perfectly competitive market depends on the price they expect to get from selling the product, the cost, productivity and availability of inputs, the technology available to make the product, sellers' expectations about the future, changes in the profitability of other markets the seller can supply, and the number and size of suppliers. In order to determine the relationship between the factors that affect suppliers and the prices and quantities of goods, economists developed the supply curve that shows the precise relationship between the price of a good and the quantity of the good supplied at each price. The marginal cost of producing a product, which is driven by the cost and marginal productivity of inputs, determines the slope of the supply curve (whether it is steep or flat), and the other factors affect the location of the supply curve (whether it is shifted to the left or to the right). First, we will focus on the relationship between price and the quantity sup- plied. Quantity supplied is the amount of a good or service that sellers are willing to offer for sale in a particular time period at each price. The law of supply states that, other things being equal, the quantity of a good sup- plied is directly related to its price. When price increases, quantity sup- plied increases. When price decreases, quantity supplied decreases. This means that the supply curve is upward sloping in the short run. The short run is the period of time in which one or more inputs are fixed and cannot be changed, so only variable inputs can be adjusted. For a pizzeria, in the short run they are stuck with the size of their restaurant and kitchen-their capital stock is fixed. If they experience an increase in demand for pizzas, they can supply pizzas quickly and easily until all of the specialized jobs in198 MARKETS, SUPPLY AND DEMAND the pizzeria are taken. But once all of the ovens are baking and all of the waiters. cooks, delivery persons. and cashiers are working at capacity. it is extremely dif- ficult to increase pizza production any further. And it would be less efficient to do so. involving people crowding in each other's way to do their work. watch raiting for a pizza oven to become free, and so on. The cost of each additional Pizza ives would rise as more are produced under these conditions. Thus, the only way the pizzas pizzeria will continue to increase production when the restaurant is running of ing out of capacity and costs per pizza are increasing is if the price of pizza is high enough to offset the increasing costs. In other words, the only way to entice a pizzeria to produce more pizza is for consumers to offer a higher price: An upward sloping su oping supply cu Economists construct a model of the supply curve based on these characteris- tics of small firms in competitive markets. Figure 9.10 shows the quantity of large cheese pizzas supplied every month at each price by two firms, Pizza Hut and Domino's. At a price of $4 per pizza, neither pizzeria wants to sell any pizzas: That price isn't high enough to cover their costs and they would have to close down. If the price increases to $6, Pizza Hut will offer 1000 pizzas for sale and Domino's will offer 2000 pizzas for sale. If the price increases to $8, Pizza Hut will offer 2000 pizzas for sale and Domino's will offer 4000. And so on. Notice that as the prize of a pizza rises and selling pizzas becomes more profitable, the quantity of pizzas supplied per month increases. To construct a market quantity supplied, we add up the quantity supplied for all sellers in the market. If we assume that Pizza Hut and Domino's are the only sellers, the market quantity supplied is found by adding up all of the individual quantities supplied at each price. The result is the "quantity supplied" column in Figure 9.10. We can use the information in Figure 9.10 to construct a graph of the supply curves for Pizza Hut, Domino's, and the pizza market. A supply curve shows the quantity of a good that a seller will offer for sale at each price within a particular period of time. Figure 9.11 plots out the supply curves for Pizza Hut, Domino's, and the pizza market (if Pizza Hut and Domino's make up the entire sellers' side of the market). All of the supply curves have a positive slope, in keeping with the law of supply. Pizza Hut's quantity Domino's quantity Market supply (sum Price supplied supplied of both) $ 14.00 5000 10,000 15,000 $ 12.00 4000 8000 12,000 $ 10.00 3000 6000 9000 $ 8.00 2000 4000 6000 $ 6.00 1000 2000 3000 $ 4.00 0 0 FIGURE 9.10 Table showing the quantity of pizza supplied per month at each price.MARKETS AND HOW THEY WORK 199 16 SMarket 14 'SPizzaHut -Domino's 12 10 -.. . Pizza Hut's Supply Curve - - Domino's Supply Curve Market Supply Curve (sum of both) 0 1000 8 8 8 0,000 9000 8 . 13,000 14,000 15,000 FIGURE 9.11 Supply curves for Pizza Hut, Domino's, and the market for pizzas. We can also use an equation to express a supply curve. Quantity supplied depends on price. In mathematical terms, Q, = f(P). Linear demand curves take the form Q, = a+ bP. -= is the intercept on the price axis when Q = 0 and b is the inverse of the slope. The slope of the supply curve is the rise over the run. Slope = (AP / AQ,) = (1/ b)a. b is always a positive number in the equation for a supply curve because when price increases, quantity supplied increases and when price decreases, quantity sup- plied decreases. In Figure 9.11, the equation for Pizza Hut's supply curve is Q, = -2000 + (500) P. The equation for the market supply curve is Q, = -6000 + 1500P. We can use equations for supply and demand to solve for equilibrium price and quantity. Suppose that the equation for the market demand curve is Q = 12,000 - 300P. In equilibrium we know that Q, = Qp. Setting the equations for Q, and Qp equal to each other, we get the following: Qs = -6000 + 1500P; Qa = 12,000 - 300P; Qs = QD;(-6000 + 1500P) = (12,000 - 300P) Solving for P we get 180OP=18,000. The equilibrium price P. = 10. If we plug P = 10 into the equations for Q, and Qp. we find that the equilibrium quantity Q, = 9000.200 MARKETS. SUPPLY AND DEMAND '5 ssssssss Guantlty (plun- per month) 1 FIGURE 9.12 Equilibrium where 03 = On. [Five plot out the equations for the demand curve and the supply curve. We get Figure 9.12. The supply (5) and demand (D) curves intersect at the equilibrium price of 510 and the equilibrium quantity of 9000 pizzas per month. Therefore. we can use either an equation or a graph to show the relationship between supply and demand and to nd equilibrium price and quantity. The slope of the supply curve shows how the quantity supplied changes when- ever price changes. The location of the supply curve. and whether it shifts to the left Or to the right. depends on the determinants of supply. 9.8 THE DETERMINANTS OF SUPPLY The determinants of supply are the ve factors that determine the location of the supply curve and whether or not it shifts to the left or to the right. The determinants of supply are (1) the cost, productivity, and availability of inputs; (2) the technology available to make the product; (3) sellers' expectations about the future; (4) changes in the protability of other markets the seller can supply; and (5) the number and size of sellers. Tut determinants of supply are held constant (the ceteris paribus conditions) when we draw a particular supply curve. When the determinants of supply change. we draw an entirely new supply curve reecting the new information that caused the supply curve to shift. MARKETS AND HOW THEY WORK 9.8.1 The cost, productivity. and availability of inputs Inputs are the factors of productionlabor. capital, land. and natural resourcesused to produce goods and services. Let's focus on labor for now because It is the most important input for most rms. making up about 01% oftlte costs of production on average. Suppose that the President of the United States suggests a complete ban on the use of illegal immigrant labor and threatens to impose huge lines on any companies that are caught employing illegal immigrants. Bunnesscs that slaughter and process chickens depend on illegal immigrant labor to do much oftlte work in their Industrythey nd that legal U.S. citizens do not want to do this kind of work at the wages that businesses want to pay. The result of: crackdown on illegal immigration would be a reduction in the availability of laborers for chicken processing firms. Suppliers of chicken would nor be able to supply- as much chicken at each price as they used to. so the entire supply curve for chicken shifts to the left. as we see in Figure 9.1361). When we put the shift in supply on a graph with the demand curve for chicken. we see that when the supply curve shifts to the left, this creates a shortage (the dis- tance from point A to point B). This causes the equilibrium price to rise front 51.50 per pound ofchtcken to $1.75 per pound. and the equilibrium quantity falls from 39 billion pounds per year to 32 billion. Anything that raises the cost. reduces the productivity. or reduces the avail ability ofinputs Will cause the supply curve to decrease (shift to the left). Anything thatlowers the cost. increases the productivity. or increases the availability ofinputs will cause the supply curve to increase (shift to the right). (In) Change in eduilibrium lrorn la} Shin l" \"my 10 the left a leftward shift in S potato} P d ms 9" Supply of chicken In is W W" ) Market tor chicken in the us. for one year the U.S. for one year $1.75 O: 51.50 l 39 2O 32 39 {2th of pounds of chicken per year) a (Billions of pounds of chicken per year) I'D O PGURE 9.13 A shift in supply to the left (decrease in supply). 201 202 MARKETS. SUPPLY AND DEMAND 9.8.2 The technology available to make the product Technology can be a major driver of the costs of production and therefore a major determinant of the location of the supply curve. Improvement ments in technology increase productivity and reduce the cost of producing each ing each unit of outs C output, reduc. ing a supplier's costs of production. The invention of ro of robots to produce cars an