GDP, Supply/Demand, & Inflation

What is the difference between GNP and GDP?

_________ total output of goods and services produced BY a country in one year.

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__________monetary value of all goods and services performed IN a nation in one year.

SUPPLY

What is SUPPLY?

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SUPPLY

Law of Supply: According to the law of supply, suppliers will offer more of a good at a higher price.

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SUPPLY

What is SUPPLY?

• how much of a good is offered for sale at a specific price

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• how much of a good all suppliers will offer at �different prices
• market supply curve is a graph of the quantity �supplied of a good by all suppliers at different prices.

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SUPPLY Curve

With the Law of Supply, a company will want to make things that will sell for the most money.

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So it is worthwhile to make more of the 3.00 slices than the .50 slices.

SUPPLY

Elasticity of supply is a measure of the way quantity supplied reacts to a change in price.

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• If supply is not very responsive to changes in price, it is considered inelastic.
• An elastic supply is very sensitive to changes in price.
• Time has an effect on supply
• Short term changes, companies are inelastic
• Long term changes, companies are more elastic

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SUPPLY

In determinging supply a company must consider:

• Labor
• Production Costs
• Output (how much to really make)

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SUPPLY

• Business owners have to consider how the number of workers they hire will affect their total production.
• The marginal product of labor is the change in output from hiring one additional unit of labor, or worker.
• You have 1 worker who makes 4 frisbees an hours
• You hire another worker, and together they make 10 per hour
• The marginal product of labor changes from 4 to 6
• What would a third worker do?
• Can there be too many workers?

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SUPPLY

Increasing marginal returns occur when marginal production levels increase with new investment.

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Diminishing marginal returns occur when marginal production levels decrease with new investment.

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Negative marginal returns occur when the marginal product of labor becomes negative.

What are some reasons for this?

SUPPLY - Production Costs

• A fixed cost is a cost that does not change, regardless of how much of a good is produced. Examples: rent and salaries
• Variable costs are costs that rise or fall depending on how much is produced. Examples: costs of raw materials, some labor costs.
• The total cost equals fixed costs plus variable costs.
• The marginal cost is the cost of producing one more unit of a good.

SUPPLY - Production Costs

• Marginal revenue is the additional income from selling one more unit of a good. It is usually equal to price.
• To determine the best level of output, firms determine the output level at which marginal revenue is equal to marginal cost.

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SUPPLY - Input Costs

• Any change in the cost of an input such as the raw materials, machinery, or labor used to produce a good, will affect supply.
• As input costs increase, the firm’s marginal costs also increase, decreasing profitability and supply.
• Input costs can also decrease. New technology can greatly decrease costs and increase supply.

SUPPLY - Government Influence

By raising or lowering the cost of producing goods, the government can encourage or discourage an entrepreneur or industry.

Subsidies - A subsidy is a government payment that supports a business or market. Subsidies cause the supply of a good to increase.

Taxes - The government can reduce the supply of some goods by placing an excise tax on them. An excise tax is a tax on the production or sale of a good.

Regulation - Regulation occurs when the government steps into a market to affect the price, quantity, or quality of a good. Regulation usually raises costs.

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SUPPLY - Other Influences

The Global Economy

• The supply of imported goods and services has an impact on the supply of the same goods and services here.
• Government import restrictions will cause a decrease in the supply of restricted goods.

Future Expectations of Prices

• Expectations of higher prices will reduce supply now and increase supply later. Expectations of lower prices will have the opposite effect.

Number of Suppliers

• If more firms enter a market, the market supply of the good will rise. If firms leave the market, supply will decrease.

SUPPLY

What is SUPPLY?

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DEMAND

What is DEMAND?

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DEMAND

The law of demand states that consumers buy more �of a good when its price decreases and less �when its price increases.

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• The law of demand is the result of two separate behavior patterns that overlap, the substitution effect and the income effect.
• These two effects describe different ways that a consumer can change his or her spending patterns for other goods.

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DEMAND

The Substitution Effect

• The substitution effect occurs when consumers react to an increase in a good’s price by consuming less of that good and more of other goods.

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The Income Effect

• The income effect happens when a person changes his or her consumption of goods and services as a result of a change in real income.

DEMAND Curve

Shows the quantity of a good consumers will buy at each different price

A demand curve assumes all outside factors, such as income, are held constant

A demand curve works as long as nothing changes. If something does, the demand curve will shift

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DEMAND

Factors that can lead to a change in demand

1. Income - Changes in consumers incomes affect demand. �A normal good is a good that consumers demand more of when their incomes increase. An inferior good is a good that consumers demand less of when their income increases.

2. Consumer Expectations - Whether or not we expect a good to increase or decrease in price in the future greatly affects our demand for that good today.

3. Population - Changes in the size of the population also affects the demand for most products.

4. Consumer Tastes and Advertising - Advertising plays an important role in many trends and therefore influences demand.

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DEMAND

Related goods:

The demand curve for one good can be affected by a change in the demand for another good.

• Complements are two goods that are bought and used together. Example: skis and ski boots
• Substitutes are goods used in place of one another. Example: skis and snowboards

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DEMAND - Elasticity

Elasticity of demand is a measure of how consumers react to a change in price.

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• Demand for a good that consumers will continue to buy despite a price increase is inelastic.
• Example?

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• Demand for a good that is very sensitive to changes in price (consumers may or may not buy it) is elastic.
• Example?

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DEMAND - Elasticity

Several different factors can affect the elasticity of demand for a good.

1. Availability of Substitutes - If there are few substitutes for a good, then demand will not likely decrease as price increases. The opposite is also usually true.

2. Relative Importance - Another factor determining elasticity of demand is how much of your budget you spend on the good.

3. Necessities versus Luxuries - Whether a person considers a good to be a necessity or a luxury has a great impact on the good’s elasticity of demand for that person.

4. Change over Time - Demand sometimes becomes more elastic over time because people can eventually find substitutes.

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DEMAND - Elasticity

The elasticity of demand determines how a change in prices will affect a firm’s total revenue or income.

• A company’s total revenue is the total amount of money the company receives from selling its goods or services.
• Firms need to be aware of the elasticity of demand for the good or service they are providing.
• If a good has an elastic demand, raising prices may actually decrease the firm’s total revenue.

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DEMAND

What is DEMAND?

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SUPPLY & DEMAND

Balancing the Market: The point at which quantity demanded and quantity supplied come together is known as equilibrium

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SUPPLY & DEMAND

Market Disequilibrium: If the market price or quantity supplied is not at the equilibrium price, the market is in a state called disequilibrium. There are two causes:

Excess Demand - Excess demand occurs when quantity demanded is more than quantity supplied.

Excess Supply - Excess supply occurs when quantity supplied exceeds quantity demanded.

Interactions between buyers and sellers will always push the market back towards equilibrium.

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SUPPLY & DEMAND

In some cases the government steps in to control prices. These interventions create price ceilings and price floors.

• A price ceiling is a maximum price that can be legally charged for a good.
• An example of a price ceiling is rent control, where a government sets a maximum amount that can be charged for rent in an area.
• A price floor is a minimum price, set by the government, that must be paid for a good or service.
• One well-known price floor is the minimum wage, which sets a minimum price an employer can pay a worker for an hour of labor.

SUPPLY & DEMAND

Supply Shifts

• Understanding a Shift - Since markets tend toward equilibrium, a change in supply will set market forces in motion that lead the market to a new equilibrium price and quantity sold.
• Excess Supply - A surplus is a situation in which quantity supplied is greater than quantity demanded. If a surplus occurs, producers reduce prices to sell their products. This creates a new market equilibrium.
• A Fall in Supply - The exact opposite will occur when supply is decreased. As supply decreases, producers will raise prices and demand will decrease.

SUPPLY & DEMAND

Demand Shifts

• Excess Demand - A shortage is a situation in which quantity demanded is greater than quantity supplied.
• Search Costs - Search costs are the financial and opportunity costs consumers pay when searching for a good or service.
• A Fall in Demand - When demand falls, suppliers respond by cutting prices, and a new market equilibrium is found.

SUPPLY & DEMAND

This shows how the market finds a new equilibrium when there is an increase in supply

SUPPLY & DEMAND

This shows how the market finds a new equilibrium when there is an increase in demand

SUPPLY & DEMAND

The Role of Price in a Free Market

• Prices serve a vital role in a free market economy.
• Prices help move land, labor, and capital into the hands of producers, and finished goods in to the hands of buyers.
• Prices create efficient resource allocation for producers and a language that consumers and producers both use.
• How do you use price?

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Price - What are the advantages?

Prices provide a language for buyers and sellers.

1. Prices as an Incentive - Prices communicate to both buyers and sellers whether goods or services are scarce or easily available. Prices can encourage or discourage production.

2. Signals - Think of prices as a traffic light. A relatively high price is a green light telling producers to make more. A relatively low price is a red light telling producers to make less.

3. Flexibility - In many markets, prices are much more flexible than production levels. They can be easily increased or decreased to solve problems of excess supply or excess demand.

4. Price System is "Free" - Unlike central planning, a distribution system based on prices costs nothing to administer.

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Efficient Resource Allocation

Resource Allocation

• A market system, with changing prices, ensures that resources go to the uses that consumers value most highly.

Market Problems

• Imperfect competition between firms in a market can affect prices and consumer decisions.
• Spillover costs, or externalities, are costs of production, such as air and water pollution, that “spill over” onto people who have no control over how much of a good is produced.
• If buyers and sellers have imperfect information on a product, they may not make the best purchasing or selling decision

INFLATION

What is inflation?

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INFLATION

What is inflation?

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The general increase in overall price for goods and services in an economy.

So is the economy growing/getting bigger?

As general prices go up, what happens to the value of your money?

INFLATION

Inflation is linked to money; it deals with prices.

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INFLATION

INFLATION

Inflation creates what may be referred to as "phantom" economic growth.

Total production may remain stagnant one year, but if there is a 3% inflation rate it would appear as if production (GDP) went up 3%. In order to deal with the problem of skewed / inflated statistics economists factor out inflation.

INFLATION & GDP

Real or constant GNP/GDP is where economists have factored out inflation.

Current or actual GNP/GDP has not factored out inflation.

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Economists choose a "base year" and convert all statistics to that base year.

This allows us to compare one year to the next without the influence of inflation in the statistic.

Supply & Demand graph worksheets 1-5

GDP, Supply/Demand, & Inflation

Supply curve

• Demand curve

= Price

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100

If the SUPPLY OF MONEY goes up, �what will happen to the VALUE of money?

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What happens to PRICE?

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How do we GRAPH THIS?

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100

If the SUPPLY OF MONEY goes up, �what will happen to the VALUE of money?

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What happens to PRICE?

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How do we GRAPH THIS?

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We can slide the lines up (or down) the graph, depending on circumstances.

Khan Academy: Inflation (9 min)

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Khan Academy: Inflation (3 min)

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Consumer Price Index & Inflation

Consumer Price Index (CPI)

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*What is a price index, and specifically the

Consumer Price Index?

*How does the market basket help create this index?

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Inflation

Market Basket of approximately 400 goods

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Base price is compared to new price of index products

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The change is then presented in % form

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**Current controversy - how does substitution figure into the market basket?

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Inflation: Types & Causes

Types

1 – 3 % average healthy economy

Over 5% problematic

Core Inflation rate (excluding food and energy)

Hyperinflation (out of control)

Stagflation (inflation and unemployment)

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Inflation: Types & Causes

Causes

Quantity Theory ( Too much money in supply)

Demand – Pull Theory (demand exceeds supply of goods and services)

Cost - Push Theory (Increasing production costs passed on to consumers)

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Inflation

When have you experienced inflation?

What do you think the cause was?