REAL VERSUS NOMINAL PRICES:SUPPLY AND DEMAND, The Demand Curve

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Changes in Market Equilibrium:Market for College Education >>

Microeconomics ECO402

Lesson 3

REAL VERSUS NOMINAL PRICES

Nominal price is the absolute or current dollar price of a good or service when it is sold.

Real price is the price relative to an aggregate measure of prices or constant dollar

price.

The Consumer Price Index (CPI) is an aggregate measure. Real prices are

emphasized to permit the analysis of relative prices.

Calculating Real Prices

CPI base year

Real Price =

x Nominal Price current year

CPI current year

Calculating the Real Price of Milk

Nominal Price

Real Price of Milk

Year

of Milk

CPI

in 1970 dollars

1970

.40

38.8

.40=38.8/38.8x .40

1980

.65

82.4

.31=38.8/82.4x .65

1999

1.05

167.0

.24=38.8/167.0x 1.05

Calculating Real Prices: An Example - Eggs & College

38.8 1970

Real Price of Eggs

x 1.04

163

1998 (1970 = 100)

Real Price of

38.8

College Education =

x $19,213 = $4,573

163.0

1998 (1970 = 100)

1970

1975

1980

1985

1990

1998

Consumer

Price Index

38.3

53.8

82.4

107.6

130.7

163.0

(1983 = 100)

Nominal Prices ($)

Grade A

0.61

0.77

0.84

0.80

0.98

1.04

Large Eggs

College

2530

3403

4912

8156

12800

19213

Education

Real Prices ($1970)

Grade A

0.61

0.56

0.40

0.29

0.30

0.25

Large Eggs

College

2530

2454

2313

2941

3800

4573

Education

Microeconomics ECO402

SUPPLY AND DEMAND

The Supply Curve

Price ($

The Supply

per unit)

The supply curve shows how much of a

Curve

Graphically

good producers are willing to sell at a

given price, holding constant other

factors that might affect quantity supplied

This price-quantity relationship can be

shown by the equation:

The supply curve

slopes upward

demonstrating

= Q S(P )

that at higher

irms will increase

output.

Quantit

Change in Supply

Non-price Determining Variables of Supply

Costs of Production

· Labor

· Capital

· Raw Materials

The cost of raw materials falls

At P1, produce Q2

At P2, produce Q1

Supply curve shifts right to S'

More produced at any price on S' than on S

Supply - A Review

Supply is determined by non-price supply-determining variables as such as the cost of

labor, capital, and raw materials.

Changes in supply are shown by shifting the entire supply curve.

Changes in quantity supplied are shown by movements along the supply curve and are

caused by a change in the price of the product.

The Demand Curve

Price ($

The demand curve shows how much of a good

The demand curve slopes

per

consumers are willing to buy as the price per unit

downward demonstrating that

unit)

consumers are willing to buy

changes holding non-price factors constant.

more at a lower price as

product becomes relatively

This price-quantity relationship can be shown by the

cheaper and the consumer's

equation:

real income increases

Q D = Q D (P)

Quantity

Microeconomics ECO402

Non-price Determining Variables of

Change in Demand

Demand

Income

Consumer Tastes

Price of Related Goods

· Substitutes

· Complements

Income Increases

At P1, produce Q2

At P2, produce Q1

Demand Curve shifts right

More purchased at any price on D'

than on D

Demand - A Review

Demand is determined by non-price demand-determining variables, such as,

income, price of related goods, and tastes.

Changes in demand are shown by shifting the entire demand curve.

Changes in quantity demanded are shown by movements along the demand

curve.

Price

The Market Mechanism

($ per

Characteristics of the equilibrium or market

unit)

clearing price:

QD = QS

The curves intersect

at equilibrium, or

No shortage

market clearing,

No excess supply

price. At P0 the

quantity supplied is

No pressure on the price to change

equal to the quantity

demanded at Q0 .

Quantity

Price

The market price is above equilibrium

($ per

A Surplus

There is excess supply

unit)

Surplus

Producers lower prices

Quantity demanded increases and

Assume the price is P1,then:

quantity supplied decreases

1) Qs : Q1 > Qd : Q2

2) Excess supply is Q1:Q2.

The market continues to adjust until

3) Producers lower price.

the equilibrium price is reached.

4) Quantity supplied decreases

and quantity demanded

increases.

5) Equilibrium at P2Q3

Quantity

Microeconomics ECO402

The market price is below equilibrium:

Price

There is a shortage

($ per

Shortage

unit)

Producers raise prices

Quantity demanded decreases and

Assume the price is

quantity supplied increases

P2,:

The market continues to adjust until the

1) Qd : Q2 > Qs : Q1

2) Shortage is Q1:Q2.

new equilibrium price is reached.

3) Producers raise

price.

4) Quantity supplied

increases and quantity

demanded decreases.

5) Equilibrium at P3, Q3

Shortage

Quantity

Market Mechanism Summary

1) Supply and demand interacts to determine the market-clearing price.

2) When not in equilibrium, the market will adjust to alleviate a shortage or

surplus and return the market to equilibrium.

3) Markets must be competitive for the mechanism to be efficient.

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