4 the market forces of supply and demand © 2014 cengage learning. all rights reserved. may not be...

4

The Market Forces of Supply and Demand

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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Slides by Ron

Cronovich2013

UPDATE

N. Gregory Mankiw

EconomicsPrinciples of

Sixth Edition


22

In this chapter, look for the answers to these questions:

• What factors affect buyers’ demand for goods?

• What factors affect sellers’ supply of goods?

• How do supply and demand determine the price of a good and the quantity sold?

• How do changes in the factors that affect demand or supply affect the market price and quantity of a good?

• How do markets allocate resources?


33

Markets and Competition

A market is a group of buyers and sellers of a particular product.

A competitive market is one with many buyers and sellers, each has a negligible effect on price.

In a perfectly competitive market: All goods exactly the same Buyers & sellers so numerous that no one can

affect market price—each is a “price taker”

In this chapter, we assume markets are perfectly competitive.


44

Demand

The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase.

Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal


55

The Demand Schedule

Demand schedule: a table that shows the relationship between the price of a good and the quantity demanded

Example: Helen’s demand for lattes.

Notice that Helen’s preferences obey the law of demand.

Price of

lattes

Quantity of lattes

demanded

$0.00 16

1.00 14

2.00 12

3.00 10

4.00 8

5.00 6

6.00 4


66

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15

Price of Lattes

Quantity of Lattes

Helen’s Demand Schedule & Curve

Price of

lattes

Quantity of lattes

demanded

$0.00 16

1.00 14

2.00 12

3.00 10

4.00 8

5.00 6

6.00 4

Market Demand versus Individual Demand

The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price.

Suppose Helen and Ken are the only two buyers in the Latte market. (Qd = quantity demanded)

4

6

8

10

12

14

16

Helen’s Qd

2

3

4

5

6

7

8

Ken’s Qd

+

+

+

+

=

=

=

=

6

9

12

15

+ = 18

+ = 21

+ = 24

Market Qd

$0.00

6.00

5.00

4.00

3.00

2.00

1.00

Price


88

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25

P

Q

The Market Demand Curve for Lattes

PQd

(Market)

$0.00 24

1.00 21

2.00 18

3.00 15

4.00 12

5.00 9

6.00 6


99

Demand Curve Shifters

The demand curve shows how price affects quantity demanded, other things being equal.

These “other things” are non-price determinants of demand (i.e., things that determine buyers’ demand for a good, other than the good’s price).

Changes in them shift the D curve…


1010

Demand Curve Shifters: # of Buyers Increase in # of buyers

increases quantity demanded at each price, shifts D curve to the right.


1111

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30

P

Q

Suppose the number of buyers increases. Then, at each P, Qd will increase (by 5 in this example).

Demand Curve Shifters: # of Buyers


1212

Demand Curve Shifters: Income

Demand for a normal good is positively related to income. Increase in income causes

increase in quantity demanded at each price, shifts D curve to the right.

(Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.)


1313

Two goods are substitutes if an increase in the price of one causes an increase in demand for the other.

Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right.

Other examples: Coke and Pepsi, laptops and desktop computers, CDs and music downloads

Demand Curve Shifters: Prices of Related Goods


1414

Two goods are complements if an increase in the price of one causes a fall in demand for the other.

Example: computers and software. If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left.

Other examples: college tuition and textbooks, bagels and cream cheese, eggs and bacon

Demand Curve Shifters: Prices of Related Goods


1515

Demand Curve Shifters: Tastes

Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right.

Example: The Atkins diet became popular in the ’90s, caused an increase in demand for eggs, shifted the egg demand curve to the right.


1616

Demand Curve Shifters: Expectations

Expectations affect consumers’ buying decisions.

Examples:

If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now.

If the economy sours and people worry about their future job security, demand for new autos may fall now.


1717

Summary: Variables That Influence Buyers

Variable A change in this variable…

Price …causes a movement along the D curve

# of buyers …shifts the D curve

Income …shifts the D curve

Price ofrelated goods …shifts the D curve

Tastes …shifts the D curve

Expectations …shifts the D curve

A C T I V E L E A R N I N G 1

Demand Curve


A. The price of iPods falls

B. The price of music downloads falls

C. The price of CDs falls

Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?

Q2

Price of music down-loads

Quantity of music downloads

D1D2

P1

Q1

Music downloads and iPods are complements.

A fall in price of iPods shifts the demand curve for music downloads to the right.


A. Price of iPods falls


The D curve does not shift.

Move down along curve to a point with lower P, higher Q.



D1

P1

Q1 Q2

P2


B. Price of music downloads falls


P1

Q1

CDs and music downloads are substitutes.

A fall in price of CDs shifts demand for music downloads to the left.



D1D2

Q2


C. Price of CDs falls



2222

Supply

The quantity supplied of any good is the amount that sellers are willing and able to sell.

Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal


2323

Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied.

Example: Starbucks’ supply of lattes.

The Supply Schedule

Notice that Starbucks’ supply schedule obeys the law of supply.

Price of

lattes

Quantity of lattes supplied

$0.00 0

1.00 3

2.00 6

3.00 9

4.00 12

5.00 15

6.00 18


2424

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15

Starbucks’ Supply Schedule & Curve

Price of

lattes

Quantity of lattes supplied

$0.00 0

1.00 3

2.00 6

3.00 9

4.00 12

5.00 15

6.00 18

P

Q

Market Supply versus Individual Supply The quantity supplied in the market is the sum of

the quantities supplied by all sellers at each price. Suppose Starbucks and Jitters are the only two

sellers in this market. (Qs = quantity supplied)

18

15

12

9

6

3

0

Starbucks

12

10

8

6

4

2

0

Jitters

+

+

+

+

=

=

=

=

30

25

20

15

+ = 10

+ = 5

+ = 0

Market Qs

$0.00

6.00

5.00

4.00

3.00

2.00

1.00

Price


2626

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

PQS

(Market)

$0.00 0

1.00 5

2.00 10

3.00 15

4.00 20

5.00 25

6.00 30

The Market Supply Curve


2727

Supply Curve Shifters

The supply curve shows how price affects quantity supplied, other things being equal.

These “other things” are non-price determinants of supply.

Changes in them shift the S curve…


2828

Supply Curve Shifters: Input Prices Examples of input prices:

wages, prices of raw materials.

A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right.


2929

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

Suppose the price of milk falls. At each price, the quantity of lattes supplied will increase (by 5 in this example).

Supply Curve Shifters: Input Prices


3030

Supply Curve Shifters: Technology Technology determines how much inputs are

required to produce a unit of output.

A cost-saving technological improvement has the same effect as a fall in input prices, shifts S curve to the right.


3131

Supply Curve Shifters: # of Sellers An increase in the number of sellers increases

the quantity supplied at each price,

shifts S curve to the right.


3232

Supply Curve Shifters: Expectations Example:

Events in the Middle East lead to expectations of higher oil prices.

In response, owners of Texas oilfields reduce supply now, save some inventory to sell later at the higher price.

S curve shifts left.

In general, sellers may adjust supply* when their expectations of future prices change. (*If good not perishable)


3333

Variable A change in this variable…

Summary: Variables that Influence Sellers

Price …causes a movement along the S curve

Input Prices …shifts the S curve

Technology …shifts the S curve

# of Sellers …shifts the S curve

Expectations …shifts the S curve

Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios?

A. Retailers cut the price of the software.

B. A technological advance allows the software to be produced at lower cost.

C. Professional tax return preparers raise the price of the services they provide.



Supply Curve

S curve does not shift.

Move down along the curve to a lower P and lower Q.

Price of tax return software

Quantity of tax return software

S1

P1

Q1Q2

P2



A. Fall in price of tax return software

S curve shifts to the right:

at each price, Q increases.



S1

P1

Q1

S2

Q2



B. Fall in cost of producing the software

This shifts the demand curve for tax preparation software, not the supply curve.



S1



C. Professional preparers raise their price


3838

Cost and the Supply Curve

name cost

Jack $10

Janet 20

Chrissy 35

A seller will produce and sell the good/service only if the price exceeds his or her cost.

Hence, cost is a measure of willingness to sell.

Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost).

Includes cost of all resources used to produce good, including value of the seller’s time.

Example: Costs of 3 sellers in the lawn-cutting business.


3939


335 & up

220 – 34

110 – 19

0$0 – 9

QsPDerive the supply schedule from the cost data:

name cost

Jack $10

Janet 20

Chrissy 35


4040


$0

$10

$20

$30

$40

0 1 2 3

P

Q

P Qs

$0 – 9 0

10 – 19 1

20 – 34 2

35 & up 3


4141

$0

$10

$20

$30

$40

0 1 2 3

Cost and the Supply CurveP

Q

At each Q, the height of the S curve is the cost of the marginal seller, the seller who would leave the market if the price were any lower.

Chrissy’s

cost

Janet’s cost

Jack’s cost


4242

$0

$10

$20

$30

$40

0 1 2 3

Producer SurplusP

Q

Producer surplus (PS): the amount a seller is paid for a good minus the seller’s cost

PS = P – cost


4343

$0

$10

$20

$30

$40

0 1 2 3

Producer Surplus and the S Curve

P

Q

PS = P – cost

Suppose P = $25.

Jack’s PS = $15

Janet’s PS = $5

Chrissy’s PS = $0

Total PS = $20

Janet’s cost

Jack’s cost

Total PS equals the area above the supply curve under the price,

from 0 to Q.

Chrissy’s

cost


4444

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

PS with Lots of Sellers & a Smooth S Curve

The supply of shoes

S

1000s of pairs of shoes

Price per pair

Suppose P = $40.

At Q = 15(thousand), the marginal seller’s cost is $30,

and her producer surplus is $10.


4545

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

PS with Lots of Sellers & a Smooth S Curve

The supply of shoes

S

PS is the area b/w P and the S curve, from 0 to Q.

The height of this triangle is $40 – 15 = $25.

So, PS = ½ x b x h = ½ x 25 x $25 = $312.50

h


4646

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

How a Lower Price Reduces PS

If P falls to $30,

PS = ½ x 15 x $15 = $112.50

Two reasons for the fall in PS.

S

1. Fall in PS due to sellers leaving market

2. Fall in PS due to remaining sellersgetting lower P


4747


Producer surplus


0

5

1015

20

25

30

3540

45

50

0 5 10 15 20 25

P

Q

supply curve

A. Find marginal seller’s cost at Q = 10.

B. Find total PS for P = $20.

Suppose P rises to $30.Find the increase in PS due to: C. selling 5

additional units

D. getting a higher price on the initial 10 units


4848


Answers


0

5

1015

20

25

30

3540

45

50

0 5 10 15 20 25

P

Q

supply curve

A. At Q = 10, marginal cost = $20

B. PS = ½ x 10 x $20 = $100

P rises to $30.

C. PS on additional units= ½ x 5 x $10 = $25

D. Increase in PS on initial 10 units= 10 x $10 = $100


4949

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

Supply and Demand Together

D S Equilibrium: P has reached the level where quantity supplied equals quantity demanded


5050

D S

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

Equilibrium price:

P QD QS

$0 24 0

1 21 5

2 18 10

3 15 15

4 12 20

5 9 25

6 6 30

the price that equates quantity supplied with quantity demanded


5151

D S

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

Equilibrium quantity:

P QD QS

$0 24 0

1 21 5

2 18 10

3 15 15

4 12 20

5 9 25

6 6 30

the quantity supplied and quantity demanded at the equilibrium price


5252

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

D S

Surplus (a.k.a. excess supply):when quantity supplied is greater than

quantity demanded

SurplusExample: If P = $5,

then QD = 9 lattes

and QS = 25 lattes

resulting in a surplus of 16 lattes


5353

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

D S


quantity demanded

Facing a surplus, sellers try to increase sales by cutting price.

This causes QD to rise

Surplus

…which reduces the surplus.

and QS to fall…


5454

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

D S


quantity demanded

Facing a surplus, sellers try to increase sales by cutting price.

This causes QD to rise and QS to fall.

Surplus

Prices continue to fall until market reaches equilibrium.


5555

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

D S

Shortage (a.k.a. excess demand):when quantity demanded is greater than quantity supplied

Example: If P = $1,

then QD = 21 lattes

and QS = 5 lattes

resulting in a shortage of 16 lattes

Shortage


5656

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

D S


Facing a shortage, sellers raise the price,

causing QD to fall

…which reduces the shortage.

and QS to rise,

Shortage


5757

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q

D S


Facing a shortage, sellers raise the price,

causing QD to falland QS to rise.

Shortage

Prices continue to rise until market reaches equilibrium.


5858

Three Steps to Analyzing Changes in Eq’m

To determine the effects of any event,

1. Decide whether event shifts S curve, D curve, or both.

2. Decide in which direction curve shifts.

3. Use supply—demand diagram to see how the shift changes eq’m P and Q.


5959

EXAMPLE: The Market for Hybrid Cars

P

Q

D1

S1

P1

Q1

price of hybrid cars

quantity of hybrid cars


6060

STEP 1:

D curve shifts because price of gas affects demand for hybrids.

S curve does not shift, because price of gas does not affect cost of producing hybrids.

STEP 2:

D shifts rightbecause high gas price makes hybrids more attractive relative to other cars.

EXAMPLE 1: A Shift in DemandEVENT TO BE ANALYZED: Increase in price of gas.

P

Q

D1

S1

P1

Q1

D2

P2

Q2

STEP 3:

The shift causes an increase in price and quantity of hybrid cars.


6161

EXAMPLE 1: A Shift in Demand

P

Q

D1

S1

P1

Q1

D2

P2

Q2

Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted.

Always be careful to distinguish b/w a shift in a curve and a movement along the curve.


6262

Terms for Shift vs. Movement Along Curve Change in supply: a shift in the S curve

occurs when a non-price determinant of supply changes (like technology or costs)

Change in the quantity supplied: a movement along a fixed S curve occurs when P changes

Change in demand: a shift in the D curveoccurs when a non-price determinant of demand changes (like income or # of buyers)

Change in the quantity demanded: a movement along a fixed D curveoccurs when P changes


6363

STEP 1:

S curve shifts because event affects cost of production.

D curve does not shift, because production technology is not one of the factors that affect demand.

STEP 2:

S shifts rightbecause event reduces cost, makes production more profitable at any given price.

EXAMPLE 2: A Shift in Supply

P

Q

D1

S1

P1

Q1

S2

P2

Q2

EVENT: New technology reduces cost of producing hybrid cars.

STEP 3:

The shift causes price to fall and quantity to rise.


6464

EXAMPLE 3: A Shift in Both Supply and Demand

P

Q

D1

S1

P1

Q1

S2

D2

P2

Q2

EVENTS: Price of gas rises AND new technology reduces production costs

STEP 1: Both curves shift.

STEP 2: Both shift to the right.

STEP 3: Q rises, but effect on P is ambiguous: If demand increases more than supply, P rises.


6565

EXAMPLE 3: A Shift in Both Supply and Demand

STEP 3, cont.

P

Q

D1

S1

P1

Q1

S2

D2

P2

Q2

EVENTS: price of gas rises AND new technology reduces production costs

But if supply increases more than demand, P falls.

Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads.

Event A: A fall in the price of CDs

Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell.

Event C: Events A and B both occur.


Shifts in supply and demand


2. D shifts left

P

QD1

S1

P1

Q1

D2

The market for music downloads

P2

Q2

1. D curve shifts

3. P and Q both fall.

STEPS



A. Fall in price of CDs

P

QD1

S1

P1

Q1

S2

The market for music downloads

Q2

P2

1. S curve shifts

2. S shifts right

3. P falls, Q rises.

STEPS

(Royalties are part of sellers’ costs)



B. Fall in cost of royalties

STEPS

1. Both curves shift (see parts A & B).

2. D shifts left, S shifts right.

3. P unambiguously falls.

Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q.

STEPS

1. Both curves shift (see parts A & B).

2. D shifts left, S shifts right.

3. P unambiguously falls.

Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q.



C. Fall in price of CDs and fall in cost of royalties


7070

CS, PS, and Total Surplus

CS = (value to buyers) – (amount paid by buyers)

= buyers’ gains from participating in the market

PS = (amount received by sellers) – (cost to sellers)

= sellers’ gains from participating in the market

Total surplus = CS + PS

= total gains from trade in a market

= (value to buyers) – (cost to sellers)


7171

The Market’s Allocation of Resources In a market economy, the allocation of resources

is decentralized, determined by the interactions of many self-interested buyers and sellers.

Is the market’s allocation of resources desirable? Or would a different allocation of resources make society better off?

To answer this, we use total surplus as a measure of society’s well-being, and we consider whether the market’s allocation is efficient.

(Policymakers also care about equality, though our focus here is on efficiency.)


7272

Efficiency

An allocation of resources is efficient if it maximizes total surplus. Efficiency means: The goods are consumed by the buyers who

value them most highly. The goods are produced by the producers with the

lowest costs. Raising or lowering the quantity of a good

would not increase total surplus.

= (value to buyers) – (cost to sellers)Total

surplus


7373

Evaluating the Market Equilibrium

Market eq’m: P = $30 Q = 15,000

Total surplus = CS + PS

Is the market eq’m efficient?

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

S

D

CS

PS


7474

Which Buyers Consume the Good?

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

S

D

Every buyer whose WTP is ≥ $30 will buy.

Every buyer whose WTP is < $30 will not.

So, the buyers who value the good most highly are the ones who consume it.


7575

Which Sellers Produce the Good?

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

S

D

Every seller whose cost is ≤ $30 will produce the good.

Every seller whose cost is > $30 will not.

So, the sellers with the lowest cost produce the good.


7676

Does Eq’m Q Maximize Total Surplus?

0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

S

D

At Q = 20, cost of producing the marginal unit is $35

value to consumers of the marginal unit is only $20

Hence, can increase total surplus by reducing Q.

This is true at any Q greater than 15.


7777


0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

S

D

At Q = 10, cost of producing the marginal unit is $25

value to consumers of the marginal unit is $40

Hence, can increase total surplus by increasing Q.

This is true at any Q less than 15.


7878


0

10

20

30

40

50

60

0 5 10 15 20 25 30

P

Q

S

D

The market eq’m quantity maximizes total surplus:At any other quantity, can increase total surplus by moving toward the market eq’m quantity.


7979

Adam Smith and the Invisible Hand

“Man has almost constant occasion for the help of his brethren, and it is vain for him to expect it from their benevolence only.

Adam Smith, 1723-1790

Passages from The Wealth of Nations, 1776

He will be more likely to prevail if he can interest their self-love in his favor, and show them that it is for their own advantage to do for him what he requires of them…It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest….


8080

Adam Smith and the Invisible Hand

“Every individual…neither intends to promote the public interest, nor knows how much he is promoting it….

Adam Smith, 1723-1790

Passages from The Wealth of Nations, 1776

He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”

an invisible hand


8181

The Free Market vs. Govt Intervention

The market equilibrium is efficient. No other outcome achieves higher total surplus.

Govt cannot raise total surplus by changing the market’s allocation of resources.

Laissez faire (French for “allow them to do”): the notion that govt should not interfere with the market.


8282

The Free Market vs. Central Planning Suppose resources were allocated not by the

market, but by a central planner who cares about society’s well-being.

To allocate resources efficiently and maximize total surplus, the planner would need to know every seller’s cost and every buyer’s WTP for every good in the entire economy.

This is impossible, and why centrally-planned economies are never very efficient.


8383

CONCLUSION

This chapter used welfare economics to demonstrate one of the Ten Principles: Markets are usually a good way to organize economic activity.

Important note: We derived these lessons assuming perfectly competitive markets.

In other conditions we will study in later chapters, the market may fail to allocate resources efficiently…


8484

CONCLUSION

Such market failures occur when: a buyer or seller has market power—the ability to

affect the market price. transactions have side effects, called externalities,

that affect bystanders. (example: pollution)

We’ll use welfare economics to see how public policy may improve on the market outcome in such cases.

Despite the possibility of market failure, the analysis in this chapter applies in many markets, and the invisible hand remains extremely important.


8585

CONCLUSION: How Prices Allocate Resources

One of the Ten Principles from Chapter 1: Markets are usually a good way to organize economic activity.

In market economies, prices adjust to balance supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources.

S U M M A RY

• A competitive market has many buyers and sellers, each of whom has little or no influence on the market price.

• Economists use the supply and demand model to analyze competitive markets.

• The downward-sloping demand curve reflects the law of demand, which states that the quantity buyers demand of a good depends negatively on the good’s price.


S U M M A RY

• Besides price, demand depends on buyers’ incomes, tastes, expectations, the prices of substitutes and complements, and number of buyers. If one of these factors changes, the D curve shifts.

• The upward-sloping supply curve reflects the Law of Supply, which states that the quantity sellers supply depends positively on the good’s price.

• Other determinants of supply include input prices, technology, expectations, and the # of sellers. Changes in these factors shift the S curve.


S U M M A RY

• The intersection of S and D curves determines the market equilibrium. At the equilibrium price, quantity supplied equals quantity demanded.

• If the market price is above equilibrium, a surplus results, which causes the price to fall. If the market price is below equilibrium, a shortage results, causing the price to rise.


S U M M A RY

• We can use the supply-demand diagram to analyze the effects of any event on a market:First, determine whether the event shifts one or both curves. Second, determine the direction of the shifts. Third, compare the new equilibrium to the initial one.

• In market economies, prices are the signals that guide economic decisions and allocate scarce resources.


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