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2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
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3
Chapter
Demand, Supply,and Market Equilibrium
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2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair " of !
Chapter Outline3
Demand, Supply,and Market Equilibrium
Firms and Households:The Basic Decision-Making UnitsInput Markets and Output Markets:
The Circular FlowDemand in Product/Output MarketsChanges in Quantity Demanded versusChanges in DemandPrice and Quantity Demanded: The Law of DemandOther Determinants of Household DemandShift of Demand versus Movementalong a Demand CurveFrom Household Demand to Market DemandSupply in Product/Output MarketsPrice and Quantity Supplied: The Law of SupplyOther Determinants of SupplyShift of Supply versus Movementalong a Supply CurveFrom Individual Supply to Market SupplyMarket EquilibriumExcess DemandExcess SupplyChanges in EquilibriumDemand and Supply in Product Markets:A Review
Looking Ahead: Markets andthe Allocation of Resources
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FIRMS AND HOUSEHOLDS:THE BASIC DECISION-MAKING UNITS
firmAn organization that transformsresources (inputs) into products(outputs). Firms are the primaryproducing units in a market economy.
entrepreneurA person who organizes,manages, and assumes the risks of afirm, taking a new idea or a new product
and turning it into a successful business.
householdsThe consuming units in aneconomy.
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INPUT MARKETS AND OUTPUT MARKETS:THE CIRCULAR FLOW
product or output marketsThemarkets in which goods and servicesare exchanged.
input or factor marketsThe markets inwhich the resources used to produceproducts are exchanged.
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INPUT MARKETS AND OUTPUT MARKETS:THE CIRCULAR FLOW
FIGURE 3.1The Circular Flow of Economic Activity
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INPUT MARKETS AND OUTPUT MARKETS:THE CIRCULAR FLOW
labor marketThe input/factor marketin which households supply work forwages to firms that demand labor.
capital marketThe input/factor marketin which households supply theirsavings, for interest or for claims tofuture profits, to firms that demand funds
to buy capital goods.
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INPUT MARKETS AND OUTPUT MARKETS:THE CIRCULAR FLOW
land marketThe input/factor market inwhich households supply land or otherreal property in exchange for rent.
factors of productionThe inputs intothe production process. Land, labor, andcapital are the three key factors ofproduction.
Input and output markets are connected through the behavior of both firms and
households. Firms determine the quantities and character of outputs produced and the
types of quantities of inputs demanded. Households determine the types and quantities of
products demanded and the quantities and types of inputs supplied.
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DEMAND IN PRODUCT/OUTPUT MARKETS
% household&s decision about 'hat (uantity of a
particular output) or product) to demand depends on a
number of factors including*
+ ,heprice of the productin (uestion+ ,he income availableto the household
+ ,he household&s amount of accumulated
wealth
+ ,heprices of other productsa-ailable to the
household
+ ,he household&s tastes and preferences
+ ,he household&s expectations about future
income) 'ealth) and prices
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DEMAND IN PRODUCT/OUTPUT MARKETS
quantity demandedThe amount(number of units) of a product that a
household would buy in a given period ifit could buy all it wanted at the currentmarket price.
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DEMAND IN PRODUCT/OUTPUT MARKETS
The most important relationship in
individual markets is that betweenmarket price and quantity demanded.
CHANGES IN QUANTITY DEMANDEDVERSUS CHANGES IN DEMAND
Changes in the price of a product affect the quantity demandedper period. Changes in any
other factor, such as income or preferences, affect demand. Thus, we say that an increase
in the price of CocaCola is likely to cause a decrease in the quantity of Coca-Cola
demanded. However, we say that an increase in income is likely to cause an increase in
the demand for most goods.
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DEMAND IN PRODUCT/OUTPUT MARKETS
PRICE AND QUANTITY DEMANDED:THE LAW OF DEMAND
demand schedule
A table showing howmuch of a givenproduct a householdwould be willing to
buy at differentprices.
TABLE 3.1 Annas Demand Schedule
for Telephone Calls
PRICE (PER CALL)
QUANTITY DEMANDED
(CALLS PER MONTH)
$ 0 30
.50 25
3.50 7
7.00 3
10.00 1
15.00 0
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DEMAND IN PRODUCT/OUTPUT MARKETS
demand curveA graph illustrating howmuch of a given product a householdwould be willing to buy at different prices.
FIGURE 3.2Annas Demand Curve
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DEMAND IN PRODUCT/OUTPUT MARKETS
law of demandThe negativerelationship between price and quantity
demanded: As price rises, quantitydemanded decreases. As price falls,quantity demanded increases.
Demand Curves Slope Downward
It is reasonable to e!pect quantity demanded to fall when price rises, ceteris paribus,
and to e!pect quantity demanded to rise when price falls, ceteris paribus. "emand
curves have a negative slope.
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DEMAND IN PRODUCT/OUTPUT MARKETS
Other Properties of Demand Curves
#s long as households have limited incomes and wealth, all demand curves will intersect
the price a!is. For any commodity, there is always a price above which a household
will not, or cannot, pay. $ven if the good or service is very important, all households
are ultimately constrained, or limited, by income and wealth.
That demand curves intersect the quantity a!is is a matter of common sense. "emand
in a given period of time is limited, if only by time, even at a %ero price.
Two additional things are notable aboutAnnas demand curve.
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DEMAND IN PRODUCT/OUTPUT MARKETS
To summarize what we know about the shape ofdemand curves:
1.They have a negative slope. An increase inprice is likely to lead to a decrease inquantity demanded, and a decrease in priceis likely to lead to an increase in quantitydemanded.
2.They intersect the quantity (X-) axis, a resultof time limitations and diminishing marginalutility.
3.They intersect the price (Y-) axis, a result oflimited incomes and wealth.
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DEMAND IN PRODUCT/OUTPUT MARKETS
OTHER DETERMINANTS OF HOUSEHOLD DEMAND
incomeThe sum of all a households
wages, salaries, profits, interest payments,rents, and other forms of earnings in agiven period of time. It is a flow measure.
Income and Wealth
wealth or net worthThe total value ofwhat a household owns minus what itowes. It is a stock measure.
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DEMAND IN PRODUCT/OUTPUT MARKETS
normal goodsGoods for which demandgoes up when income is higher and forwhich demand goes down when income
is lower.
inferior goodsGoods for which demandtends to fall when income rises.
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DEMAND IN PRODUCT/OUTPUT MARKETS
Prices of Other Goods and Services
substitutesGoods that can serve asreplacements for one another: when the
price of one increases, demand for theother goes up.
perfect substitutesIdentical products.
complements, complementary goodsGoods that go together: a decrease inthe price of one results in an increase indemand for the other, and vice versa.
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DEMAND IN PRODUCT/OUTPUT MARKETS
Tastes and Preferences
Perfect substitutes? On a hotday in the desert, one brand is
as good as another.
Expectations
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DEMAND IN PRODUCT/OUTPUT MARKETS
SHIFT OF DEMAND VERSUS MOVEMENT ALONG
A DEMAND CURVE
TABLE 3.2 Shift of Annas Demand Schedule
Due to increase in Income
SCHEDULE D0 SCHEDULE D1
Price
(Per Call)
Quantity
Demanded
(Calls Per Month
at an Income of
$300 Per Month)
Quantity
Demanded
(Calls Per Month
at an Income of
$600 Per Month)$ 0 30 35
.50 25 33
3.50 7 18
7.00 3 12
10.00 1 7
15.00 0 2
20.00 0 0
FIGURE 3.3Shift of a Demand Curve
Following a Rise in Income
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DEMAND IN PRODUCT/OUTPUT MARKETS
shift of a demand curveThe change thattakes place in a demand curve correspondingto a new relationship between quantitydemanded of a good and price of that good.
The shift is brought about by a change in theoriginal conditions.
movement along a demand curveThe changein quantity demanded brought about by a change
in price.Change in price of a good or service
leads to
Change in quantity demanded&movement along the demand curve'.
Change in income, preferences, or prices of other goods or services
leads to
Change in demand &shift of the demand curve'.
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DEMAND IN PRODUCT/OUTPUT MARKETS
FIGURE 3.4Shifts versus Movementalong a Demand Curve
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DEMAND IN PRODUCT/OUTPUT MARKETS
FROM HOUSEHOLD DEMAND TOMARKET DEMAND
market demandThe sum of all the
quantities of a good or service demandedper period by all the households buying inthe market for that good or service.
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DEMAND IN PRODUCT/OUTPUT MARKETS
FIGURE 3.5Deriving Market Demand from Individual Demand Curves
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SUPPLY IN PRODUCT/OUTPUT MARKETS
profitThe difference between revenuesand costs.
Successful firms make profits because theyare able to sell their products for more than itcosts to produce them.
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SUPPLY IN PRODUCT/OUTPUT MARKETS
PRICE AND QUANTITY SUPPLIED:THE LAW OF SUPPLY
quantity suppliedThe amount of aparticular product that a firm would be
willing and able to offer for sale at aparticular price during a given time period.
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SUPPLY IN PRODUCT/OUTPUT MARKETS
TABLE 3.3 Clarence Browns Supply Schedule
for Soybeans
PRICE (PER BUSHEL)
QUANTITY SUPPLIED
(BUSHELS PER MONTH)
$1.50 0
1.75 10,000
2.25 20,000
3.00 30,000
4.00 45,000
5.00 45,000
supply scheduleA table showing howmuch of a product firms will sell at differentprices.
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SUPPLY IN PRODUCT/OUTPUT MARKETS
law of supplyThe positive relationshipbetween price and quantity of a goodsupplied: An increase in market price will
lead to an increase in quantity supplied,and a decrease in market price will lead toa decrease in quantity supplied.
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SUPPLY IN PRODUCT/OUTPUT MARKETS
supply curveA graph illustrating howmuch of a product a firm will sell atdifferent prices.
FIGURE 3.6Clarence BrownsIndividual Supply Curve
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SUPPLY IN PRODUCT/OUTPUT MARKETS
OTHER DETERMINANTS OF SUPPLY
The Cost of Production
Regardless of the price that a firm cancommand for its product, revenue mustexceed the cost of producing the output for thefirm to make a profit.
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SUPPLY IN PRODUCT/OUTPUT MARKETS
The Prices of Related Products
A soybean farm is a producer
that supplies soybeans to themarket.
#ssuming that its ob(ective is to ma!imi%e profits, a firm)s decision about what quantity
of output, or product, to supply depends on
*. The price of the good or service
+. The cost of producing the product, which in turn depends on
The price of required inputs &labor, capital, and land'
The technologies that can be used to produce the product
-. The prices of related products
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SUPPLY IN PRODUCT/OUTPUT MARKETS
SHIFT OF SUPPLY VERSUS MOVEMENT ALONGA SUPPLY CURVE
movement along a supply curveThechange in quantity supplied brought about
by a change in price.
shift of a supply curveThe change thattakes place in a supply curve corresponding
to a new relationship between quantitysupplied of a good and the price of thatgood. The shift is brought about by achange in the original conditions.
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SUPPLY IN PRODUCT/OUTPUT MARKETS
TABLE 3.4Shift of Supply Schedule for Soybeans
Following Development of a New
Disease-Resistant Seed Strain
SCHEDULE D0 SCHEDULE D1
Price
(Per Bushel)
Quantity Supplied
(Bushels Per Year
Using Old Seed)
Quantity Supplied
(Bushels Per Year
Using New Seed)$1.50 0 5,000
1.75 10,000 23,000
2.25 20,000 33,000
3.00 30,000 40,000
4.00 45,000 54,000
5.00 45,000 54,000
FIGURE 3.7Shift of Supply Curve for SoybeansFollowing Development of a NewSeed Strain
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SUPPLY IN PRODUCT/OUTPUT MARKETS
Change in price of a good or service
leads to
Change in quantity supplied&movement along a supply curve'.
Change in total cost, technology, or prices of other goods or services
leads to
Change in supply &shift of a supply curve'.
As with demand, it is very important todistinguish between movements along supply
curves (changes in quantity supplied) andshifts in supply curves (changes in supply):
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SUPPLY IN PRODUCT/OUTPUT MARKETS
FROM INDIVIDUAL SUPPLY TO MARKET SUPPLY
market supplyThe sum of all that is
supplied each period by all producers of asingle product.
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SUPPLY IN PRODUCT/OUTPUT MARKETS
FIGURE 3.8Deriving Market Supply from Individual Firm Supply Curves
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MARKET EQUILIBRIUM
equilibriumThe condition that existswhen quantity supplied and quantity
demanded are equal. At equilibrium, thereis no tendency for price to change.
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MARKET EQUILIBRIUM
EXCESS DEMANDexcess demand or shortageThe conditionthat exists when quantity demanded exceedsquantity supplied at the current price.
Bidding at an auction starts
with excess demand and endsup with quantity demanded andquantity supplied equal.
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MARKET EQUILIBRIUM
FIGURE 3.9Excess Demand, or Shortage
hen quantity demanded e!ceeds quantity supplied, price tends to rise. hen the price in
a market rises, quantity demanded falls and quantity supplied rises until an equilibrium is
reached at which quantity demanded and quantity supplied are equal.
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MARKET EQUILIBRIUM
EXCESS SUPPLY
excess supply or surplusThe conditionthat exists when quantity supplied exceeds
quantity demanded at the current price.
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MARKET EQUILIBRIUM
FIGURE 3.10Excess Supply, or Surplus
hen quantity supplied e!ceeds quantity demanded at the current price, the price tends to
fall. hen price falls, quantity supplied is likely to decrease and quantity demanded is
likely to increase until an equilibrium price is reached where quantity supplied and quantity
demanded are equal.
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MARKET EQUILIBRIUM
CHANGES IN EQUILIBRIUM
When supply and demand curves shift, theequilibrium price and quantity change.
FIGURE 3.11The Coffee Market: A Shiftof Supply and Subsequent
Price Adjustment
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MARKET EQUILIBRIUM
FIGURE 3.12Examples of Supply
and Demand Shiftsfor Product X
DEMANDANDSUPPLYINPRODUCTMARKETS:
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DEMAND AND SUPPLY IN PRODUCT MARKETS:A REVIEW
*. # demand curve shows how much of a product a household would buy if it could buy
all it wanted at the given price. # supply curve shows how much of a product a firm
would supply if it could sell all it wanted at the given price.
+. /uantity demanded and quantity supplied are always per time period0that is, per day,
per month, or per year.
-. The demand for a good is determined by price, household income and wealth, prices
of other goods and services, tastes and preferences, and e!pectations.
1. The supply of a good is determined by price, costs of production, and prices of related
products. Costs of production are determined by available technologies of production
and input prices.
2. 3e careful to distinguish between movements along supply and demand curves and
shifts of these curves. hen the price of a good changes, the quantity of that good
demanded or supplied changes0that is, a movement occurs along the curve. hen
any other factor changes, the curve shifts, or changes position.
4. 5arket equilibrium e!ists only when quantity supplied equals quantity demanded at
the current price.
Here are some important points to remember about the mechanics
of supply and demand in product markets:
LOOKINGAHEAD:MARKETSANDTHE
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LOOKING AHEAD: MARKETS AND THEALLOCATION OF RESOURCES
You can already begin to see how marketsanswer the basic economic questions of whatis produced, how it is produced, and who getswhat is produced.
+ /emand cur-es reflect 'hat people are'illing and able to pay for products they areinfluenced by incomes) 'ealth) preferences)prices of other goods) and e1pectations
+ Firms in business to ma3e a profit ha-e agood reason to choose the best a-ailable
technology4lo'er costs mean higherprofits
+ 5hen a good is in short supply) price rises%s it does) those 'ho are 'illing and able tocontinue buying do so others stop buying
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Equilibrium
capital marketcomplements, complementary
goods
demand curve
demand schedule
entrepreneur
equilibriumexcess demand or shortage
excess supply or surplus
factors of production
firm
households
incomeinferior goodsinput or factor marketslabor marketland marketlaw of demand
law of supplymarket demand
market supply
movement along a demand curve
movement along a supply curve
normal goods
perfect substitutesproduct or output markets
profit
quantity demanded
quantity supplied
shift of a demand curve
shift of a supply curve
substitutes
supply curve
supply schedule
wealth or net worth
REVIEW TERMS AND CONCEPTS