Economics chapter 3
Price, Quantity, and efficiency
Demand, Supply, and Market Equilibrium
Objectives outlines
Objective 3-1: Characterize and give examples of markets.
Objective 3-2: Describe demand and explain how it can change.
Objective 3-3: Describe supply and explain how it can change.
Objective 3-4: Relate how supply and demand interact to determine market equilibrium.
Objective 3-5: Explain how changes in supply and demand affect equilibrium prices and
quantities.
Objective 3-6: Identify what government-set prices are and how they can cause product
surpluses and shortages.
Objective 3-7: (Appendix) Illustrate how supply and demand analysis can provide insights
on actual-economy situations.
Markets LO 3-1
Markets bring together buyers (“demanders”) and sellers (“suppliers”).
Some markets are local, others international. Some have physical locations while others are
online.
For simplicity, this chapter focuses on highly competitive markets in which large numbers of
buyers and sellers come together to buy and sell standardized products. All such markets
involve demand, supply, price, and quantity, with price being “discovered” through the
interacting decisions of buyers and sellers.
Demand LO 3-2
Demand is a schedule or a curve that shows the various amounts of a product that
consumers are willing and able to purchase at each of a series of possible prices during a
specified period of time. Demand shows the quantities of a product that will be purchased at
various possible prices, other things equal.
Demand can easily be shown in table form. (Figure 3.1 page 54)
The table in Figure 3.1 is a hypothetical demand schedule for a single consumer purchasing
bushels of corn. The table reveals the relationship between the various prices of corn and the
quantity of corn a particular consumer would be willing and able to purchase at each of these
prices.
Law of demand
Other things equal, as price falls, the quantity demanded rises, and as price rises, the
quantity demanded falls. In short, there is a negative or inverse relationship between price
and quantity demanded. Economists call this inverse relationship the law of demand.
Why the inverse relationship between price and quantity demanded? Three explanations:
• The law of demand is consistent with common sense. People ordinarily do buy more of a
product at a low price than at a high price. Price is an obstacle that deters consumers from
buying. The higher that obstacle, the less of a product they will buy; the lower the price
obstacle, the more they will buy. The fact that businesses have “sales” to clear out unsold
items is evidence of their belief in the law of demand.
, • In any specific time period, each buyer of a product will derive less satisfaction (or benefit,
or utility) from each successive unit of the product consumed. The second Big Mac will yield
less satisfaction to the consumer than the first, and the third still less than the second. That
is, consumption is subject to diminishing marginal utility. And because successive units of a
particular product yield less and less marginal utility, consumers will buy additional units only
if the price of those units is progressively reduced.
• We can also explain the law of demand in terms of income and substitution effects. The
income effect indicates that a lower price increases the purchasing power of a buyer’s
money income, enabling the buyer to purchase more of the product than before. A higher
price has the opposite effect. The substitution effect suggests that at a lower price buyer
have the incentive to substitute what is now a less expensive product for other products that
are now relatively more expensive. The product whose price has fallen is now “a better deal”
relative to the other products.
The demand curve
The demand curve is a graphical representation of the relationship between the price of a
good or service and the quantity demanded for a given period of time. Price is always on the
horizontal axis and quantity is always on the vertical axis.
Market demand
So far, we have concentrated on just one consumer. But competition requires that more than
one buyer be present in each market. By adding the quantities demanded by all consumers
at each of the various possible prices, we can get from individual demand to market demand.
The determinants of individual demand of a particular good, service or commodity refer to all
the factors that determine the quantity demanded of an individual or household for the
particular commodity. The basic determinants of demand are:
(1) Consumers’ tastes (preferences)
(2) The number of buyers in the market
(3) Consumers’ incomes
(4) The prices of related goods
(5) Consumer expectations.
Changes in demand
Products whose demand varies directly with money income are called superior goods, or
normal goods.
Goods whose demand varies inversely with money income are called inferior goods.
A change in the price of a related good may either increase or decrease the demand for a
product, depending on whether the related good is a substitute or a complement:
• A substitute good is one that can be used in place of another good.
• A complementary good is one that is used together with another good.
The vast majority of goods are not related to one another and are called independent goods.
An increase in demand may be caused by:
• A favorable change in consumer tastes.
• An increase in the number of buyers.
• Rising incomes if the product is a normal good.
• Falling incomes if the product is an inferior good.
• An increase in the price of a substitute good.
• A decrease in the price of a complementary good.
• A new consumer expectation that either prices or income will be higher in the future.
