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© 2007 Thomson South-Western, all rights reserved N. G R E G O R Y M A N K I W PowerPoint ® Slides by Ron Cronovich 4 P R I N C I P L E S O F F O U R T.

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Presentation on theme: "© 2007 Thomson South-Western, all rights reserved N. G R E G O R Y M A N K I W PowerPoint ® Slides by Ron Cronovich 4 P R I N C I P L E S O F F O U R T."— Presentation transcript:

1 © 2007 Thomson South-Western, all rights reserved N. G R E G O R Y M A N K I W PowerPoint ® Slides by Ron Cronovich 4 P R I N C I P L E S O F F O U R T H E D I T I O N The Market Forces of Supply and Demand

2 1 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 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?

3 2 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 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.  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.

4 3  Demand:is a willingness and an ability to pay (comes from the behavior of buyers)  The demand function: Demand = f{Price, income, the prices of related goods, tastes, etc.}  Prices are the tool by which market coordinates individuals’ desires and limits how much people demand. Thus, price mechanism ensures what people demand matches what’s available Example: when goods are scarce, the market reduces the quantity people demand; as their prices go up, people buy fewer goods, vice versa other things constant (ceteris paribus) Demand

5 4 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Cont,…  The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase.

6 5 Quantity Demanded 1)Desired quantity It is the amount that consumers wish to purchase, given the price of the product, other prices, their incomes, their taste and everything else that might matter 2)Effective quantity It is not an idle dream but it is the amounts that people are willing to buy, given the price they must pay for the product 3)Continuous flow of purchase It must therefore expressed as so much per period of time: 1 million units per day, etc. Quantity Demanded Source: Lipsey and Courant

7 6  Quantity demanded rises as price falls, other things constant or alternatively:  Quantity demanded falls as price rises, other things constant  As price changes, people change how much of a particular good they are willing to buy  What accounts for the law of demand? Individual’s tendency to substitute other goods for goods whose relative price has gone up  An inverse relationship between price and quantity demanded, other things constant The Law of Demand

8 7 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 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. Price of lattes Quantity of lattes demanded $  Notice that Helen’s preferences obey the Law of Demand.

9 8 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Price of Lattes Quantity of Lattes Helen’s Demand Schedule & Curve Price of lattes Quantity of lattes demanded $

10 9  Konsumen cenderung membagi pendapatannya untuk mengkonsumsi bermacam barang. Peningkatan harga salah satu barang yang dikonsumsinya berarti lebih sedikit barang lain yang bisa dikonsumsi atau harga relatif barang yang naik tersebut menjadi lebih mahal diukur dengan unit barang lainnya. Hal ini yang mendorong konsumen untuk mengurangi jumlah yang diminta ketika harga naik  Hukum utilitas marginal yang semakin menurun Semakin banyak unit barang yang dikonsumsi, tambahan kepuasan (utilitas) yang diperoleh dari mengkonsumsi unit barang terakhir akan semakin menurun Alasan Kurva Permintaan Berslope Negatif

11 10

12 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. (Q d = quantity demanded) Helen’s Q d Ken’s Q d = = = = =18 +=21 +=24 Market Q d $ Price

13 12 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q The Market Demand Curve for Lattes P Q d (Market) $

14 13 Price (per DVD) Alice’s Demand Terry’s Demand Raul’s Demand Market Demand A$ B$ C$ D$ E$ F$ Another Example Demand for DVD

15 14 Alice Terry Raul Market Demand Prices of DVD Quantities of DVD Cont,…

16 15

17 16  Happens due to price movements, a change in price changes the quantity demanded  Graphically, this situation is showed by a movement along a demand curve A PAPA QAQA QdQd Price of X Quantity of X PBPB QBQB B Change in quantity demanded

18 17  Happens due to the change in anything other than price (the ‘constant factors’)  Graphically, this situation is showed by a shift in demand (a shift in entire demand curve) Qd1Qd1 Price of X Quantity of X PAPA QAQA Qd2Qd2 QBQB A B Change in demand

19 18 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 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…

20 19 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Demand Curve Shifters: # of buyers  An increase in the number of buyers causes an increase in quantity demanded at each price, which shifts the demand curve to the right.

21 20 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q Suppose the number of buyers increases. Then, at each price, quantity demanded will increase (by 5 in this example). Demand Curve Shifters: # of buyers

22 21 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND  Demand for a normal good is positively related to income. An increase in income causes increase in quantity demanded at each price, shifting the 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.) Demand Curve Shifters: income

23 22 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND  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, compact discs and music downloads Demand Curve Shifters: prices of related goods

24 23 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND  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

25 24 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND  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. Demand Curve Shifters: tastes

26 25 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND  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 turns bad and people worry about their future job security, demand for new autos may fall now. Demand Curve Shifters: expectations

27 26  Taxes  Taxes levied on consumers increase the cost of goods to consumers and therefore reduce demand for those goods  Subsidies  Subsidies have the opposite effect  Subsidies reduce the cost of goods to consumers and therefore increase demand for those goods Demand Curve Shifters: taxes & subsidies

28 27  Population growth does not by itself create new demand. The additional people must have purchasing power (that is, earning income) before demand is change  If population growth results in an extra employed people, then the following statement is usually true: An increase in population will shift the demand of most products to the right, indicating that more will be bought at each price Demand Curve Shifters: population growth

29 28 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Summary: Variables That Affect Demand VariableA change in this variable… Price…causes a movement along the D curve No. of buyers…shifts the D curve Income…shifts the D curve Price of related goods…shifts the D curve Tastes…shifts the D curve Expectations…shifts the D curve

30 29 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Cont,… VariableA change in this variable… Taxes…shifts the D curve Subsidies…shifts the D curve Population growth…shifts the D curve

31 30 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Additional Information on Demand Each individual has his/her owns limitations on how much of goods or services that they can consume.. The limit is perhaps time constraint, the number of his/her fortunes or the work of the law of diminishing marginal utility— an increase in consuming one good/service will eventually decrease utility derived from that consumption Consequently, these facts are depicted on the graph by the intersection of the demand curve with each of the axis – Case and Fair

32 31 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND The demand curve will intersect with axis if… Axiscauses… Price (Y)the limitation on consumer’s income and wealth Quantity (X)the limitation of time and the work of the law of diminishing marginal utility Cont.,…

33 32 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q Cont.,…

34 33  Kurva permintaan akan memotong sumbu harga (Y) sebagai akibat terbatasnya pendapatan dan kekayaan rumah tangga. Akan ada tingkat harga tertentu yang maksimal bisa disanggupi oleh konsumen  Kurva permintaan akan memotong sumbu kuantitas (X) sebagai akibat keterbatasan waktu dan hukum utilitas marginal yang semakin menurun. Keterbatasan waktu menyebabkan jumlah yang diminta konsumen pada saat harga suatu barang adalah nol terbatas. Pada tingkat konsumsi tertentu, tambahan utilitas yg didapat dari mengkonsumsi suatu barang sama dengan nol. Sehingga mengkonsumsi lebih banyak dari titik ini tidak memberikan manfaat bagi konsumen. Kurva Permintaan Memotong Sumbu

35 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 compact discs falls 34 Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?

36 A C T I V E L E A R N I N G 1 : A. price of iPods falls 35 Q2Q2 Price of music down- loads Quantity of music downloads D1D1 D2D2 P1P1 Q1Q1 Music downloads and iPods are complements. A fall in price of iPods shifts the demand curve for music downloads to the right. Music downloads and iPods are complements. A fall in price of iPods shifts the demand curve for music downloads to the right.

37 A C T I V E L E A R N I N G 1 : B. price of music downloads falls 36 The D curve does not shift. Move down along curve to a point with lower P, higher Q. The D curve does not shift. Move down along curve to a point with lower P, higher Q. Price of music down- loads Quantity of music downloads D1D1 P1P1 Q1Q1 Q2Q2 P2P2

38 A C T I V E L E A R N I N G 1 : C. price of CDs falls 37 P1P1 Q1Q1 CDs and music downloads are substitutes. A fall in price of CDs shifts demand for music downloads to the left. CDs and music downloads are substitutes. A fall in price of CDs shifts demand for music downloads to the left. Price of music down- loads Quantity of music downloads D1D1 D2D2 Q2Q2

39 38 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Supply  Supply comes from the behavior of sellers.  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

40 39 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND The Supply Schedule  Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied.  Example: Starbucks’ supply of lattes.  Notice that Starbucks’ supply schedule obeys the Law of Supply. Price of lattes Quantity of lattes supplied $

41 40 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Starbucks’ Supply Schedule & Curve Price of lattes Quantity of lattes supplied $ P Q

42 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. (Q s = quantity supplied) Starbucks Jitters = = = = =10 +=5 +=0 Market Q s $ Price

43 42 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q The Market Supply Curve P Q S (Market) $

44 43 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 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…

45 44 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 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.

46 45 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 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

47 46 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Supply Curve Shifters: technology  Technology determines how much inputs are required to produce a unit of output.  A cost-saving technological improvement has same effect as a fall in input prices, shifts the S curve to the right.

48 47 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Supply Curve Shifters: # of sellers  An increase in the number of sellers increases the quantity supplied at each price, shifts the S curve to the right.

49 48 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Supply Curve Shifters: expectations  Suppose a firm expects the price of the good it sells to rise in the future.  The firm may reduce supply now, to save some of its inventory to sell later at the higher price.  This would shift the S curve leftward.

50 49 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Summary: Variables That Affect Supply VariableA change in this variable… Price…causes a movement along the S curve Input prices…shifts the S curve Technology…shifts the S curve No. of sellers…shifts the S curve Expectations…shifts the S curve

51 A C T I V E L E A R N I N G 2 : Supply curve 50 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.

52 A C T I V E L E A R N I N G 2 : A. fall in price of tax return software 51 The S curve does not shift. Move down along the curve to a lower P and lower Q. The 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 S1S1 P1P1 Q1Q1 Q2Q2 P2P2

53 A C T I V E L E A R N I N G 2 : B. fall in cost of producing the software 52 The S curve shifts to the right: at each price, Q increases. The S curve shifts to the right: at each price, Q increases. Price of tax return software Quantity of tax return software S1S1 P1P1 Q1Q1 S2S2 Q2Q2

54 A C T I V E L E A R N I N G 2 : C. professional preparers raise their price 53 This shifts the demand curve for tax preparation software, not the supply curve. Price of tax return software Quantity of tax return software S1S1

55 54 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q Supply and Demand Together D S Equilibrium: P has reached the level where quantity supplied equals quantity demanded

56 55 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND D S P Q Equilibrium price: PQDQD QSQS $ The price that equates quantity supplied with quantity demanded

57 56 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND D S P Q Equilibrium quantity: PQDQD QSQS $ The quantity supplied and quantity demanded at the equilibrium price

58 57 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q D S Surplus: when quantity supplied is greater than quantity demanded Surplus Example: If P = $5, then Q D = 9 lattes and Q S = 25 lattes resulting in a surplus of 16 lattes

59 58 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q D S Surplus: when quantity supplied is greater than quantity demanded Facing a surplus, sellers try to increase sales by cutting the price. This causes Q D to rise Surplus …which reduces the surplus. and Q S to fall…

60 59 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q D S Surplus: when quantity supplied is greater than quantity demanded Facing a surplus, sellers try to increase sales by cutting the price. Falling prices cause Q D to rise and Q S to fall. Surplus Prices continue to fall until market reaches equilibrium.

61 60 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q D S Shortage: when quantity demanded is greater than quantity supplied Example: If P = $1, then Q D = 21 lattes and Q S = 5 lattes resulting in a shortage of 16 lattes Shortage

62 61 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q D S Shortage: when quantity demanded is greater than quantity supplied Facing a shortage, sellers raise the price, causing Q D to fall …which reduces the shortage. and Q S to rise, Shortage

63 62 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND P Q D S Shortage: when quantity demanded is greater than quantity supplied Facing a shortage, sellers raise the price, causing Q D to fall and Q S to rise. Shortage Prices continue to rise until market reaches equilibrium.

64 63 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND Three Steps to Analyzing Changes in Eq’m 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. 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. To determine the effects of any event,

65 64 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND EXAMPLE: The Market for Hybrid Cars P Q D1D1 S1S1 P1P1 Q1Q1 price of hybrid cars quantity of hybrid cars

66 65 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 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 right because high gas price makes hybrids more attractive relative to other cars. EXAMPLE 1: A Change in Demand EVENT TO BE ANALYZED: Increase in price of gas. P Q D1D1 S1S1 P1P1 Q1Q1 D2D2 P2P2 Q2Q2 STEP 3: The shift causes an increase in price and quantity of hybrid cars.

67 66 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND EXAMPLE 1: A Change in Demand P Q D1D1 S1S1 P1P1 Q1Q1 D2D2 P2P2 Q2Q2 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.

68 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 curve occurs when a non-price determinant of demand changes (like income or # of buyers)  Change in the quantity demanded: a movement along a fixed D curve occurs when P changes

69 68 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 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 right because event reduces cost, makes production more profitable at any given price. EXAMPLE 2: A Change in Supply P Q D1D1 S1S1 P1P1 Q1Q1 S2S2 P2P2 Q2Q2 EVENT: New technology reduces cost of producing hybrid cars. STEP 3: The shift causes price to fall and quantity to rise.

70 69 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND EXAMPLE 3: A Change in Both Supply and Demand P Q D1D1 S1S1 P1P1 Q1Q1 S2S2 D2D2 P2P2 Q2Q2 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.

71 70 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND EXAMPLE 3: A Change in Both Supply and Demand STEP 3, cont. P Q D1D1 S1S1 P1P1 Q1Q1 S2S2 D2D2 P2P2 Q2Q2 EVENTS: price of gas rises AND new technology reduces production costs But if supply increases more than demand, P falls.

72 A C T I V E L E A R N I N G 3 : Changes in supply and demand 71 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 compact discs 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.

73 2.D shifts left A C T I V E L E A R N I N G 3 : A. fall in price of CDs 72 P Q D1D1 S1S1 P1P1 Q1Q1 D2D2 The market for music downloads P2P2 Q2Q2 1.D curve shifts 3.P and Q both fall. STEPS

74 A C T I V E L E A R N I N G 3 : B. fall in cost of royalties 73 P Q D1D1 S1S1 P1P1 Q1Q1 S2S2 The market for music downloads Q2Q2 P2P2 1.S curve shifts 2.S shifts right 3.P falls, Q rises. STEPS (royalties are part of sellers’ costs)

75 A C T I V E L E A R N I N G 3 : C. fall in price of CDs AND fall in cost of royalties 74 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.

76 75 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 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.

77 76 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND CHAPTER SUMMARY  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.

78 77 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND CHAPTER SUMMARY  Besides price, demand depends on buyers’ incomes, tastes, expectations, the prices of substitutes and complements, and # 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.

79 78 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND CHAPTER SUMMARY  The intersection of S and D curves determine 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.

80 79 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND CHAPTER SUMMARY  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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