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CHAPTER 3 Demand and Supply. Chapter 3 Demand, Supply and Relative Prices  Demand and supply determine relative prices.  The word “price” means relative.

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Presentation on theme: "CHAPTER 3 Demand and Supply. Chapter 3 Demand, Supply and Relative Prices  Demand and supply determine relative prices.  The word “price” means relative."— Presentation transcript:

1 CHAPTER 3 Demand and Supply

2 Chapter 3 Demand, Supply and Relative Prices  Demand and supply determine relative prices.  The word “price” means relative price. Price is an opportunity cost.  If we predict a price will fall, we mean its price will fall relative to the average price of other goods and services.

3 Calculation of Relative Prices  Relative price is usually calculated by dividing the price of a good in question by a price index.  The most commonly used price index is the CPI (Consumer Price Index).  The CPI represents the “average” price of consumer goods in a particular month or year.

4 Demand  The quantity demanded of a good or service is the amount that consumers plan to (or are willing to) buy in a given period of time at a particular (relative) price.  Quantity demanded is measured as an amount per unit time: pizzas per day, pizzas per week, or pizzas per year.

5 The Law of Demand  Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded.  The phrase “other things being equal” is sometimes abbreviated with the Latin phrase ceteris paribus (cet. par.).  Thus, when we say price changes, we mean relative price changes.

6 Demand Schedule and Demand Curve  A demand schedule lists the quantities demanded at each different price when all the other influences on consumers’ planned purchases remain the same.  A demand curve is a graph of the demand schedule.

7 Demand Schedule a.509 b1.006 c1.504 d2.003 e2.502 PriceQuantity Demanded (dollars per CD-R)(millions of CD-Rs per week)

8 Demand Curve Quantity (millions of CD-Rs per week) Price ( dollar per CD-R)

9 Demand Curve Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) e d c b a

10 Demand Curve e d c b a Demand for CD-Rs Quantity (millions of CD-Rs per week) Price ( dollar per CD-R)

11 Factors That Influence Demand  Price (of the good in question)  Prices of related goods  Income  Expected future price  Population  Preferences (or Tastes)

12 Price  If the price of the good rises, the quantity demanded falls (a movement up along the demand curve).  If the price of the good falls, the quantity demanded rises (a movement down along the demand curve).

13 Prices of Related Goods  A substitute is a good that can be used in place of another good. If the price of a CD-RW rises, the demand for CD-Rs rises (demand curve shifts out to the right).  A complement is a good that is used in conjunction with another good. If the price of a CD burner rises, the demand for CD-Rs falls (demand curve shifts in to the left).

14 Example-Decrease in Price of a Complement Original demand schedule New demand schedule CD Burner $300 CD Burner $100 Price QuantityPrice Quantity (dollars (millions of CD-Rs (dollars (millions of CD-Rs per CD-R) per week) per CD-R)per week)) a.50 9 b c d e Assume the original price of A CD Burner is $300. The demand schedule shows the Price-Quantity relationship for CD-Rs.

15 Example-Decrease in Price of a Complement Original demand schedule New demand schedule CD Burner $300 CD Burner $100 Price QuantityPrice Quantity (dollars (millions of CD-Rs (dollars (millions of CD-Rs per CD-R) per week) per CD-R)per week)) a.50 9a’.5013 b1.00 6b’ c1.50 4c’ d2.00 3d’ e e’2.50 6

16 Demand Before Price of Complement Decreases Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) e d c b a Demand for CD-Rs (CD Burner $300)

17 Demand after Price of Complement Decreases e d c b a Demand for CD-Rs (CD Burner $300) Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) e' d' c' b' a' Demand for CD-Rs (CD Burner $100)

18 Income  Normal goods are those for which demand increases as income increases (demand curve shifts out to the right).  Inferior goods are those for which demand decreases as income increases (demand curve shifts in to the left).  The terms normal and inferior do not necessarily refer to the quality of the product

19 Expected Future Price  If the price of a good is expected to rise in the future and if the good can be stored, people will often substitute over time by buying more of the good today.  Demand for the good increases (demand curve shifts out to the right). This is sometimes called speculation.

20 Population  Other things remaining the same, the larger the population, the greater is the demand for all goods and services (demand curve shifts out to the right).  The smaller the population, the smaller is the demand for all goods and services (demand curve shifts in to the left).

21 Preferences (or Tastes)  Preferences are an individual’s attitudes toward goods and services.  Different people have different preferences and will therefore have different demands for a particular good or service.

22 Summary of Changes in Demand  Changes In Demand –The demand for CD-Rs Decreases if: –The price of a substitute falls –The price of a complement rises –Income falls (since CD-R is a normal good) –The price of a CD-R is expected to fall in the future –The population decreases – Preferences decrease

23 Summary of Changes in Demand  Changes In Demand –The demand for CD-Rs Increases if: –The price of a substitute rises –The price of a complement falls –Income rises (since CD-R is a normal good) –The price of a CD-R is expected to rise in the future –The population increases – Preferences increase

24 Movement Along Versus a Shift of the Demand Curve  If the price of a good changes but everything else remains the same, there is a movement along the demand curve.  If the price of a good remains constant but some other influence on buyers’ plans changes, there is a shift of the demand curve.

25 A Change in Quantity Demanded Versus a Change in Demand  A movement along the demand curve shows a change in the quantity demanded.  A shift of the demand curve shows a change in demand.

26 A Change in the Quantity Demanded Versus a Change in Demand Quantity Price D0D0

27 Quantity Price D0D0 Decrease in quantity demanded Increase in quantity demanded A Change in the Quantity Demanded Versus a Change in Demand

28 Quantity Price D0D0 P0P0 Q0Q0 A Change in the Quantity Demanded Versus a Change in Demand

29 Quantity Price D0D0 P0P0 P1P1 Q0Q0 Q1Q1 A Change in the Quantity Demanded Versus a Change in Demand

30 Quantity Price D0D0 P0P0 P2P2 P1P1 Q0Q0 Q2Q2 Q1Q1 A Change in the Quantity Demanded Versus a Change in Demand

31 Quantity Price D0D0 A Change in the Quantity Demanded Versus a Change in Demand

32 Quantity Price D0D0 D1D1 Increase in demand A Change in the Quantity Demanded Versus a Change in Demand

33 Price Quantity D0D0 D1D1 D2D2 Increase inDecrease in demand A Change in the Quantity Demanded Versus a Change in Demand

34 Quantity Price D0D0 D1D1 D2D2 D0D0 Decrease in quantity demanded Increase in quantity demanded Increase in demand Decrease in demand A Change in the Quantity Demanded Versus a Change in Demand

35 Supply  If a firm supplies a good or service, the firm –Has the resources and technology to produce it, –Can profit from producing it, and –Has made a definite plan to produce it and sell it.

36 Supply  The amount of a good or service that producers plan to (or are willing to) sell during a given time period at a particular price is called the quantity supplied.  Quantity supplied is not necessarily the same as the quantity actually sold (which depends on the interaction of supply and demand).

37 The Law of Supply  Other things remaining the same, the higher the price of a good, the greater is the quantity supplied.  Increasing opportunity cost is the reason behind the law of supply.

38 Supply Schedule and Supply Curve  A supply schedule lists the quantities supplied at each different price when all other influences on the amount firms plan to sell remain the same.  A supply curve is a graph of a supply schedule.

39 Supply Schedule a.500 b1.003 c1.504 d2.005 e2.506 PriceQuantity (dollars per CD-R) (millions of CD-Rs per week)

40 Supply Curve Quantity (millions of CD-Rs per week) Price ( dollar per CD-R)

41 Supply Curve Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) a b c d e

42 Supply Curve Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs a b c d e

43 Other Influences on Supply Besides Price  Prices of factors of production  Prices of other goods produced  Expected future prices  The number of suppliers  Technology

44 Prices of Factors of Production  A change in the price of a factor of production causes supply to change by changing production costs.  For example, suppose the product is automobiles and the price of labor increases. Automakers will cut back on their supply (the supply curve will shift to the left).

45 Prices of Related Goods Produced - Substitutes  Two goods are substitutes in production if the same factors of production can be used to produce each good. Examples are sedans and sports cars.  If the price of sports cars rises, the quantity supplied of sports cars rises (move up the supply curve) and the supply of sedans falls (the supply curve of sedans shifts to the left).

46 Prices of Related Goods Produced - Complements  Two goods are complements in production if they are produced together. Examples are beef and cowhide.  If the price of cowhide rises, the quantity supplied of cowhide rises (move up along the supply curve) and the supply of beef rises (the supply curve of beef shifts to the right).

47 Expected Future Prices  If producers expect the price of a good to be higher in the future (and the good can be stored), they may substitute over time.  This means they will offer a smaller quantity of the good for sale today so the current supply decreases (the supply curve shifts to the left).

48 The Number of Suppliers  Other things remaining the same, the larger the number of producers supplying a good, the larger is the supply of the good (the supply curve shifts to the right).

49 Technology  New technologies that enable producers to use less (or cheaper) factors of production lower the cost of production and increase supply (the supply curve shifts to the right).

50 Supply Response to Change in Technology Original supply schedule Old technology Price Quantity (dollars (millions of CD-Rs per CD-R) per week) a.50 0 b c d e2.50 6

51 Original supply schedule New supply schedule Old technology New technology Price Quantity Price Quantity (dollars (millions of CD-Rs (dollars (millions of CD-Rs per CD-R) per week) per CD-R)per week) a.50 0 a'.50 b b' 1.00 c c' 1.50 d d' 2.00 e e' 2.50 Supply Response to Change in Technology

52 Original supply schedule New supply schedule Old technology New technology Price Quantity Price Quantity (dollars (millions of CD-Rs (dollars (millions of CD-Rs per CD-R) per week) per CD-R)per week) a.50 0 a'.50 3 b b' c c' d d' e e' Supply Response to Change in Technology

53 Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (old technology) e d c b a Supply Response to Change in Technology

54 Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (new technology) a a' b' c' d' e'e d c b Supply of CD-Rs (old technology) Supply Response to Change in Technology

55 Movement Along Versus a Shift of the Supply Curve  If the price of a good changes but everything else influencing supply remains constant, there is a movement along the supply curve.  If the price of a good remains the same but another influence on supply changes, there is a shift of the supply curve.

56 A Change in Quantity Supplied Versus a Change in Supply  A movement along the supply curve shows a change in quantity supplied.  A shift of the supply curve shows a change in supply.

57 A Change in the Quantity Supplied Versus a Change in Supply Quantity Price S0S0

58 A Change in the Quantity Supplied Versus a Change in Supply Quantity Price S0S0 Decrease in quantity supplied Increase in quantity supplied

59 A Change in the Quantity Supplied Versus a Change in Supply Quantity Price S0S0 P0P0 Q0Q0

60 A Change in the Quantity Supplied Versus a Change in Supply Quantity Price S0S0 P0P0 Q1Q1 Q0Q0 P1P1

61 A Change in the Quantity Supplied Versus a Change in Supply Quantity Price S0S0 P0P0 Q1Q1 Q0Q0 P1P1 P2P2 Q2Q2

62 A Change in the Quantity Supplied Versus a Change in Supply Quantity S1S1 Price S0S0 supply Increase in

63 A Change in the Quantity Supplied Versus a Change in Supply Quantity S1S1 Price S0S0 S2S2 supply Increase inDecrease in supply

64 A Change in the Quantity Supplied Versus a Change in Supply Quantity Price S0S0 Decrease in quantity supplied Increase in quantity supplied S0S0 S1S1 S2S2 Increase in supply Decrease in

65 Price Determination  The price of a good regulates the quantities demanded and supplied.  There is one price, and only one price, at which the quantity demanded equals the quantity supplied.  Price is the rationing (or regulating) mechanism

66 Shortages  If the price is too low, the quantity demanded exceeds the quantity supplied. People are willing to pay more for the good.  To eliminate this shortage, sellers will raise the price, increasing the quantity supplied and reducing the quantity demanded.

67 Surpluses  If the price is too high, the quantity supplied exceeds the quantity demand. Inventories pile up.  To eliminate this surplus, sellers will lower the price, reducing quantity supplied and increasing quantity demanded.

68 Market Equilibrium  The market equilibrium price is the price at which the quantity demanded equals the quantity supplied.  The market equilibrium quantity is the quantity bought and sold at the equilibrium price.  At market equilibrium, both buyers and sellers are satisfied. This is not true at any other price or quantity.

69 Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per CD-R) (millions of CD-Rs per week)

70 Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per CD-R) (millions of CD-Rs per week).5090–

71 Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per CD-R) (millions of CD-Rs per week).5090– –

72 Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per CD-R) (millions of CD-Rs per week).5090– –

73 Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per CD-R) (millions of CD-Rs per week).5090– –

74 Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per CD-R) (millions of CD-Rs per week).5090– –

75 Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per CD-R) (millions of CD-Rs per week).5090– –

76 Market Equilibrium Quantity (millions of CD-Rs per week) Price ( dollar per CD-R)

77 Market Equilibrium Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Demand for CD-Rs

78 Market Equilibrium Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs Demand for CD-Rs

79 Market Equilibrium Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs Demand for CD-Rs

80 A Shortage Forces the Price Up  If demand exceeds supply, sellers will raise price, decreasing quantity demanded.

81 A Surplus Forces the Price Down  If supply exceeds demand, sellers will see their inventories of unsold goods piling up and will cut price to sell them.

82 Market Equilibrium Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs Surplus of 2 million CD-Rs at $2 a CD-R Shortage of 3 million CD-Rs at $1 a CD-R Demand for CD-Rs Equilibrium

83 The Best Deal Available for Buyers and Sellers  The equilibrium price is the best deal available for buyers and sellers.  This is the price at which trade takes place.

84 Predicting Changes in Price and Quantity  The theory we have just studied provides us with a powerful way of analyzing influences on prices and the quantities bought and sold.  A change in price must be caused by either a change in demand or a change in supply.

85 A Change in Demand  An increase in demand shifts the demand curve up and to the right.  The new equilibrium price and quantity are higher.

86 Predicting Changes in Price and Quantity  A Change in Demand –What would happen to the price and quantity of CD-Rs if the price of a CD Burner falls from $300 to $100.

87 The Effects of a Change in Demand Quantity demanded Price (millions of CD-Rs per week) (dollars Quantity supplied per CD-R ) CD Burner $300 CD Burner $100 (millions of CD-Rs per week)

88 The Effects of a Change in Demand Quantity demanded Price (millions of CD-Rs per week) (dollars Quantity supplied per CD-R ) CD Burner $300 CD Burner $100 (millions of CD-Rs per week)

89 The Effects of a Change in Demand Quantity demanded Price (millions of CD-Rs per week) (dollars Quantity supplied per CD-R ) CD Burner $300 CD Burner $100 (millions of CD-Rs per week)

90 The Effects of a Change in Demand Quantity demanded Price (millions of CD-Rs per week) (dollars Quantity supplied per CD-R ) CD Burner $300 CD Burner $100 (millions of CD-Rs per week)

91 The Effects of a Change in Demand Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs Demand for CD-Rs (CD Burner $300)

92 The Effects of a Change in Demand Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs Demand for CD-Rs (CD Burner $300) Demand for CD-Rs (CD Burner $100)

93 The Effects of a Change in Demand Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs Demand for CD-Rs (CD Burner $300) Demand for CD-Rs (CD Burner $100)

94 A Change in Supply  An increase in supply shifts the supply curve down and to the right.  The new equilibrium price is lower, but the equilibrium quantity is higher.

95 The Effects of a Change in Supply Quantity supplied Price (millions of CD-Rs per week) (dollars Quantity demanded old new per CD-R ) (millions of CD-Rs per week) technology technology

96 The Effects of a Change in Supply Quantity supplied Price (millions of CD-Rs per week) (dollars Quantity demanded old new per CD-R ) (millions of CD-Rs per week) technology technology

97 Quantity supplied Price (millions of CD-Rs per week) (dollars Quantity demanded old new per CD-R ) (millions of CD-Rs per week) technology technology The Effects of a Change in Supply

98 Quantity supplied Price (millions of CD-Rs per week) (dollars Quantity demanded old new per CD-R ) (millions of CD-Rs per week) technology technology The Effects of a Change in Supply

99 Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Demand for CD-Rs Supply of CD-Rs (old technology) The Effects of a Change in Supply

100 Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (old technology) Demand for CD-Rs Supply of CD-Rs (new technology) The Effects of a Change in Supply

101 Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (old technology) Demand for CD-Rs Supply of CD-Rs (new technology) The Effects of a Change in Supply

102 A Change in Both Demand and Supply  Both curves shift.  The direction in which price and quantity change will depend on how each curve shifts.

103 Demand and Supply Change in the Same Direction  If demand and supply increase, both the demand and supply curves shift out.  The new equilibrium quantity will be higher.  The new equilibrium price may be higher, lower, or it may remain the same.

104 The Effects of an Increase in Both Demand and Supply Original Quantities New Quantities (millions of CD-Rs per week) (millions of CD-Rs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD-R ) CD Burner old CD Burner new $300 technology $100 technology

105 The Effects of an Increase in Both Demand and Supply Original Quantities New Quantities (millions of CD-Rs per week) (millions of CD-Rs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD-R ) CD Burner old CD Burner new $300 technology $100 technology

106 The Effects of an Increase in Both Demand and Supply Original Quantities New Quantities (millions of CD-Rs per week) (millions of CD-Rs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD-R ) CD Burner old CD Burner new $300 technology $100 technology

107 The Effects of an Increase in Both Demand and Supply Original Quantities New Quantities (millions of CD-Rs per week) (millions of CD-Rs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD-R ) CD Burner old CD Burner new $300 technology $100 technology

108 The Effects of an Increase in Both Demand and Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (old technology) Demand for CD-Rs (CD Burner $300 )

109 The Effects of an Increase in Both Demand and Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (old technology) Demand for CD-Rs (CD Burner $300 ) Demand for CD-Rs (CD Burner $100)

110 The Effects of an Increase in Both Demand and Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (old technology) Demand for CD-Rs (CD Burner $300) Demand for CD-Rs (CD Burner $100) Supply of CD-Rs (new technology)

111 A Decrease in Both Demand and Supply  When both demand and supply decrease, the quantity decreases and the price increases, decreases, or remains constant

112 The Effects of a Decrease in Both Demand and Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Demand for CD-Rs (CD Burner $100) Supply of CD-Rs (wage=$9)

113 The Effects of a Decrease in Both Demand and Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (wage=$10) Demand for CD-Rs (CD Burner $100) Supply of CD-Rs (wage=$9)

114 The Effects of a Decrease in Both Demand and Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (wage=$10) Demand for CD-Rs (CD Burner $300) Demand for CD-Rs (CD Burner $100) Supply of CD-Rs (wage=$9)

115 Demand and Supply Change in Opposite Directions  Suppose supply increases but demand decreases.  Price falls.  The direction in which quantity changes will depend on the magnitude of the shifts in the two curves.

116 The Effects of an Decrease in Demand and an Increase in Supply Original Quantities New Quantities (millions of CD-Rs per week) (millions of CD-Rs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD-R ) MP3 download old MP3 download new free technology $20 technology

117 The Effects of an Decrease in Demand and an Increase in Supply Original Quantities New Quantities (millions of CD-Rs per week) (millions of CD-Rs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD-R ) MP3 download old MP3 download new free technology $20 technology

118 The Effects of an Decrease in Demand and an Increase in Supply Original Quantities New Quantities (millions of CD-Rs per week) (millions of CD-Rs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD-R ) MP3 download old MP3 download new free technology $20 technology

119 The Effects of an Decrease in Demand and an Increase in Supply Original Quantities New Quantities (millions of CD-Rs per week) (millions of CD-Rs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD-R ) MP3 download old MP3 download new free technology $20 technology

120 A Decrease in Demand and an Increase in Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (old technology) Demand for CD-Rs (MP3 Download free )

121 A Decrease in Demand and an Increase in Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (old technology) Demand for CD-Rs (MP3 Download free ) Demand for CD-Rs (MP3 Download $20 )

122 A Decrease in Demand and an Increase in Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (old technology) Demand for CD-Rs (MP3 Download free ) Demand for CD-Rs (MP3 Download $20 ) Supply of CD-Rs (new technology)

123 The Effects of an Increase in Demand and a Decrease in Supply  When demand increases and supply decreases, the price rises and the quantity increases, decreases, or remains constant.

124 An Increase in Demand and a Decrease in Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Demand for CD-Rs (MP3 download $20 ) Supply of CD-Rs (wage=$9)

125 An Increase in Demand and a Decrease in Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Demand for CD-Rs (MP3 download free ) Demand for CD-Rs (MP3 download $20 ) Supply of CD-Rs (wage=$9)

126 An Increase in Demand and a Decrease in Supply Quantity (millions of CD-Rs per week) Price ( dollar per CD-R) Supply of CD-Rs (wage=$10) Demand for CD-Rs (MP3 download free ) Demand for CD-Rs (MP3 download $20 ) Supply of CD-Rs (wage=$9)


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