The Circular-Flow Diagram Firms Households Market for Factors of Production Market for Goods and Services SpendingRevenue Wages, rent, and profit Income Goods & Services sold Goods & Services bought Labor, land, and capital Inputs for production

Markets uA market is a group of buyers and sellers who interact to buy and sell a particular good or service.

Market Types: Competitive and Otherwise uProducts are the same uNumerous buyers and sellers so that each has no influence over price uBuyers and Sellers are price takers Perfect Competition

Market Types: Competitive and Otherwise uMonopoly u One seller who controls price uOligopoly u Few sellers u Not always aggressive competition uMonopolistic Competition u Many sellers u Slightly differentiated products u Each seller may set price for its own product

The Circular-Flow Diagram Firms Households Market for Factors of Production Market for Goods and Services SpendingRevenue Wages, rent, and profit Income Goods & Services sold Goods & Services bought Labor, land, and capital Inputs for production

The quantity demanded is the amount of a good that a buyer is (buyers are) willing and able to buy during a specified period of time. Quantity demanded refers to a particular number of units.

The quantity demanded by a consumer will depend upon the following factors: uThe good’s own price. uThe consumer’s income. uPrices of related goods. uThe consumer’s tastes and and preferences. uExpectations and other special influences.

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Demand is the relationship between the price of a good or service and the quantity demanded, ceteris paribus. Market demand is the relationship between the price of a good or service and the quantity demanded by all buyers in the market, ceteris paribus.

price quantity D dkdk dDdD dvdv a b ce mn q r s

The market demand curve is obtained by horizontally summing the demand curves for all buyers in the market. Implication: An increase in the number of buyers will result in an increase in market demand, ceteris paribus.

Changes in Quantity Demanded 0 D1D1 Price of Cigarettes per Pack Number of Cigarettes Smoked per Day The price of cigarettes increases. A C $

Change in Quantity Demanded uMovement along the demand curve. uCaused by a change in the price of the product.

Demand is the relationship between the quantity demanded and the good’s own price, ceteris paribus. Other factors being held constant: uIncome. uPrices of related goods. uTastes and and preferences. uExpectations and other special influences.

A change in demand is a change in the relationship between the quantity demanded and price. uA shift in the demand curve, either to the left or right. uCaused by a change in a determinant other than the price.

price quantity dvdv d*vd*v Example of a Decrease in Demand

Changes in Demand 0 D1D1 Price of Ice-Cream Cone Quantity of Ice-Cream Cones D3D3 D2D2 Increase in demand Decrease in demand

Consumer Income uAs income increases the demand for a normal good will increase. uAs income increases the demand for an inferior good will decrease.

Consumer Income Normal Good $ Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 Increase in demand An increase in income... D1D1 D2D2

Consumer Income Inferior Good $ Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 Decrease in demand An increase in income... D1D1 D2D2

Prices of Related Goods Substitutes & Complements uWhen a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. uWhen a fall in the price of one good increases the demand for another good, the two goods are called complements.

Show graphically and explain what will happen to the demand for gasoline when: uThe price of air travel increases. uAutomobile prices fall. uIncomes rise. uHighway tolls rise. uThe price of gasoline rises.

Quantity supplied is the quantity of a good a seller is (sellers are) willing and able to make available in the market over a given period of time. Quantity supplied refers to a particular number of units.

The quantity supplied will depend upon: uthe good’s own price uprices of inputs used in producing the good utechnology uprices of other goods the seller could supply uexpectations and other factors

Supply is the relationship between the price of a good or service and the quantity supplied, ceteris paribus. The law of supply states that there is a direct (positive) relationship between price and quantity supplied.

Supply Curve $ Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0

Market Supply uMarket supply refers to the sum of all individual supplies for all sellers in a market for a particular good or service. uGraphically, individual supply curves are summed horizontally to obtain the market supply curve.

Change in Quantity Supplied 1 5 Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 S 1.00 A C $3.00 The price increases from $1.00 to $3.00

Change in Quantity Supplied Movement along the supply curve. Caused by a change in the market price of the product.

Change in Supply Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 S1S1 S2S2 S3S3 Increase in Supply Decrease in Supply

Change in Supply A shift in the supply curve, either to the left or right. Caused by a change in a determinant other than price.

Factors that can cause a change in supply: uChanges in input prices. uChanges in technology. uChanges in prices of other goods that the seller could supply. uChanges in expectation and other factors.

How would the supply of personal computers be affected by: uA decline in the prices of a computer component. uA faster method for assembling computers is developed. uDell Corporation goes out of business. uThe price of personal computers declines.

Equilibrium uEquilibrium is the state of balance between opposing forces. uIn equilibrium, the system is in a state of rest in that there is no tendency for change. uIn economics, there is an equilibrium when economic forces are in balance so that economic variables have no tendency to change.

Excess Demand Quantity of Ice-Cream Cones Price of Ice-Cream Cone Supply Demand $1.50 Shortage

uThere is a shortage (excess demand) when the quantity demanded exceeds the quantity supplied. uA shortage will result in upward pressure on price.

Price of Ice-Cream Cone Quantity of Ice-Cream Cones $ Supply Demand Surplus Excess Supply

uThere is a surplus (excess supply) when the quantity demanded is less than the quantity supplied. uA surplus will result in downward pressure on price.

Supply Demand Price of Ice-Cream Cone Quantity of Ice-Cream Cones Equilibrium of Supply and Demand $ Equilibrium

uA market equilibrium exists when the price of a good is such that the quantity demanded equals the quantity supplied. uIn equilibrium, the price and number of units traded will have no tendency to change.

Market Equilibrium Supply Demand P Q QeQe PePe Factors affecting demand: income prices of related goods tastes expectations Factors affecting supply: input prices technology prices of other goods that could be produced expectations

How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone Quantity of Ice-Cream Cones Supply Initial equilibrium D1D1 D2D2 $ New equilibrium Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Q P D1D1 S P1P1 Q1Q1 D2D2 P2P2 Q2Q2 Q3Q3 A. An increase in demand, ceteris paribus, will result in increases in both the equilibrium price and the equilibrium quantity.

Q P D1D1 S P1P1 Q1Q1 D5D5 P4P4 Q4Q4 Q5Q5

Q P D SaSa P1P1 Q1Q1 Q2Q2 P2P2 SbSb C. An increase in supply, ceteris paribus, will result in a reduction in the equilibrium price and an increase in the equilibrium quantity.

Q P D1D1 S1S1 P1P1 Q1Q1 D2D2 P2P2 Q3Q3 S2S2 Q P D1D1 S1S1 P1P1 Q1Q1 D2D2 P2P2 Q3Q3 S2S2