How Markets Work Demand & Supply

Introduction Economics is about choices that people make to face scarcity and how those choices are affected by incentives. Prices act as incentives. The demand & supply model is the main tool of Economics. It tells us how people respond to prices and how prices are determined by demand & supply. This model helps us to answer the economic questions : What How, and for whom are goods and services are produced?

Prices And Markets Prices of goods and services are determined by demand and supply of these goods and services in the markets. A market has two sides : buyers & sellers. Examples of goods and services: Some markets are physical places where buyers & sellers meet. Some markets are groups of people around the world who never meet, but connected through Internet. Examples: E-commerce markets and currency markets.

Money Prices & Relative Prices A Money Price of a good is the amount of money must be paid in exchange of it. A Relative Price is the ratio of the price of one good to another and it is an opportunity cost. Example : If the money price of coffee is 1 SR and the money price of gum is 0.5 SR, then the relative price of coffee to gum= 1 /0.5 = 2 : 1 and it is the opportunity cost of a cup of coffee : To get one cup of coffee,you must give up two packs of gum.

Demand If you demand something that means: You want it. You can afford it,and Plan to buy it. Demand reflect a choice : What wants to be satisfied and by what goods and services.

The Quantity Demanded The quantity demanded of goods & services is the amount that consumer plan to buy during a period of time at a particular price. Many factors influence buying plans and price is one of them.

The Law of Demand Other things remain the same, the higher the price of a good, the smaller the quantity demanded and the lower the price of a good, the greater the quantity demanded.

Substitution Effect and Income Effect To explain why a higher price reduce the quantity demanded ? For two reasons: Substitution Effect: When the price of a good rises. Other things remaining the same, its relative price ( the opportunity cost) rises. As the opportunity cost of a good rises, the incentive to reduce its use and switch to a substitute becomes stronger.

Income Effect When the price of a good rises, Other things remaining the same, people face a higher price and an unchanged income. They cannot pay for all goods and services that they used to buy. So when the price of a good rises, Other things remaining the same, they must decrease the quantities of some goods and services specially the good whose price has increased.

The Demand Curve It shows the inverse relationship between the quantity demanded of a good and its price, other things that affect demand being the same. Quantity Demanded Price

A Demand Schedule It lists the quantity demanded at each price other things that influence demand being the same. Example: Quantity demanded PricePoint 220.5A 151B 101.5C 72D 52.5E

The Demand Curve