M ARKET E CONOMY : U NIT 7 Ch. 21

I. C IRCULAR F LOW OF E CONOMICS A. Factor Market - where businesses buy factors of production from households 1. Labor- the work at a business 2. Capital (investments)- buy equipment or rent out land for business Factor market: Incomes Households Businesses

B. Product Market - business supply goods and services for sale to households 1. Households return money to businesses by buying from firm 2. Circular flow of economic activity - flow of money from firms to households Factor market: Incomes Households Businesses Product market: Expenditures Circular Flow of Economic Activity

C. In a mixed economy, the government also plays a role 1. Individuals and businesses pay taxes to the government 2. The government uses that money to regulate the economy, make public works, and provide entitlements Factor market: Incomes Households Businesses Product market: Expenditures Taxes Taxes and Fees Entitlements and Services Regulation Government

F REE E NTERPRISE S YSTEM

E. Market inhibitors 1. Price ceiling - a maximum price is set for a good/service a. Ex: rent control b. Result: market shortage 2. Price floor - a minimum price is set for a good/service a. Ex: minimum wage b. Result: market surplus SHORTAGE SURPLUS

IV. COMPETITION A. Competition increases market efficiency, growth, quality while decreasing prices B. Market is most efficient when it is close to perfect competition 1. pure competition at equilibrium 2. Large number of firms all producing the same product at the same price

C.Conditions for Perfect Competition 1. Many buyers and sellers- a. no one individual can be powerful enough to influence quantily or price b. Buyers benefit when more sellers- more goods at better quality at lower price

4. Free market entry and exit- firms must be able to enter markets when they can make money and leave when they can’t stay in business

3. Informed buyers and sellers- consumers know enough about the market to find the best deal

II. S UPPLY AND D EMAND A. Demand 1. Demand - desire to own something and the ability to pay for it 2. Law of demand - When a good’s price is lower, consumers will buy more of it. When the price is higher, consumers will buy less of it.

B. Supply 1. Supply - the amount of goods available 2. Law of supply - The higher the price, the larger the quantity produced. As price falls, quantity of supply falls. P RICE P ROFITS P RICE P ROFITS

C. Equilibrium Price 1. When quantity demand and quantity supplied are at the same price then they reach an equilibrium price 2. Equilibrium is ideal for producers because more of their product gets sold 3. Equilibrium is ideal for consumers because the right amount of product is available for the people who want it

E XAMPLE PriceCars SuppliedCars Demanded $ $ $ $ $ $ Why does quantity supplied go up with price? 2.Why does quantity demanded go down with price? 3.What is the equilibrium price? 4.If the price was $10000, how many cars would be sold? Why? 5.If the price was $15000, how many cars would be sold? Why? 6.Why is the equilibrium price usually ideal for both consumers and producers?

D. Surplus 1. If supply exceeds demand there is a surplus 2. Price is too high so goods and services exchanged are limited by demand

E. Shortage 1. If demand exceeds supply, there will be a shortage 2. Price is too low so goods and services exchanged are limited by supply

E XAMPLE : P IZZA ! Supply and Demand Schedule: after exhaustive research you have determined how many slices of pizza customers would be willing to buy certain prices. Your cost/benefit analysis has helped you understand how many you are willing to offer at certain prices Price per SliceSlices of Pizza Supplied Slices of Pizza Demanded $ $ $ $ $ $

If the price was $1, how many would be sold? What is this an example of? If the price was $2.50, how many would be sold? What is this an example of? What is the equilibrium price? Why is this price ideal for both consumers and producers?

S UPPLY AND D EMAND : P IZZA S LICES Equilibrium price : 175 slices at $1.75 Shortage Surplus

III. SHIFTS IN MARKET EQUILIBRIUM A. Problem of Excess Demand 1. When a “fad” occurs, there can be a sudden increase in demand 2. This leads to a shortage because demand>supply 3. When demand increases, equilibrium price will increase

B EANIE B ABIES S ALES E: $3.50 E: $4.00

B. Fall in Demand 1. When a fad passes its peak, demand can fall as quickly as it rose 2. Excess demand turns into excess supply (surplus) 3. Suppliers cut prices in response 4. Price and quantity slide downward and eventually original equilibrium is restored

C.Changes in Demand 1. Substitutes - competing related goods a. Increase in price of one will cause a rise in demand of the other b.Ex: butter and margarine 2. compliments - goods that are dependant on each other a. Increase in price of one will cause a fall in demand of the other b.Ex: DVDs and DVD players

3. Demand elasticity - market in which a change in price will automatically cause a change in demand (luxury goods with substitutes) 4. Demand inelasticity - market in which a change in price will not cause a significant change in demand (necessary good with no substitutes)

D. Reasons for changes in supply 1. Cost of resources 2. Amount available 3. Productivity 4. Technology 5. Role of Government: Regulations, taxes, and subsidies - gov’t money to help production 6. Expectations

2. Identical products - no difference in product sold a. commodity - an essential product that is the same regardless who makes or sells it

Review Questions 1. A new technology increases the speed of computers without increasing production costs. What is the likely effect of this technology? 2. In what situation would a shoe store reduce the price of shoes? 3. What impact would healthy competition have on prices, quality, and choice of products? 4. In the circular flow free enterprise model, how are prices for goods established? 5. In a market economic system, what happens to the price of a good when its supply increases and its demand decreases?