Demand and Supply: The Basics of the Market Economy Chapter 2 Demand and Supply: The Basics of the Market Economy McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives Basics of Market Economy Local, National and Global Markets Prices Defined Demand Defined Supply Defined New Markets 2-2

Basics of Market Economy Markets consist of buyers and sellers. Voluntary exchange of a product for money. Product is a good or service. Price is rate at which exchange takes place. Starbucks is an example of a market. Seller of coffee; but also buyer of coffee beans and employee hours. 2-3

Local, National, and Global Markets Markets differ geographically. Local markets - buyers and sellers are close to each other. Personal services are an example (e.g., dry cleaning). National market - transactions across the country. Stock transactions are an example. 2-4

Local, National, and Global Markets Global market - goods and services are sold anywhere in the world. Oil is a product sold in the global market. Price of oil is determined by global supply and demand. The internet has transformed local markets into national and global ones. As a result, more goods and services traded in national market. Online auction market created by eBay has played a major role. 2-5

Prices Defined The market price is defined as the typical price at which goods and services are exchanged in a market. Identifying the price is not always easy. Sale price: seller lowers typical price. Negotiated price: Set by bargaining between buyers and sellers. Differs from sticker price. Common in markets for big-ticket items such as automobiles. 2-6

Prices Defined Often, prices are lowered for large, bulk purchases (volume discount). Purchases at warehouse stores such as Costco and Sam’s Club are examples. Purchases made ahead of their use result in lower prices (advance purchase discounts). Purchasing an airline ticket is an example. 2-7

Demand Defined Quantity demanded is the amount of a good or service the buyer is willing to purchase. The quantity demanded for a good or service varies with the price. A demand schedule is the relation between the quantity demanded and the selling price. 2-8

Demand Defined Demand schedule is based on ceteris paribus – all other things equal. Ceteris paribus assumes the factors (other than price) that affect demand do not change. These factors include consumer incomes and taste, price of related goods, etc. 2-9

Demand Schedule for Music Downloads Price per song (dollars) Quantity demanded ( no. of songs downloaded) $0.50 20 $1.00 10 $2.00 3 $3.00 1 $4.00 2-10

Law of Demand The law of demand states that there is an inverse relation between quantity demanded and price. As prices go up, people buy less, so quantity demand goes down. As prices go down, people buy more, so quantity demand goes up. A good example of the law of demand: the iPhone. Many goods allow unlimited consumption after paying an initial fee. Examples include cell phone, cable plans and broadband access. 2-11

Demand Curve The demand curve is the graphic representation of the demand schedule. All the possible different prices are shown on the vertical axis (y-axis). All the possible different quantity demands are shown on the horizontal axis (x-axis). Demand curve is downward-sloping due to law of demand. 2-12

Demand Curve for Coffee $7.00 Demand $6.00 curve $5.00 $4.00 Price per cup $3.00 A $2.00 $1.00 $0.00 3 6 9 12 15 18 Quantity demanded (cups per week) 2-13

Supply Defined Quantity supplied is the amount of a good or service that the seller is willing to produce at various prices. Quantity supplied for a good or service varies with price. A supply schedule is the relation between quantity supplied and the selling price. Supply schedule is again based on ceteris paribus conditions. 2-14

Supply Schedule for Haircuts Price per haircut (dollars) Quantity supplied ( no. of haircuts available) $5.00 40 $10.00 60 $15.00 80 $20.00 100 $25.00 120 $30.00 140 $35.00 160 2-15

Law of Supply The law of supply states that there is a direct relation between quantity supplied and price. As prices go up, businesses have an incentive to produce more, so quantity supplied goes up. If prices go down, businesses produce less, so quantity supplied goes down. Labor market is a good example of the law of supply. Price of labor is the wage rate. 2-16

Supply Curve The supply curve is the graphic representation of the supply schedule. All the possible different prices are shown on the vertical axis (y-axis). All the possible different quantity supplies are shown on the horizontal axis (x-axis). Supply curve is upward-sloping due to law of supply. 2-17

Supply Curve for Lawn Mowing $25.00 Supply curve $20.00 $15.00 Price per lawn mowed A $10.00 $5.00 $- 5 10 15 20 25 30 35 40 Quantity supplied (lawns mowed per week) 2-18

New Markets Demand and supply schedules describe behavior in existing markets. New markets - created due to technology and to meet changing needs of consumers. New products - include iPod, Amazon.com, iPhone, etc. One major advantage of the market-based economy is an ability to adjust to changes in consumer demand and technological advances. 2-19