1. Chapter 2: Economic Systems & Resource Allocation

2. Basic Economic Questions
What to Produce (guns vs. butter)
How to Produce (labor-intensive vs. capital-intensive technology)
For Whom to Produce (rich vs. poor)

3. Economic Systems Tradition & Custom Economy Command & Control Economy
Central Planning
Market Economy
Pure vs. Mixed
Competitive vs. Non-competitive

4. Market System Network of buyers & sellers who transact in the market
Buyers “demand” goods & services
Sellers “supply” goods & services

5. Advantage of Market Economy
Free interactions between buyers & sellers
Full information to make decisions
Free to choose between alternatives

6. Demand
Definition: quantities of a good or service consumers are able to buy at various prices
Law of Demand: price and quantity are negatively related
Movement along demand is caused by a price change

7. Demand Schedule Demand for Pepsi Price Quantity Demanded $1.50 1,500
$2.00
1,000
$2.50
500

8. Demand Line
Price D A
2.00 B
1.50 D
Quantity
1000
1500

9. Shift in Demand Shift in demand is caused by a change in
Consumer income & tastes
Consumer expectations (price, income)
Number of consumers
Price of related goods (substitute, complementary)

10. Increase in Demand
Price D’ D A C
2.00 B D’ D
Quantity
1500
2000

11. Supply
Definition: quantities of a good or service producers are able to sell at various prices
Law of Supply: price and quantity supplied are positively related
Movement along supply is caused by a price change

12. Supply Schedule Supply for Pepsi Price Quantity Supplied $1.50 500
$2.00
1,000
$2.50
1,500

13. Supply Line
Price S
2.00 B
1.50 A S
500
1000
Quantity

14. Shift in Supply Shift in supply is caused by an change in
production cost & technology
number of firms
price of related goods
price expectations

15. Increase in Supply
Price S B S’ A
1.50 C S S’
500
1000
Quantity

16. Equilibrium
A condition at which the independent plans of buyers and sellers exactly coincide in the marketplace.
At equilibrium: Demand = Supply to determine equilibrium price & quantity

17. Equilibrium in Pepsi Market
Market Equilibrium
Equilibrium in Pepsi Market
Price
Quantity Demanded
Quantity Supplied
$1.50
1,500
500
$2.00
1,000
$2.50

18. Demand-Supply Interaction
Price
Surplus S
2.50
Equilibrium
2.00 B
1.50
Shortage S D
Quantity
500
1000
1500

19. Stability
Shortage: at a price below equilibrium quantity demanded > quantity supplied
Surplus: at a price above equilibrium quantity supplied > quantity demanded
Price adjustments eliminate shortages & surpluses

20. Increase in Demand: Price D’ D S B P’ A P D’ D S Quantity Q Q’
Higher Price
Larger Quantity B P’ A P D’ D S
Quantity Q Q’

21. Increase in Supply: Price D S S’ A P B P’ S D S’ Q’ Q Quantity
Lower Price
Larger Quantity B P’ S D S’ Q’ Q
Quantity

22. Increase in Demand & Supply:
Price D’ D S S’ P’ B
Here:
Higher Price
Larger Quantity A P D’ S D S’
Quantity Q Q’

23. Market: Command Economy
Price D S
Shortage=AC
if price is fixed B P’ C P A D’ D Q Q’
Quantity