1. THE PRICE SYSTEM A major discovery of 18 th century economists was that the price system is a social control mechanism--a mechanism that coordinates individual and decentralized decisions.

2. Components of the Price System n n Demand Demand refers to the various quantities per unit of time that a buyer (buyers) is (are) willing and able to buy at all alternative prices, other things being equal. n n Supply Supply refers to the various quantities per unit of time that a firm (firms) is (are) willing to sell at all alternative prices, other things being equal.

3. The Determinants of Demand n n The price of the product; n n Consumer income; n n Consumer tastes and preferences; n n Prices of related goods--substitute goods or complementary goods. n n Consumer expectations about future prices.

4. The Determinants of Supply n n The price of the product; n n The costs of the inputs used to produce the product; n n The state of technology; n n The number of producers; n n Producers expectations about future prices; n n Taxes or subsidies from the government.

5. The Laws of Demand and Supply n n The Law of Demand : The higher (lower) the price, the smaller (larger) the quantity demanded, ceteris paribus. Q D = Q D (P) Q D = a - bP n n The Law of Supply : The higher (lower) the price, the larger (smaller) the quantity supplied, ceteris paribus. Q S = Q S (P) Q S = a’ + b’P

6. Market Equilibrium n n Market equilibrium is a situation in which the quantity of a good demanded equals the quantity supplied, so there is no pressure to change the price. P 0 Q S D PePe QeQe

7. Market Disequilibrium Market disequilibrium is a situation in which the quantity of a good demanded does not equal the quantity supplied, so there is pressure to change the price.

8. Market Disequilibrium n n Excess Demand A situation in which, at the prevailing price, consumers are willing to buy more than producers are willing to sell. Excess demand is sometimes called a shortage. n n Excess Supply A situation in which, at the prevailing price, producers are willing to sell more than consumers are willing to buy. Excess supply is sometimes called a surplus.