1. Chapter 7
Demand and supply

2. demand: the amount of a good or service that consumers are able and willing to buy at various possible prices during a specified time period

3. supply: the amount of a good or service that producers are able and willing to sell at various prices during a specified time period

4. market: the process of freely exchanging goods and services between buyers and sellers

5. The Marketplace (cont.)
Section 1
The Marketplace (cont.)
In a market economy, consumers collectively have a great deal of influence on prices of all goods and services.
The demand of a good or service creates supply.
A market represents the freely chosen actions between buyers and sellers.

6. The Marketplace (cont.)
Section 1
The Marketplace (cont.)
In a market economy, individuals decide for themselves the answers to:
What?
How?
For Whom?

7. The Marketplace (cont.)
Section 1
The Marketplace (cont.)
A market economy is based on the principle of voluntary exchange.
Supply and demand analysis is a model of how buyers and sellers operate in the marketplace.

8. voluntary exchange: a transaction in which a buyer and a seller exercise their economic freedom by working out their own terms of exchange

9. The Law of Demand Section 1
The law of demand states that as price goes up, quantity demanded goes down, and vice versa.

10. The law of demand states that as price goes up, quantity demanded goes down. As price goes down, quantity demanded goes up.

11. The law of supply states that as price goes up, quantity supplied also goes up. As price goes down, quantity supplied goes down.

12. The Law of Demand (cont.)
Section 1
The Law of Demand (cont.)
The law of demand explains consumer reactions to changing prices in terms of the quantities demanded of a good or service. There is an inverse or opposite relationship between quantity demanded and price.

13. The Law of Demand (cont.)
Section 1
The Law of Demand (cont.)
Several factors explain the inverse relation between price and quantity demanded, or how much people will buy of any item at a particular price.
Factors include:
Real income effect
Substitution effect

14. real income effect: economic rule stating that individuals cannot keep buying the same quantity of a product if its price rises while their income stays the same

15. substitution effect: economic rule stating that if two items satisfy the same need and the price of one rises, people will buy more of the other

16. The Law of Demand (cont.)
Section 1
The Law of Demand (cont.)
Diminishing marginal utility:
Utility
Marginal utility
Law of diminishing marginal utility

17. Vocab11
law of diminishing marginal utility: rule stating that the additional satisfaction a consumer gets from purchasing one more unit of a product will lessen with each additional unit purchased

18. real income effect: economic rule stating that individuals cannot keep buying the same quantity of a product if its price rises while their income stays the same

19. substitution effect: economic rule stating that if two items satisfy the same need and the price of one rises, people will buy more of the other

20. Section 2
A demand curve shows the quantity demanded of a good or service at each possible price. Demand curves slope downward, clearly showing the inverse relationship.

21. Determinates of Demand (cont.)
Section 2
Determinates of Demand (cont.)
Factors that can affect demand for a specific product or service:
Changes in population
Changes in income
Changes in people’s tastes and preferences

22. Determinates of Demand (cont.)
Section 2
Determinates of Demand (cont.)
The availability and price of substitutes
The price of complementary goods
The decrease in the price of one good will increase the demand for its complementary.

23. Figure 3

24. Figure 4

25. Figure 5

26. The Price Elasticity of Demand
Section 2
The Price Elasticity of Demand
Elasticity of demand measures how much the quantity demanded changes when price goes up or down.

27. price elasticity of demand: economic concept that deals with how much demand varies according to changes in price

28. elastic demand: situation in which a given rise or fall in a product’s price greatly affects the amount that people are willing to buy

29. inelastic demand: situation in which a product’s price change has little impact on the quantity demanded by consumers

30. Figure 9

31. The Price Elasticity of Demand (cont.)
Section 2
The Price Elasticity of Demand (cont.)
Three factors determine the price elasticity of demand for an item:
The existence of substitutes
The percentage of a person’s total budget devoted to the purchase of that good
The time consumers are given to adjust to a change in price

32. Figure 11

33. law of supply: economic rule stating that price and quantity supplied move in the same direction

35. Role of Profit
One of the most important factors that motivates people in a market economy

36. supply curve: upward-sloping line that shows in graph form the quantities supplied at each possible price

37. Profits and the Law of Supply (cont.)
Section 3
Profits and the Law of Supply (cont.)
To understand pricing, you must look at both demand and supply.
The law of supply states that as the price of a good rises, the quantity supplied also rises. As the price falls, the quantity supplied also falls.
The higher the price of a good, the greater the incentive is for a producer to produce more.

38. The Determinants of Supply (cont.)
Section 3
The Determinants of Supply (cont.)
Many factors affect the supply of a specific product. Four of the major determinants are:
The price of inputs
The number of firms in the industry
Taxes imposed or not imposed

39. The Determinants of Supply (cont.)
Section 3
The Determinants of Supply (cont.)
Technology
Any improvement in technology will increase supply.

40. Law of diminishing returns
Adding units of one factor of production to all the other factors of production increases total output.

41. Equilibrium Price Section 4
In free markets, prices are determined by the interaction of supply and demand.

42. Equilibrium Price (cont.)
Section 4
Equilibrium Price (cont.)
Demand and supply operate together. As the price of a good goes down, the quantity demanded rises and the quantity supplied falls (and vice versa).
The point at which the quantity demanded and quantity supplied meet is called the equilibrium price.

43. Prices as Signals Section 4
Under a free-enterprise system, prices function as signals that communicate information and coordinate the activities of producers and consumers.

44. Prices as Signals (cont.)
Section 4
Prices as Signals (cont.)
Rising prices signal producers to produce more and consumers to purchase less.
Falling prices signal producers to produce less and consumers to purchase more.
A shortage occurs when at the current price, the quantity demanded is greater than the quantity supplied.
Prices above the equilibrium price reflect a surplus to suppliers.

45. Prices as Signals (cont.)
Section 4
Prices as Signals (cont.)
When a market economy operates without restriction, it eliminates shortages and surpluses.
When a shortage occurs, the price goes up to eliminate the shortage.
When surpluses occur, the price falls to eliminate the surplus.

46. Price Controls Section 4
Under certain circumstances, the government sometimes sets a limit on how high or low a price of a good or service can go.

47. Price Controls (cont.) Section 4
The government sometimes gets involved in setting prices if it believes such measures are needed to protect consumers and suppliers.

48. Price Controls (cont.) Section 4
A price ceiling is a government-set maximum price that may be charged for a particular good or service.
Effective price ceilings, and resulting shortages, often lead to non-market ways of distributing goods and services such as rationing and leading to the black market.

49. Price Controls (cont.) Section 4
Conversely, a price floor, is a government-set minimum price that can be charged for goods and services.