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Chapter 3: Demand, Supply, and Market Equilibrium

  • Markets - Bring together buyers + sellers

    • Highly competitive markets have large #s of independently acting buyers + sellers of standardized products

  • Demand - Schedule/curve showing various amounts of product that consumers willing + able to buy at several possible prices during a specific period of time

    • Statement of buyer’s plans/intentions of purchase of product

  • Demand schedule - Illustrates quantity demanded of a good or service at different prices

  • Law of demand - Other things equal, as price falls, the quantity demanded rises (and vice versa)

    • Inverse relationship

    • Diminishing marginal utility - Each successive unit of product consumed → Buyers get less satisfaction

    • Income effect - Lower price increases purchasing power of income → Buyer can purchase more of product than before (and vice versa)

    • Substitution effect - Buyer has incentive to substitute less expensive products for similar products that are relatively more expensive

  • Demand curve - Quantity demanded on horizontal axis, price on vertical axis; downward slope reflects law of demand

    • Increase in demand → Curve shifts right

    • Decrease in demand → Curve shifts left

  • Add quantities demanded by all consumers at each possible price → Market demand

  • Determinants of demand - Other factors besides price that affect purchases; shifts the demand curve

    • Consumer preferences

    • Number of buyers

    • Consumer incomes

      • Normal goods - Rise in income causes increase in demand

      • Inferior goods - Rise in income causes decrease in demand

    • Prices of related goods

      • Substitute goods - Increase in price of one related good → Demand for other good increases

      • Complementary goods - Increase in price of one related good → Demand for other good decreases

      • Independent/unrelated goods

    • Consumer expectations

  • Change in demand - Shift of demand curve to right/left

  • Change in quantity demanded - Movement from one point to another on a fixed demand curve (the same demand curve)

  • Supply - Schedule/curve showing various amounts of product that producers are willing + able to make available for sale at several possible prices during a specific period of time

  • Supply schedule - Illustrates quantity supplied of a good or service at different prices

  • Law of supply - Other things equal, as price rises, the quantity supplied rises (and vice versa)

  • Supply curve - Upward sloping; reflects law of supply

  • Sum quantities supplied by each producer at each price → Market supply

  • Determinants of supply - Other factors besides price that affect supply; shifts supply curve

    • Resource prices

    • Technology

    • Taxes and subsidies

    • Prices of other goods

    • Producer expectations

    • Number of sellers in the market

  • Change in supply - Shift of supply curve to right/left

  • Change in quantity supplied - Movement from one point to another on a fixed supply curve (the same supply curve)

  • Equilibrium price - Price where quantity demanded = quantity supplied

    • Intersection of supply + demand curve

  • Equilibrium quantity - Quantity demanded and quantity supplied at the equilibrium price

  • Surplus - Quantity supplied exceeds quantity demanded; drives prices down

  • Shortage - Quantity demanded exceeds quantity supplied; drives prices up

  • Rationing function of prices - Competitive forces of supply + demand establish equilibrium price

  • Productive efficiency - Production of a good in the least-costly way

  • Allocative efficiency - Production of the particular mix of goods and services most highly valued by society

  • Demand reflects marginal benefit, supply reflects marginal supply

    • MB = MC → Allocative efficiency

  • Changes in supply + demand

    • Increase in demand → Increase in equilibrium price + equilibrium quantity

    • Increase in supply → Decrease in equilibrium price + increase in equilibrium quantity

    • Supply increase, demand decrease → Equilibrium price decrease, equilibrium quantity indeterminate

    • Supply decrease, demand increase → Equilibrium price increase, equilibrium quantity indeterminate

    • Supply increase, demand increase → Equilibrium price indeterminate, equilibrium quantity increase

    • Supply decrease, demand decrease → Equilibrium price indeterminate, equilibrium quantity decrease

  • Price ceiling - Maximum legal price a seller can charge for a good or service

    • Must be below equilibrium price to be binding

    • Shortage

    • Rationing problem - Gov’t must establish formal system of rationing in order to solve inequitable distribution of gasoline

    • Black markets - Goods illegally bought and sold at prices above the legal limits

    • Rent controls - Maximum rents established by law

  • Price floor - Minimum legal price a seller can charge for a good or service

    • Must be above equilibrium price to be binding

    • Surplus

      • Gov’t can solve surplus by either restricting supply or purchasing surplus output

    • Distorts resource allocation

  • Markets - Bring together buyers + sellers

    • Highly competitive markets have large #s of independently acting buyers + sellers of standardized products

  • Demand - Schedule/curve showing various amounts of product that consumers willing + able to buy at several possible prices during a specific period of time

    • Statement of buyer’s plans/intentions of purchase of product

  • Demand schedule - Illustrates quantity demanded of a good or service at different prices

  • Law of demand - Other things equal, as price falls, the quantity demanded rises (and vice versa)

    • Inverse relationship

    • Diminishing marginal utility - Each successive unit of product consumed → Buyers get less satisfaction

    • Income effect - Lower price increases purchasing power of income → Buyer can purchase more of product than before (and vice versa)

    • Substitution effect - Buyer has incentive to substitute less expensive products for similar products that are relatively more expensive

  • Demand curve - Quantity demanded on horizontal axis, price on vertical axis; downward slope reflects law of demand

    • Increase in demand → Curve shifts right

    • Decrease in demand → Curve shifts left

  • Add quantities demanded by all consumers at each possible price → Market demand

  • Determinants of demand - Other factors besides price that affect purchases; shifts the demand curve

    • Consumer preferences

    • Number of buyers

    • Consumer incomes

      • Normal goods - Rise in income causes increase in demand

      • Inferior goods - Rise in income causes decrease in demand

    • Prices of related goods

      • Substitute goods - Increase in price of one related good → Demand for other good increases

      • Complementary goods - Increase in price of one related good → Demand for other good decreases

      • Independent/unrelated goods

    • Consumer expectations

  • Change in demand - Shift of demand curve to right/left

  • Change in quantity demanded - Movement from one point to another on a fixed demand curve (the same demand curve)

  • Supply - Schedule/curve showing various amounts of product that producers are willing + able to make available for sale at several possible prices during a specific period of time

  • Supply schedule - Illustrates quantity supplied of a good or service at different prices

  • Law of supply - Other things equal, as price rises, the quantity supplied rises (and vice versa)

  • Supply curve - Upward sloping; reflects law of supply

  • Sum quantities supplied by each producer at each price → Market supply

  • Determinants of supply - Other factors besides price that affect supply; shifts supply curve

    • Resource prices

    • Technology

    • Taxes and subsidies

    • Prices of other goods

    • Producer expectations

    • Number of sellers in the market

  • Change in supply - Shift of supply curve to right/left

  • Change in quantity supplied - Movement from one point to another on a fixed supply curve (the same supply curve)

  • Equilibrium price - Price where quantity demanded = quantity supplied

    • Intersection of supply + demand curve

  • Equilibrium quantity - Quantity demanded and quantity supplied at the equilibrium price

  • Surplus - Quantity supplied exceeds quantity demanded; drives prices down

  • Shortage - Quantity demanded exceeds quantity supplied; drives prices up

  • Rationing function of prices - Competitive forces of supply + demand establish equilibrium price

  • Productive efficiency - Production of a good in the least-costly way

  • Allocative efficiency - Production of the particular mix of goods and services most highly valued by society

  • Demand reflects marginal benefit, supply reflects marginal supply

    • MB = MC → Allocative efficiency

  • Changes in supply + demand

    • Increase in demand → Increase in equilibrium price + equilibrium quantity

    • Increase in supply → Decrease in equilibrium price + increase in equilibrium quantity

    • Supply increase, demand decrease → Equilibrium price decrease, equilibrium quantity indeterminate

    • Supply decrease, demand increase → Equilibrium price increase, equilibrium quantity indeterminate

    • Supply increase, demand increase → Equilibrium price indeterminate, equilibrium quantity increase

    • Supply decrease, demand decrease → Equilibrium price indeterminate, equilibrium quantity decrease

  • Price ceiling - Maximum legal price a seller can charge for a good or service

    • Must be below equilibrium price to be binding

    • Shortage

    • Rationing problem - Gov’t must establish formal system of rationing in order to solve inequitable distribution of gasoline

    • Black markets - Goods illegally bought and sold at prices above the legal limits

    • Rent controls - Maximum rents established by law

  • Price floor - Minimum legal price a seller can charge for a good or service

    • Must be above equilibrium price to be binding

    • Surplus

      • Gov’t can solve surplus by either restricting supply or purchasing surplus output

    • Distorts resource allocation