Economics: Private and Public Choice|Part 2: Markets & Government|Chapter 3: Supply, Demand, & the Market Process
1. Consumer choice & the Law of Demand
A. Law of Demand - A principle that states there is an inverse relationship between the price of a good & the
quantity of its buyers are willing to purchase. As the price of a good increases, consumers will wish to
purchase less of it. As the price decreases, consumers will wish to purchase more of it.
B. Substitutes - Products that serve similar purposes. An increase in the price of one will cause an increase in
demand for the other (examples are hamburgers & tacos, butter & margarine, Microsoft Xbox & Sony
Playstation, Chevrolets & Fords).
C. The Market Demand Schedule
1. Exhibit 1
B. Read horizontally, the demand curve shows how much of a particular good consumers are willing to buy
at a given price. Read vertically, the demand curve shows how much consumers value the good.
D. Consumer Surplus
1. Consumer Surplus - The difference between the maximum price consumers are willing to pay & the
price they actually pay. It is the net gain derived by the buyers of the good.
2. Exhibit 2
a.
3. Because the value a consumer places on a particular good is shown by the corresponding height of the
demand curve, we can use the demand curve to clarify the difference between the marginal value &
total value of a good
Economics: Private and Public Choice|Part 2: Markets & Government|Chapter 3: Supply, Demand, & the Market Process
E. Responsiveness of Quantity Demanded to Price Changes: Elastic & Inelastic Demand Curves
1. Exhibit 3
a.
2. Changes in Demand Versus Changes in Quantity Demand
A. The purpose of the demand curve is to show what effect a price change will have on the quantity demanded
(or purchased) of a good.
B. A change in demand is a shift in the entire demand curve. A change in quantity demanded is a movement
along the same demand curve.
C. Some of the factors that cause a "change in demand" - an inward or outward shift in the entire demand
curve
1. Changes in consumer income
a. An increase in consumer income makes it possible for consumers to purchase more goods
b. Alternatively, when the economy goes into recession, falling incomes & rising unemployment
can cause consumers to reduce their purchases of many items
c. More income, the demand curve shifts to the right
d. Exhibit 4
i.
2. Changes in the number of consumers in the market
a. Exhibit 5
Economics: Private and Public Choice|Part 2: Markets & Government|Chapter 3: Supply, Demand, & the Market Process
i.
3. Changes in the price of a related good
a. Substitutes or complements change price
b. Complements - Products that are usually consumed jointly (for example, bread & butter, hot
dogs & hot dog buns). A decrease in the price of one will cause an increase in demand for the
other.
4. Changes in expectations
5. Demographics Change
6. Changes in consumer tastes & preferences
3. Producer Choice & the Law of Supply
A. Producers convert resources into goods & services by doing the following:
1. Organizing productive inputs & resources, like land, labor, capital, natural resources, & intermediate
goods
2. Transforming & combining these inputs into goods & services
3. Selling the final product to consumers
B. Opportunity Cost of Production - The total economic cost of producing a good or service. The cost includes
the opportunity cost of all the resources, including those owned by the firm. The opportunity cost is equal to
the value of the production of other goods/sacrificed as the result of producing the good.
C. The role of Profits & Losses
1. Profit - An excess of sales revenue relative to the opportunity cost of production. The cost component
includes the opportunity cost of all resources, including those owned by the firm. Therefore, profit
accrues only when the value of the good produced is greater than the value of the good produced is
greater than the value of the resources used for its production.
2. The willingness of consumers to pay a price greater than a goods opportunity cost indicates that they
value the good more than the other things that could have been purchased with the same resources.
3. Losses - A deficit of sales revenue relative to the opportunity cost of production. Losses are a penalty
imposed on those who produce goods even though they are valued less than their resources required
for their production.
D. Supply & the Entrepreneur
1. Entrepreneurs organize the production of new products
2. Their success or failure depends on how much consumers eventually value the products that could
have been produced with the resources
3. To prosper, entrepreneurs must convert & rearrange resources in a manner that will increase their
value
E. Market Supply Schedule
1. A higher price: will increase the producer's incentive to supply the good
2. Law of Supply - A principle that states there is a direct relationship between the price of a good & the
quantity of it producers are willing to supply. As the price of a good increases, producers will wish to
supply more of it. As the price decreases, producers will wish to supply less.
3. Exhibit 6
Economics: Private and Public Choice|Part 2: Markets & Government|Chapter 3: Supply, Demand, & the Market Process
a.
F. Producer Surplus
1. Producer Supply - The difference between the price suppliers actually receive & the minimum price
they would be willing to accept. It measures the net gains to producers
& resource suppliers from market exchange. It is not the same as profit.
2. Exhibit 7
a.
G. Responsiveness of Quantity Supplied to Price Changes: Elastic & Inelastic Supply Curves
1. Like the quantity demanded, the responsiveness of the quantity supplied to a change in price is
different for different goods. The supply curve is said to be elastic when a modest change in price
leads to a large change in quantity supplied.
2. Exhibit 8
a.
4. Changes in Supply Versus Changes in Quantity Supplied
A. When producers change the number of units they are willing to supply in response to a change in price, this
movement along the supply curve is called a "change in quantity supplied". A change in any factor other than
price shifts the supply curve & is called a "change in supply"
B. Primary factors that will cause a change in supply & shift the entire curve right or left.
1. Changes in resource prices
a. Exhibit 9
Economics: Private and Public Choice|Part 2: Markets & Government|Chapter 3: Supply, Demand, & the Market Process
i.
2. Changes in technology
3. Elements of Nature & Political Disruptions
4. Changes in Taxes
5. How Market Prices are Determined: Supply & Demand Interact
A. Market - An abstract concept encompasses the forces of supply & demand, & the interaction of buyers &
sellers with the potential for exchange to occur
B. Equilibrium - A state in which the conflicting forces of supply & demand are in balance. When a market is in
equilibrium, the decisions of consumers & producers are brought into harmony with one another, & the
quantity supplied will equal the quantity demanded.
C. Market Equilibrium
1. Excess demand is solved by consumers bidding up prices
2. Exhibit 10
a.
D. Efficiency & Market Equilibrium
1. Economic Efficiency - A situation in which all of the potential gains from trade have been realized. An
action is efficient only if it creates more benefit than cost. With well-defined property rights &
competition, market equilibrium is efficient.
2. Exhibit 11
Economics: Private and Public Choice|Part 2: Markets & Government|Chapter 3: Supply, Demand, & the Market Process
a.
6. How Markets Respond to Changes in Demand & Supply
A. Exhibit 12
1.
B. In a market economy, when the demand for a good increases, its price will rise, which will (1) motivate
consumers to search for substitutes & cut back on additional purchases of the good & (2) motivate
producers to supply more of the good. These 2 forces will eventually bring the quantity demanded &
quantity supplied back into balance
C. Exhibit 13
1.
D. Invisible Hand Principle - The tendency of market prices to direct individuals pursuing their own interests to
engage in activates promoting the economic well-being of society
E. Prices & Market Order
1. 3 vitally important functions performed by market prices
a. Prices communicate information to Decision Makers
i.
Market prices register information derived from the choices of millions of consumers,
producers, & resource suppliers, & provide them with everything they need to know to
make wise decisions.
Economics: Private and Public Choice|Part 2: Markets & Government|Chapter 3: Supply, Demand, & the Market Process
b. Prices coordinate the actions of market participants
c. Prices motivate economic players
F. Qualifications: Competition & Property Rights
1. The efficiency of market organization is, in fact, dependent upon these 2 things: (1) competitive
markets & (2) well-defined & enforced private-property rights.