The Circular-Flow Diagram
Revenue
Goods &
Services sold
Market for
Goods
and Services
Firms
Inputs for
production
Wages, rent,
and profit
Spending
Goods &
Services
bought
Households
Market for
Factors
of Production
Labor, land,
and capital
Income
Markets
A market is a group of buyers and
sellers who interact to buy and sell a
particular good or service.
Market Types:
Competitive and Otherwise
Perfect Competition
Products are the same
Numerous buyers and sellers so that each
has no influence over price
Buyers and Sellers are price takers
Market Types:
Competitive and Otherwise
Monopoly
 One
seller who controls price
Oligopoly
 Few
sellers
 Not always aggressive competition
Monopolistic Competition
 Many
sellers
 Slightly differentiated products
 Each seller may set price for its own product
The Circular-Flow Diagram
Revenue
Goods &
Services sold
Market for
Goods
and Services
Firms
Inputs for
production
Wages, rent,
and profit
Spending
Goods &
Services
bought
Households
Market for
Factors
of Production
Labor, land,
and capital
Income
The quantity demanded is the amount
of a good that a buyer is (buyers are)
willing and able to buy during a specified
period of time.
Quantity demanded refers to a particular
number of units.
The quantity demanded by a consumer
will depend upon the following factors:
The good’s own price.
The consumer’s income.
Prices of related goods.
The consumer’s tastes and and preferences.
Expectations and other special influences.
Vanessa’s
demand schedules
for DVD rentals
quantity demanded
(per month)
price
case A
$10
2
$8
4
price
14
12
10
8
6
$6
6
$4
8
4
$2
10
2
dv
2
4
6
8
10 12 14
quantity
Demand is the relationship between the
price of a good or service and the
quantity demanded, ceteris paribus.
Market demand is the relationship
between the price of a good or service
and the quantity demanded by all buyers
in the market, ceteris paribus.
Demand Schedules
for Video Rentals
quantity demanded
(per month)
price Kim Derrek Van- total
essa
$10 1
0
2
3
$8
2
0
4
6
$6
3
1
6
10
$4
4
2
8
14
$2
5
3
10
18
price
14
12
10
8
a
b
c
m
n
q
e
6
4
2
s
r
D
dD
2
dk
4
6
dv
8
10 12 14 16
quantity
The market demand curve is obtained
by horizontally summing the demand
curves for all buyers in the market.
Implication: An increase in the number of
buyers will result in an increase in
market demand, ceteris paribus.
Changes in Quantity Demanded
Price of
Cigarettes
per Pack
$4.00
The price of cigarettes
increases.
C
A
2.00
D1
0
12
20
Number of Cigarettes
Smoked per Day
Change in Quantity Demanded
Movement along the demand curve.
Caused by a change in the price of
the product.
Demand is the relationship between the
quantity demanded and the good’s own
price, ceteris paribus.
Other factors being held constant:
Income.
Prices of related goods.
Tastes and and preferences.
Expectations and other special influences.
A change in demand is a change in the
relationship between the quantity
demanded and price.
A shift in the demand curve, either to the
left or right.
Caused by a change in a
determinant other than the price.
Example of a Decrease in Demand
Vanessa’s
demand schedules
for video rentals
quantity demanded
(per month)
price case A case B
price
14
12
10
$10
2
0
8
$8
4
1
6
$6
6
2
$4
8
3
$2
10
4
4
2
d*v
2
4
dv
6
8
10 12 14
quantity
Changes in Demand
Price of
Ice-Cream
Cone
Increase in
demand
Decrease in
demand
D2
0
D3
D1
Quantity of
Ice-Cream
Cones
Consumer Income
As income increases the demand for
a normal good will increase.
As income increases the demand for
an inferior good will decrease.
Consumer Income
Price of
Ice-Cream
Cone
Normal Good
$3.00
An increase
in income...
2.50
Increase
in demand
2.00
1.50
1.00
0.50
D1
0 1
2 3 4 5 6 7 8 9 10 11 12
D2
Quantity of
Ice-Cream
Cones
Consumer Income
Price of
Ice-Cream
Cone
Inferior Good
$3.00
An increase
in income...
2.50
2.00
Decrease
in demand
1.50
1.00
0.50
D2
0 1
D1
2 3 4 5 6 7 8 9 10 11 12
Quantity of
Ice-Cream
Cones
Prices of Related Goods
Substitutes & Complements
When a fall in the price of one good
reduces the demand for another good,
the two goods are called substitutes.
When a fall in the price of one good
increases the demand for another good,
the two goods are called complements.
Show graphically and explain what
will happen to the demand for gasoline
when:
The price of air travel increases.
Automobile prices fall.
Incomes rise.
Highway tolls rise.
The price of gasoline rises.
Quantity supplied is the quantity of a
good a seller is (sellers are) willing and
able to make available in the market over
a given period of time.
Quantity supplied refers to a particular number
of units.
The quantity supplied will depend upon:
the good’s own price
prices of inputs used in producing the good
technology
prices of other goods the seller could supply
expectations and other factors
Supply is the relationship between the
price of a good or service and the
quantity supplied, ceteris paribus.
The law of supply states that there is a
direct (positive) relationship between
price and quantity supplied.
Price of
Ice-Cream
Cone
$3.00
2.50
2.00
1.50
1.00
Supply Curve
Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
Quantity
0
0
1
2
3
4
5
0.50
0
1 2 3 4 5 6 7 8 9 10 11 12
Quantity of
Ice-Cream
Cones
Market Supply
Market supply refers to the sum of all
individual supplies for all sellers in a
market for a particular good or service.
Graphically, individual supply curves
are summed horizontally to obtain the
market supply curve.
Change in Quantity Supplied
Price of
Ice-Cream
Cone
S
C
$3.00
The price
increases from
$1.00 to $3.00
A
1.00
0
1
5
Quantity of
Ice-Cream
Cones
Change in Quantity Supplied
Movement along the supply curve.
Caused by a change in the market price of the
product.
Change in Supply
S3
Price of
Ice-Cream
Cone
S1
S2
Decrease in
Supply
Increase in
Supply
0
Quantity of
Ice-Cream
Cones
Change in Supply
A shift in the supply curve, either to the left or
right.
Caused by a change in a determinant other
than price.
Factors that can cause a
change in supply:
Changes in input prices.
Changes in technology.
Changes in prices of other goods that the seller
could supply.
Changes in expectation and other factors.
How would the supply of personal
computers be affected by:
A decline in the prices of a computer
component.
A faster method for assembling computers is
developed.
Dell Corporation goes out of business.
The price of personal computers declines.
Equilibrium
Equilibrium is the state of balance between
opposing forces.
In equilibrium, the system is in a state of rest
in that there is no tendency for change.
In economics, there is an equilibrium when
economic forces are in balance so that
economic variables have no tendency to
change.
Excess Demand
Price of
Ice-Cream
Cone
Supply
$1.50
Shortage
0
1
2
3
4
5 6
7
Demand
8 9 10 11 12 13
Quantity of
Ice-Cream Cones
There is a shortage (excess demand)
when the quantity demanded exceeds
the quantity supplied.
A shortage will result in upward
pressure on price.
Excess Supply
Price of
Ice-Cream
Cone
Surplus
$3.00
Supply
2.50
2.00
1.50
1.00
Demand
0.50
0
1 2 3 4 5 6 7 8 9 10 11 12
Quantity of
Ice-Cream
Cones
There is a surplus (excess supply)
when the quantity demanded is less
than the quantity supplied.
A surplus will result in downward
pressure on price.
Equilibrium of
Supply and Demand
Price of
Ice-Cream
Cone
Supply
$3.00
Equilibrium
2.50
2.00
1.50
1.00
Demand
0.50
0
1 2 3 4 5 6 7 8 9 10 11 12
Quantity of
Ice-Cream
Cones
A market equilibrium exists when the
price of a good is such that the quantity
demanded equals the quantity supplied.
In equilibrium, the price and number
of units traded will have no tendency
to change.
Market Equilibrium
P
Supply
P
e
Demand
Qe
Factors affecting demand:
income
prices of related goods
tastes
expectations
Q
Factors affecting supply:
input prices
technology
prices of other goods that could be produced
expectations
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
How an Increase in Demand Affects
the Equilibrium
Price of
Ice-Cream
Cone
Supply
$2.50
New equilibrium
2.00
Initial
equilibrium
D2
D1
0
7
10
Quantity of
Ice-Cream Cones
A. An increase in demand, ceteris paribus, will result in increases in
both the equilibrium price and the equilibrium quantity.
P
Effect of an increase in demand
with supply unchanged
demand Supply net
equil.
effect effect effect
quantity
up
-up
price
up
-up
D1
D2
S
P2
P1
Q1 Q2 Q 3
Q
P
Effect of an decrease in demand
with supply unchanged
demand Supply net
equil.
effect effect effect
quantity down
-down
price
down
-down
D1
S
P1
P4
Q5 Q4 Q1
D5
Q
C. An increase in supply, ceteris paribus, will result in a reduction
in the equilibrium price and an increase in the equilibrium quantity.
P
Effect of an increase in supply
with demand unchanged
demand supply net
equil.
effect effect effect
quantity
-up
up
price
-down down
D
Sa
Sb
P1
P2
Q1 Q2
Q
P
D1
D2
S1
S2
P2
P1
Effect of an increase in demand
together with an increase in supply
Q1
equil.
quantity
price
demand
effect
up
up
supply
effect
up
down
net
effect
up
?
P
D1
Q3
Q
D2
S1
S2
P1
P2
Q1
Q3
Q