© 2010 Pearson Addison-Wesley

CHAPTER 1
© 2010 Pearson Addison-Wesley

Markets and Prices
A market is any arrangement that enables buyers and

sellers to get information and do business with each other.
A competitive market is a market that has many buyers
and many sellers so no single buyer or seller can influence
the price.
The money price of a good is the amount of money
needed to buy it.
The relative price of a good—the ratio of its money price
to the money price of the next best alternative good—is its
opportunity cost.

Demand
If you demand something, then you
1. Want it,
2. Can afford it, and
3. Have made a definite plan to buy it.
Wants are the unlimited desires or wishes people have for
goods and services. Demand reflects a decision about
which wants to satisfy.
The quantity demanded of a good or service is the
amount that consumers plan to buy during a particular
time period, and at a particular price.

Demand
The Law of Demand
The law of demand states:
Other things remaining the same, the higher the price of a
good, the smaller is the quantity demanded; and
the lower the price of a good, the larger is the quantity
demanded.
The law of demand results from
 Substitution effect
 Income effect

Demand
Substitution effect
When the relative price (opportunity cost) of a good or
service rises, people seek substitutes for it, so the
quantity demanded of the good or service decreases.
Income effect
When the price of a good or service rises relative to
income, people cannot afford all the things they
previously bought, so the quantity demanded of the
good or service decreases.

Demand
Demand Curve and Demand Schedule

The term demand refers to the entire relationship between
the price of the good and quantity demanded of the good.
A demand curve shows the relationship between the
quantity demanded of a good and its price when all other
influences on consumers’ planned purchases remain the
same.

Demand
Figure 3.1 shows a

demand curve for energy
bars.
A rise in the price, other
things remaining the same,
brings a decrease in the
quantity demanded and a
movement along the
demand curve.

Demand
Willingness and
Ability to Pay
A demand curve is also a
willingness-and-ability-to-
pay curve.
The smaller the quantity
available, the higher is the
price that someone is
willing to pay for another
unit.
Willingness to pay
measures marginal benefit.
Demand
A Change in Demand
When some influence on buying plans other than the price
of the good changes, there is a change in demand for
that good.
The quantity of the good that people plan to buy changes
at each and every price, so there is a new demand curve.
When demand increases, the demand curve shifts
rightward.
When demand decreases, the demand curve shifts
leftward.

Demand
Six main factors that change demand are

 The prices of related goods
 Expected future prices
 Income
 Expected future income and credit
 Population
 Preferences

Demand
Prices of Related Goods

A substitute is a good that can be used in place of
another good.
A complement is a good that is used in conjunction with
another good.
When the price of substitute for an energy bar rises or
when the price of a complement of an energy bar falls, the
demand for energy bars increases.

Demand
Expected Future Prices
If the price of a good is expected to rise in the future,
current demand for the good increases and the demand
curve shifts rightward.
Income
When income increases, consumers buy more of most
goods and the demand curve shifts rightward.
A normal good is one for which demand increases as
income increases.
An inferior good is a good for which demand decreases
as income increases.
Demand
Expected Future Income and Credit

When income is expected to increase in the future or
when credit is easy to obtain, the demand might increase
now.
Population
The larger the population, the greater is the demand for all
goods.
Preferences
People with the same income have different demands if
they have different preferences.

Demand
Figure 3.2 shows an

increase in demand.
Because an energy bar
is a normal good, an
increase in income
increases the demand
for energy bars.

Demand
A Change in the Quantity

Demanded Versus a
Change in Demand
Figure 3.3 illustrates the
distinction between a
change in demand and a
change in the quantity
demanded.

Demand
A Movement along the

Demand Curve
When the price of the good
changes and everything
else remains the same, the
quantity demanded
changes and there is a
movement along the
demand curve.

Demand
A Shift of the Demand

Curve
If the price remains the
same but one of the other
influences on buyers’
plans changes, demand
changes and the demand
curve shifts.

Supply
If a firm supplies a good or service, then the firm
1. Has the resources and the technology to produce it,
2. Can profit from producing it, and
3. Has made a definite plan to produce and sell it.
Resources and technology determine what it is possible
to produce. Supply reflects a decision about which
technologically feasible items to produce.
The quantity supplied of a good or service is the amount
that producers plan to sell during a given time period at a
particular price.

Supply
The Law of Supply
The law of supply states:
Other things remaining the same, the higher the price of a
good, the greater is the quantity supplied; and
the lower the price of a good, the smaller is the quantity
supplied.
The law of supply results from the general tendency for the
marginal cost of producing a good or service to increase
as the quantity produced increases (Chapter 2, page 35).
Producers are willing to supply a good only if they can at
least cover their marginal cost of production.
Supply
Supply Curve and Supply Schedule

The term supply refers to the entire relationship between
the quantity supplied and the price of a good.
The supply curve shows the relationship between the
quantity supplied of a good and its price when all other
influences on producers’ planned sales remain the same.

Supply
Figure 3.4 shows a supply

curve of energy bars.
A rise in the price of an
energy bar, other things
remaining the same,
brings an increase in the
quantity supplied.

Supply
Minimum Supply Price
A supply curve is also a
minimum-supply-price
curve.
As the quantity produced
increases, marginal cost
increases.
The lowest price at which
someone is willing to sell
an additional unit rises.
This lowest price is
marginal cost.

Supply
A Change in Supply
When some influence on selling plans other than the price
of the good changes, there is a change in supply of that
good.
The quantity of the good that producers plan to sell
changes at each and every price, so there is a new supply
curve.
When supply increases, the supply curve shifts rightward.
When supply decreases, the supply curve shifts leftward.

Supply
The five main factors that change supply of a good are

 The prices of factors of production
 The prices of related goods produced
 Expected future prices
 The number of suppliers
 Technology
 State of nature

Supply
Prices of Factors of Production

If the price of a factor of production used to produce a
good rises, the minimum price that a supplier is willing to
accept for producing each quantity of that good rises.
So a rise in the price of a factor of production decreases
supply and shifts the supply curve leftward.

Supply
Prices of Related Goods Produced

A substitute in production for a good is another good that
can be produced using the same resources.
The supply of a good increases if the price of a substitute
in production falls.
Goods are complements in production if they must be
produced together.
The supply of a good increases if the price of a
complement in production rises.

Supply
Expected Future Prices

If the price of a good is expected to rise in the future,
supply of the good today decreases and the supply curve
shifts leftward.
The Number of Suppliers
The larger the number of suppliers of a good, the greater
is the supply of the good. An increase in the number of
suppliers shifts the supply curve rightward.

Supply
Technology
Advances in technology create new products and lower
the cost of producing existing products.
So advances in technology increase supply and shift the
supply curve rightward.
The State of Nature
The state of nature includes all the natural forces that
influence production—for example, the weather.
A natural disaster decreases supply and shifts the supply
curve leftward.

Supply
Figure 3.5 shows an

increase in supply.
An advance in the
technology for producing
energy bars increases the
supply of energy bars and
shifts the supply curve
rightward.

Supply
A Change in the Quantity

Supplied Versus a
Change in Supply
distinction between a
change in supply and a
change in the quantity
supplied.

Supply
A Movement Along the

Supply Curve
When the price of the good
changes and other
influences on sellers’ plans
remain the same, the
quantity supplied changes
and there is a movement
along the supply curve.

Supply
A Shift of the Supply

Curve
If the price remains the
same but some other
influence on sellers’ plans
changes, supply changes
and the supply curve
shifts.

Market Equilibrium
Equilibrium is a situation in which opposing forces balance

each other. Equilibrium in a market occurs when the price
balances the plans of buyers and sellers.
The equilibrium price is the price at which the quantity
demanded equals the quantity supplied.
The equilibrium quantity is the quantity bought and sold
at the equilibrium price.
 Price regulates buying and selling plans.
 Price adjusts when plans don’t match.

Market Equilibrium
Price as a Regulator
equilibrium price and
equilibrium quantity.
If the price is $2.00 a bar,
the quantity supplied
exceeds the quantity
demanded.
There is a surplus of
6 million energy bars.

Market Equilibrium
If the price is $1.00 a bar,

the quantity demanded
exceeds the quantity
supplied.
There is a shortage of
9 million energy bars.
If the price is $1.50 a bar, the

quantity demanded equals
the quantity supplied.
There is neither a shortage
nor a surplus of energy bars.

Market Equilibrium
Price Adjustments
At prices above the
equilibrium price, a surplus
forces the price down.
At prices below the
equilibrium price, a shortage
forces the price up.
At the equilibrium price,
buyers’ plans and sellers’
plans agree and the price
doesn’t change until some
event changes either
demand or supply.

Market Equilibrium
An Increase in Demand
Figure 3.8 shows that
when demand increases
the demand curve shifts
rightward.
At the original price, there
is now a shortage.
The price rises, and the
quantity supplied increases
along the supply curve.

Predicting Changes in Price and
Quantity
An Increase in Supply
Figure 3.9 shows that
when supply increases
the supply curve shifts
rightward.
At the original price, there
is now a surplus.
The price falls, and the
quantity demanded
increases along the
demand curve.

Quantity
All Possible Changes in
Demand and Supply
A change demand or
supply or both demand
and supply changes the
equilibrium price and the

Quantity
Change in Demand with
No Change in Supply
When demand increases,

equilibrium price rises and
the equilibrium quantity
increases.

Quantity
Change in Demand with

No Change in Supply
When demand decreases,

the equilibrium price falls
and the equilibrium
quantity decreases.

Quantity
Change in Supply with No

Change in Demand
When supply increases,

the equilibrium price falls
and the equilibrium
quantity increases.

Quantity
Change in Supply with

No Change in Demand
When supply decreases,

the equilibrium price rises
and the equilibrium
quantity decreases.

Quantity
Increase in Both Demand
and Supply
An increase in demand and

an increase in supply
increase the equilibrium
quantity.
The change in equilibrium

price is uncertain because the
increase in demand raises
the equilibrium price and the
increase in supply lowers it.
Quantity
Decrease in Both Demand
and Supply
A decrease in both demand

and supply decreases the

price is uncertain because
the decrease in demand
lowers the equilibrium price
and the decrease in supply
raises it.
Quantity
Decrease in Demand and
Increase in Supply
A decrease in demand and

an increase in supply lowers
the equilibrium price.

quantity is uncertain because
the decrease in demand
decreases the equilibrium
quantity and the increase in
supply increases it.
Quantity
Increase in Demand and
Decrease in Supply
An increase in demand and a

decrease in supply raises the
equilibrium price.

quantity is uncertain because
the increase in demand
increases the equilibrium
quantity and the decrease in
supply decreases it.
EXERCISE 1
What effect will each of the following have on the
demand for product B?
1. Product B becomes more fashionable.
2. The price of substitute product C falls.
3. A decline in incomes if B is an inferior product.
4. Consumers anticipate the price of B will be lower in
the near future.
5. The price of complementary product D falls.
6. Foreign tariff barriers on B are eliminated.

EXERCISE 2
What effect will each of the following have on the supply for
product B?
1. A technological advance in the methods of producing B.
2. A decline in the number of firms in industry B.
3. An increase in the price of resources required in the
production of B.
4. The expectation that the equilibrium price of B will be lower in
the future than it is currently.
5. A decline in the price of product A, a good whose production
requires substantially the same techniques as does the
production of B.
6. The levying of a specific sales tax upon B.
7. The granting of a 50-cent per unit subsidy of B produced.

How each of the following changes in demand and/or supply
affect equilibrium price and equilibrium quantity in a
competitive market; that is do price and quantity rise, fall,
remains unchanged, of are the answers indeterminate,
depending on the magnitudes of the shifts in supply and
demand.
1. Supply decreases and demand remains constant.
2. Demand decreases and supply remains constant.
3. Supply increases and demand is constant.
4. Demand increases and supply increases.
5. Demand increases and supply is constant.
6. Supply increases and demand decreases.
7. Demand increases and supply decreases.
8. Demand decreases and supply decreases.

Exercise 4
The table sets out the demand and supply schedules for chewing gum.
a. Draw a graph of the gum market

and mark in the equilibrium
price and quantity.
b. Suppose that chewing gum is
70 pence a packet. Describe the
situation in the gum market and
explain how the price of gum
adjusts.
Suppose that a ﬁre destroys some gum producing factories and the supply
of gum decreases by 40 million packs a week.
c. Has there been a shift of or a movement along the supply curve of gum?
d. Has there been a shift of or a movement along the demand curve for gum?
e. What are the new equilibrium price and equilibrium quantity of gum?

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CHAPTER 1