Transcript THE PRICE SYSTEM

THE PRICE SYSTEM
A major discovery of 18th century
economists was that the price
system is a social control
mechanism--a mechanism that
coordinates individual and
decentralized decisions.
Components of the Price System

Demand
Demand refers to the
various quantities per
unit of time that a
buyer (buyers) is
(are) willing and able
to buy at all
alternative prices,
other things being
equal.

Supply
Supply refers to the
various quantities per
unit of time that a firm
(firms) is (are) willing
to sell at all
alternative prices,
other things being
equal.
The Determinants of Demand
The price of the product;
 Consumer income;
 Consumer tastes and preferences;
 Prices of related goods--substitute goods or
complementary goods.
 Consumer expectations about future prices.

The Determinants of Supply
The price of the product;
 The costs of the inputs used to produce the
product;
 The state of technology;
 The number of producers;
 Producers expectations about future prices;
 Taxes or subsidies from the government.

The Laws of Demand and Supply

The Law of
Demand:
The higher (lower)
the price, the smaller
(larger) the quantity
demanded, ceteris
paribus.
QD = QD(P)
QD = a - bP

The Law of
Supply:
The higher (lower) the
price, the larger
(smaller) the quantity
supplied, ceteris
paribus.
QS = QS(P)
QS = a’ + b’P
Market Equilibrium

Market equilibrium
is a situation in which
the quantity of a good
demanded equals the
quantity supplied, so
there is no pressure to
change the price.
P
S
Pe
D
0
Qe
Q
Market Disequilibrium
Market disequilibrium is a situation in
which the quantity of a good demanded
does not equal the quantity supplied, so
there is pressure to change the price.
Market Disequilibrium

Excess Demand
A situation in which,
at the prevailing price,
consumers are willing
to buy more than
producers are willing
to sell. Excess
demand is sometimes
called a shortage.

Excess Supply
A situation in which,
at the prevailing price,
producers are willing
to sell more than
consumers are willing
to buy. Excess
supply is sometimes
called a surplus.