THE PRICE SYSTEM A major discovery of 18

THE PRICE SYSTEM A major discovery of 18 th 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 n 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 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; n Consumer income; n Consumer tastes and preferences; n Prices of related goods--substitute goods or complementary goods. n Consumer expectations about future prices. n

The Determinants of Supply The price of the product; n The costs of the inputs used to produce the product; n The state of technology; n The number of producers; n Producers expectations about future prices; n Taxes or subsidies from the government. n

The Laws of Demand Supply n The Law of Demand: The higher (lower) the price, the smaller (larger) the quantity demanded, ceteris paribus. QD = QD(P) QD = a - b. P n 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 n 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 n 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. n 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.