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Chapter 2: Economic Systems & Resource Allocation

Chapter 2: Economic Systems & Resource Allocation. Basic Economic Questions. W hat to Produce (guns vs. butter) H ow to Produce (labor-intensive vs. capital-intensive technology) F or Whom to Produce (rich vs. poor). Economic Systems. Tradition & Custom Economy Command & Control Economy

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Chapter 2: Economic Systems & Resource Allocation

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  1. Chapter 2: Economic Systems & Resource Allocation

  2. Basic Economic Questions • What to Produce (guns vs. butter) • How to Produce (labor-intensive vs. capital-intensive technology) • For Whom to Produce (rich vs. poor)

  3. Economic Systems • Tradition & Custom Economy • Command & Control Economy • Central Planning • Market Economy • Pure vs. Mixed • Competitive vs. Non-competitive

  4. Market System • Network of buyers & sellers who transact in the market • Buyers “demand” goods & services • Sellers “supply” goods & services

  5. Advantage of Market Economy • Free interactions between buyers & sellers • Full information to make decisions • Free to choose between alternatives

  6. Demand • Definition: quantities of a good or service consumers are able to buy at various prices • Law of Demand: price and quantity are negatively related • Movement along demand is caused by a price change

  7. Demand Schedule Demand for Pepsi

  8. Demand Line Price D A 2.00 B 1.50 D Quantity 1000 1500

  9. Shift in Demand • Shift in demand is caused by a change in • Consumer income & tastes • Consumer expectations (price, income) • Number of consumers • Price of related goods (substitute, complementary)

  10. Increase in Demand D’ Price D A C 2.00 B D’ D Quantity 1500 2000

  11. Supply • Definition: quantities of a good or service producers are able to sell at various prices • Law of Supply: price and quantity supplied are positively related • Movement along supply is caused by a price change

  12. Supply for Pepsi Supply Schedule

  13. Supply Line Price S 2.00 B 1.50 A S 500 1000 Quantity

  14. Shift in Supply • Shift in supply is caused by an change in • production cost & technology • number of firms • price of related goods • price expectations

  15. Increase in Supply Price S B S’ A 1.50 C S S’ 500 1000 Quantity

  16. Equilibrium • A condition at which the independent plans of buyers and sellers exactly coincide in the marketplace. • At equilibrium: Demand = Supply to determine equilibrium price & quantity

  17. Market Equilibrium Equilibrium in Pepsi Market

  18. Demand-Supply Interaction D Price Surplus S 2.50 Equilibrium 2.00 B 1.50 Shortage S D Quantity 500 1000 1500

  19. Stability • Shortage: at a price below equilibrium quantity demanded > quantity supplied • Surplus: at a price above equilibrium quantity supplied > quantity demanded • Price adjustments eliminate shortages & surpluses

  20. Increase in Demand: Price D’ D S Higher Price Larger Quantity B P’ A P D’ D S Quantity Q Q’

  21. Increase in Supply: Price D S S’ A P Lower Price Larger Quantity B P’ S D S’ Q’ Quantity Q

  22. Increase in Demand & Supply: Price D’ D S S’ P’ B Here: Higher Price Larger Quantity A P D’ S D S’ Quantity Q Q’

  23. Market: Command Economy D’ Price S D Shortage=AC if price is fixed B P’ C P A D’ D Quantity Q Q’

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