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THE PRICE SYSTEM

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. Demand

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THE PRICE SYSTEM

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  1. 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.

  2. 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. Components of the Price System

  3. 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.

  4. 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.

  5. 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 The Laws of Demand and Supply

  6. 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 Qe 0 Q

  7. 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.

  8. 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. Market Disequilibrium

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