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Chapter 16: Introduction to Economics
Section 3 Objectives:
1.) Understand how demand and supply affect prices.
2.) Examine how prices help consumers and businesses make economic decisions.
Lesson 3: Demand and Supply in a Market Economy (Page 452)
I. Demand and Supply Make Markets
1. In a command economy, government officials set prices for most goods
a. They also decide what to manufacture
2. In an economy based on a market system (like the U.S.), prices are set by a
kind of interaction
3. This interaction is the effect that demand and supply have on each other
4. Supply and demand are caused by two groups:
a. Consumers – people that buy goods and services
b. Producers – people or businesses that provide goods and services
A. Demand and Supply
1. Demand – amount of a good or service that consumers are willing and able to
buy at various prices
2. Four parts to demand:
a. Amount: measures how much of a good or service consumers are
willing to buy
b. Willing to buy: consumers must be willing to buy a good or service or
there is no demand
c. Able to buy: consumers must have the ability to buy the good or service
d. Price: quantity that consumers are willing and able to buy is associated
with a particular price
3. Supply – amount of a good or service that producers are willing and able to sell
at various prices
4. As the price goes up, producers want to supply more; as the price does down
they tend to supply less
B. Markets and Competition
1. Quantity that is demanded or supplied at each price can be shown in a schedule,
which can be seen on a graph including the demand and supply curve (Page 453)
2. Demand line slopes down to the right because people will demand more when
the price is low and less when the price is high
3. Supply line slopes up to the right because producers will supply more when the
price is high and less when the price is low
4. The demand and supply curve show a market (place where buyers and sellers
of the same good or service come together)
a. Example: farmers market or the Internet
5. To be efficient, markets much have competition (efforts by different
businesses to sell the same good or service)
a. Too few sellers may keep prices too high
C. How Prices Are Set
1. Markets are vital to our economy because they allow us to choose how we
spend our money
2. Markets help with efficiency since they set prices and prevent the production of
too many, or too few goods and services
3. Markets set prices through the equilibrium price (price set for a good or
service in the marketplace, or the point where demand and supply are balanced)
4. Surplus – amount supplied by producers is greater than the amount demanded
by consumers
a. Surplus causes prices to fall (companies offer sales)
5. Shortage – occurs when the quantity demanded is greater than the quantity
a. Shortage will cause prices to rise
6. Spending your dollars is like voting for the products you want
D. Factors Affecting Demand
1. Number of consumers:
a. If more consumers enter the market, they buy more of the product,
causing the demand curve to shift right (consumers leaving the market
causes the curve to shift left)
2. Change in consumer income:
a. If people earn more money, they will buy more causing the demand to
go up and the demand curve to shift right (earning less money will
decrease the equilibrium price, causing the curve to shift left)
3. Change in consumer preferences:
a. This is the consumer’s like or dislike for a product
E. Factors Affecting Supply
1. Number of suppliers:
a. As the number of suppliers increases, the quantity of a good or service
increases, the more of the item is produced, causing the supply curve to
shift left
b. When there are few suppliers, price tends to up
2. Cost of production:
a. If the cost of producing a good or service goes up, producers supply
less, causing the supply curve to shift left
b. If producers find ways to make a good or service more cheaply, they are
willing to supply more of it (New technology usually drives down
production costs)
c. Lower costs lead to more supply, curve goes right
II. The Economic Role of Prices
1. In a market economy, prices drive the markets for goods and services
2. Consumers and producers use prices to help make economic decisions
A. Prices and the Economic Questions
1. In a market economy, prices help answer the three basic questions (What to
produce, how to produce, and for whom to produce)
2. Prices determine what to produce by influencing the decisions of producers
a. Consumer demand for a product is high, demand drives up the price and
businesses react by increasing production
b. If consumer demand is low, the price of the product falls and businesses
produce less of it
3. Price affects how goods and services are produced
a. Example: mass production of automobiles keeps the price where
consumers can still afford them
4. Prices decide for whom goods and services are produced
a. Products made for consumers who can and will buy them at a particular
B. Prices as Measures of Value
1. Every good or service in a market economy has a price, which sets the value of
the good or service
a. Imagine buying goods and services if there were not prices
C. Prices as Signals
1. Prices send signals to consumers and producers
2. If consumers think an item is priced too high, they will not buy it
3. If consumers cannot find a good or service at the low price they want to pay,
they must understand that no producer is willing to supply it to them at that price
D. Prices in a Command System
1. In a command economy, government officials answer the three basic economic
2. Government officials also set prices on most goods and services
a. Price is based on its idea of the relative value of goods and services
3. In some command economies, the works get paid the same wage
a. Gives everyone the same buying power, but does nothing to increase
Section 3 Note Check Questions:
1.) Explain the four (4) parts of the definition of demand.
Amount: how much consumers will buy
Willing to buy: if consumers are not willing to buy a good or service, there is no demand
Able to buy: if consumers do not have the money, they cannot buy the good or service
Price: affects how much consumers buy
2.) When a store has a sale, it cuts the prices on the goods it sells. Is that more likely to happen
when there is a surplus or when there is a shortage? Explain.
Surplus; because if there is not enough demand for the goods the store has at the current price, it
has to cut the price in order to increase demand
3.) What three (3) changes will cause demand to rise?
1. Increase in the number of consumers
2. Increase in consumers’ income
3. Increase in consumers’ likes (preference)
4.) What are three (3) functions of prices in a market economy?
1. Help answer the three basic economic questions
2. Measure the value of goods and services
3. Send signals to consumers and producers
5.) Are prices more changeable in a market economy or in a command economy? Why?
Market economy; because they are the result of the interaction of supply and demand, whereas in
a command economy they are fixed by the government