Download Chapter 1: Human Misery

Chapter 2:
Economic Systems &
Resource Allocation
Basic Economic Questions
What to Produce (guns vs. butter)
How to Produce (labor-intensive vs. capitalintensive technology)
For Whom to Produce (rich vs. poor)
Economic Systems
Tradition & Custom Economy
Command & Control Economy
– Central Planning
Market Economy
– Pure vs. Mixed
– Competitive vs. Non-competitive
Market System
Network of buyers & sellers who transact in the
market
Buyers “demand” goods & services
Sellers “supply” goods & services
Advantage of Market Economy
Free interactions between buyers & sellers
Full information to make decisions
Free to choose between alternatives
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
Demand Schedule
Demand for Pepsi
Price
Quantity Demanded
$1.50
1,500
$2.00
1,000
$2.50
500
Demand Line
Price
D
A
2.00
B
1.50
D
1000
1500
Quantity
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)
Increase in Demand
Price
D’
D
A
2.00
C
B
D’
D
1500
2000
Quantity
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
Supply Schedule
Supply for Pepsi
Price
Quantity Supplied
$1.50
500
$2.00
1,000
$2.50
1,500
Supply Line
Price
S
2.00
B
1.50
A
S
500
1000
Quantity
Shift in Supply
Shift in supply is caused by an change in
–
–
–
–
production cost & technology
number of firms
price of related goods
price expectations
Increase in Supply
Price
S
S’
B
A
1.50
C
S
S’
500
1000
Quantity
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
Market Equilibrium
Equilibrium in Pepsi Market
Price
Quantity Demanded
Quantity Supplied
$1.50
1,500
500
$2.00
1,000
1,000
$2.50
500
1,500
Demand-Supply Interaction
Price
2.50
D
Surplus
S
Equilibrium
2.00
B
1.50
Shortage
S
500
D
1000
1500
Quantity
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
Increase in Demand:
Price
D’
D
S
Higher Price
Larger Quantity
B
P’
P
A
D’
D
S
Q Q’
Quantity
Increase in Supply:
Price
D
S
S’
A
P
P’
B
S
Lower Price
Larger Quantity
D
S’
Q
Q’
Quantity
Increase in Demand & Supply:
Price
D’
D
S
S’
P’
B
Here:
Higher Price
Larger Quantity
A
P
D’
S
S’
Q
D
Q’ Quantity
Market: Command Economy
Price
D’
S
B
D
P’
P
Shortage=AC
if price is fixed
C
A
D’
D
Q
Q’
Quantity