Introduction to Markets - Supply and Demand

• Understand the Laws of Supply and Demand
• Know what effects the supply and demand curves - shift factors
• Understand the concept of equilibrium
• Be able to use supply and demand analysis to identify the effects of real-world situations on markets

Module Summary: Societies have developed many ways to allocate their scarce resources, from a single dictator determining who gets what to governments centrally planning and organizing production, to markets. Each method of resource allocation has its costs and benefits and the type of economic structure chosen must be carefully analyzed based upon these costs and benefits. We will discuss central planning and government intervention later in the course. This module is designed to explain the market as a rationing mechanism (since the market is the primary rationing mechanism for the U.S. economy)

The benefit of a market is that it is self-correcting. The market does not need some grand mastermind to adjust prices and output level in response to the changing wants and desires of society or to the changing availability of resources and technology. In contrast, the markets use peoples own self-interest to make price and allocation adjustments naturally. The benefit to this is that there is no one person or group in control of allocating scarce resources. In other words, markets decentralize power from a central decision making body to the will of the people.

How do markets accomplish this without some external control? Economists use the analogy of an invisible hand to describe how the market will set the price for a particular good or service and eventually allocate the resources to that market.

If a producer sets a price for his good that is too high, he will not be able to sell his products (quantity supplied greater than quantity demanded) at the current price. Eventually the existing surplus supplier will cause the supplier to lower the price of the good until they can sell all their goods. On the other hand, if a seller sets his price too low, he will sell out quickly and more customers will want the product, but the supplier will be sold out. Recognizing the fact he could probably sell out his inventory at higher prices, the existing shortage will eventually cause the seller to raise their price. As high prices are lowered toward the equilibrium price surpluses are eliminated. As low prices are raised, shortages are eliminated. This movement toward the equilibrium price and equilibrium output (quantity) is known as the invisible hand. Notice nobody told producers to raise or lower their price and no one told anybody to enter or leave the market. Everyone made these decisions independently and based on their own self-interest.

Section 1 - Vocabulary: Test your comprehension of key economic terms used throughout the course by completing the following sentence frames using the terms listed below.

Equilibrium Quantity Market Shift Factor
Equilibrium Price Quantity Demanded Shortage
Law of Demand Quantity Supplied Surplus
Law of Supply Price

1. The _____________________ states that as the price of a good increases, businesses will have incentives to increase the amount of a good supplied to the market.

2. A ___________________ occurs whenever the price of a good or service is above the equilibrium price.

3. Anything that moves the demand curve right or left is called a _____________________ of demand.

4. The price the market sets when quantity supplied is equal to quantity demanded is called the ______________________.

5, The market is the force which sets price and allocates resources. The amount of a good or service produced as a result of market equilibrium is called the ____________________________.

6. The _____________________ is the amount of a good willing to be produced and brought to the market at any given price.

7. The fact that consumers will be willing to purchase less of a product as the price of the product increases is known as the _____________________________.

8. The amount of a good or service willing and able to be consumed at any given price is called the _________________________.

9. A situation where quantity demanded is greater than quantity supplied is called a ______________.

10. A _______________________ economy is one where resources are allocated by the Law of Supply and the Law of Demand.

11. __________________ serve as the marginal cost to consumers when deciding to buy a product.

Section 2: Short Answer Questions: Test your understanding of markets by answering each of the prompts. Please use complete sentences and try to use economic terms where possible.

1. As a consumer, your behavior is defined by the Law of Demand. Briefly define the law of demand and give an example of a situation where you have experienced the Law of Demand.

2. What creates shortages in markets? Explain how markets will naturally eliminate a shortage and return to equilibrium.

3. What creates a surplus in markets? Explain how markets will naturally eliminate any surplus and return to equilibrium.

Section 3 - Identifying Shift Factors: The market is a beautiful mechanism which will naturally adjust prices (P) and resource allocation (Q) given changes in our world. Economists call anything that will affect a market "shift factors" or "determinants". Below is a list of the shift factors of supply and demand. For each situation below, determine which shift factor the statement refers to.