SUPPLY AND DEMAND

Household

• basic consumer unit in economy

• how to acquire and spend income

Firms

• basic unit of production

• conversion of inputs into different and more valuable outputs

• choosing correct combination of inputs and the correct level of output

Economic system - allocation and distribution of goods and services

• Government - public

• Market economy - private

Basis for Market System

• economic self interest

• exchange of goods and services for a set price

• exchange is voluntary - agreement on exchange

• consumer sovereignty dictates demand

• competition for allocation of goods and services

The Market System

• multiple markets - housing, automobiles, food, entertainment

• size of market - global, regional, local, neighborhood

• exchange is limited by supply and demand

• circular flow of inputs and outputs

Demand

The Law of Demand

• quantity demanded depends on price ceteris paribus

• negative relationship for most goods

• inferior goods - some goods (such as beans and rice) are purchased in smaller quantities when income rises above a certain level

Change in quantity demanded affected by price - movement along demand line

Change in demand - shift in demand line

• increase moves line right

• decrease moves line left

Supply

The Law of Supply

• quantity supplied depends on price ceteris paribus

• positive relationship

Change in quantity supplied affected by price - movement along supply line

Change in supply - shift in supply line

• increase moves line right

• decrease moves line left

The Law of Supply and Demand

equilibrium price

• price at which supply is equal to demand

• quantity sellers wish to sell is exactly equal to the quantity buyers wish to buy

• price above equilibrium--then less is sold; sellers try to reduce price

• price below equilibrium--then more is sold; buyers bid up the price

An economic approach to the cocaine problem

or

Why the "War on Drugs" is doomed to failure

• Government intervention to reduce supply, not demand - supply side economics

• Existing/expanding demand forces price up

• Demand is not dependent on price, because there is no substitute good (coffee and tea)

• Higher prices encourage more firms (smugglers) to enter the market

• the higher the price, the more firms willing to take risk

• higher prices provide increased profits as cost of production remains fairly constant