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Chapter 3 suuply, demand & market price Overview

As you read this chapter, look for answers to the following questions:

• What roles do prices play in a market economy?

• What affects the demand for goods and services in a market economy?

• What affects the supply of a particular good or service?

• How do price, demand, and supply interact?

• How do shifts in demand and supply affect prices?

Do you ever buy CDs or tapes? How about T-shirts and jeans? If so, you have participated in markets for recorded music and clothing. To an economist, a market consists of all the people interested in buying or selling a particular good or service. You become part of the CD market as you shop in a music store. You also enter a market when you sell goods or ser­vices. If you are looking for work in a fast-food restaurant or clothing store, you are part of the labor market.

The interaction of buyers and sellers in markets drives a market economy. Prices, as you have learned, also play an important role in the U.S. market system. But why are prices so important in a market econo­my? And how are they determined?

3.1. Prices In a Market Economy

Have you ever attended an auction, or seen one on TV? An auction shows the rationing effect of prices. The person conducting the sale—the auctioneer— offers individual items for sale. Buyers "enter the market" by signaling their willingness to pay a par­ticular price. For example, many sports fans would happily pay $5 for an autographed pair of the shoes Michael Jordan wore during the 1992 Olympic Games. However, as the price rises to thousands of dollars, the number of interested buyers would prob­ably fall off dramatically. In this case, price has rationed, or allocated, the shoes to a wealthy or fanatical basketball fan.

Although you don't usually think of the stores where you shop as "auctions," the economic principles are similar. At high prices there are usually fewer buy­ers. People buy more hamburger than steak, and a music store will sell more CDs at $16.95 than at $24.95. Relatively few people who enjoy football can afford to pay for the tickets, airfare, meals and hotel room required for a trip to the Super Bowl. Prices, as you can see, often determine who eats steak, buys CDs, and attends the Super Bowl.

Price increases and decreases also send messages to suppliers of goods and services. Prices encourage producers to increase or decrease their output. As prices rise, the increase attracts additional produc­ers. Similarly, price decreases drive producers out of the market. For example, if farmers discovered that consumers were willing to pay higher prices for broc­coli, you could expect many of them to plant broccoli instead of carrots. On the other hand, declining prices for Bart Simpson T-shirts signal producers to print fewer Simpson shirts. Economists call this the production-motivating function of prices.

But what causes prices to rise and fall in a market economy?