1) With which group are Adam Smith’s ideas most in agreement: the mercantilists or the physiocrats?
2) What is another term for Smith’s invisible hand? How does it operate in a nation’s economy? How can you project these ideas on to what is going on in our country today? What system do you support and why? What are the +’s and -‘s of Government control.
5. A market economy is one that relies upon buyers and producers to determine production, consumption, investment and savings.
* Provide three examples of new products that have come on the market in your country because of consumer demand. As these products have been on the market, have they become more expensive or less expensive?
* Provide three products or services that have gone off the market or become difficult to obtain in your country because of declining demand.
6. Look through the text “Supply and Demand Revisited” and do the following tasks:
1) Answer the following questions: What product is used to demonstrate the principle of supply and demand? What is the specific market that is discussed?
2) Write a definition for the following terms and suggest Russian equivalents for: diminishing marginal utility; marginal costs of production; equilibrium price and quantity; excess supply; demand schedule; supply schedule; the market price.
3) In the final sentence of the article, the author says that the equilibrium of price and quantity will remain the same forever “unless something else changes.” Identify what specific changes might alter the equilibrium.
4) If you were to rewrite this article for our country, what product and what market would be more appropriate for you to use to demonstrate supply and demand?
7. Organizing our thoughts and testing our ideas. Pair up and discuss possible answers to the questions below and report back to the whole group on the ideas exchanged by you.
1) What affects the demand for goods and services in a market economy?
2) What affects the supply of a particular good or service?
3) How do demand and supply interact to determine prices?
4) How do profits, economic self-interest and other incentives keep a market economy growing? Give specific examples.
Supply and Demand Revisited
As we have already learned from the textbook, we can represent the decisions of buyers with the demand curve and the decisions of sellers with the supply curve.
The Demand Curve. This curve shows the relationship between the price of a good or service and the quantity consumers will buy, at a specific time, and holding everything else constant. Demand curves usually slope downward from left to right. This means that consumers are more willing and able to buy larger quantities of goods and services at relatively lower prices. This can be explained by the principles of diminishing marginal utility. After consuming a certain amount people get less and less satisfaction from each additional purchase. For example, the first ice cream cone consumed at the baseball game is great; the second is good; the third one is fair; the fourth one was “too much”; and the fifth one made you sick. Clearly we would not choose to pay as much to feel sick (the fifth cone) as we would pay to feel great (the first cone).
Believe it or not, at some point the principle of diminishing marginal utility applies to almost everything we consume. As I buy more clothes I get better wear from the clothes I own, my wardrobe becomes more flexible, and my ”satisfaction” or “utility” may increase. But sooner or later, the utility of having additional clothes will diminish. For example, you don’t get your money’s worth because you seldom wear certain outfits. Because of diminishing marginal utility, the demand curve for a commodity will show that more will be demanded only at lower prices.
T
he
Supply Curve. The
supply curve shows the relationship between the price of a good or
service and how much sellers will offer for sale at a specified time
and holding
everything else constant.
In general, supply
curves slope upward from left to right. This means that at
relatively high prices, businesses will naturally want to
produce and sell more. At lower prices less will be produced and
supplied. For example, suppose we are making ice cream in our
kitchen to sell at Friday’s baseball game. With the available
kitchen equipment we are able to store ingredients used (the cream,
etc.) and freeze 20 gallons of finished ice cream. But we want to
produce more. In order to do so we have to find additional
storage space. We could buy dry ice and pack the ice cream and the
ice in a big metal tub purchased from the hardware store. This would
allow us to
increase production to, say, 40 gallons. But the
last 20 gallons now cost more to produce
than the first 20 gallons did because we had to buy the ice and the
tub in addition to the cream. Because it costs more to increase
production, if we
hold everything else constant
(such
as the size of the refrigerator), economists say that the marginal
cost of
production will tend to increase after some point.
(5) It is easy to see why the supply curve slopes upward. You produce ice cream to make a profit from sales. Since it costs more per unit to produce more than 20 gallons, you will find it profitable to produce the additional 20 gallons only if the selling price goes up. Thus, supply increases only as price increases.
Equilibrium Price and Quantity. Now we see that buyers and sellers are in conflict: Buyers will only purchase more at lower prices, while sellers will only sell more at higher prices. Can they reach an agreement?
Yes. Their agreement is called the equilibrium price and quantity. It is that price-and-quantity combination of the good in question at which there is no tendency to change unless something else changes. In the example above, it is the price of ice cream produced and sold, from which there is no tendency to change unless something else changes.
Is any and every price we see an equilibrium price? No. The difference between equilibrium and nonequilibrium prices is that equilibrium prices will remain unchanged as long as nothing else changes, while nonequilibrium prices will change even when nothing else changes.
The graph shows how much ice cream you will supply and demand at each price. Is US$.75 per ice cream cone an equilibrium price? According to the supply curve, at US$.75 you would produce and supply 40 gallons of ice cream and still make a profit. Even though the cost per cone is higher when we produce 40 gallons, US$.75 is even higher. You will not be able to sell all 40 gallons, however, because the baseball crowd will buy only 10 gallons, leaving an excess quantity supplied of 30 gallons.
To get consumers to buy some of this excess supply from you, you must reduce the price. When you lower the price, more people will want to buy ice cream from you. Nevertheless, you will probably decide to produce fewer gallons next week to avoid increasing your marginal costs of production. (Look at how the quantity offered for sale changes as price declines. What is the connection with increasing marginal cost? Hint: Everything is working in reverse here.) Seventy-five cents is a nonequilibrium price because there is excess supply, which produces a tendency to change price and quantity even though nothing else has changed.
Suppose you go back to the game next week and try to sell ice cream at US$.25 a cone. Is US$.25 an equilibrium price? Well, at US$.25 you can only produce 10 gallons of ice cream and make a profit (again, because of the increasing margin al cost of producing more). But, as shown by the demand curve, the baseball crowd will want to buy 40 gallons at a price of US$.25. The result is an excess quantity demanded of 30 gallons. There will be some people who will want to buy at that price but who will be unable to because you will run out of ice cream. You now know that next week you can sell more than 10 gallons and at a price higher than US$.25. Thus, US$.25 is not an equilibrium price.
What is the equilibrium price and quantity that will not change unless something else changes? We know the equilibrium price is greater than US$.25 and less that US $.75, and we know the equilibrium quantity is greater than 10 gallons and less than 40 gallons. We also know that price declines when there is excess supply and rises when there is excess demand, even when nothing else changes. So the equilibrium price and quantity must be at that point at which there is no excess supply or demand. It is where supply equals demand. This occurs at a price of US$.50. At that price you will profitably supply 25 gallons, and the crowd will demand 25 gallons. There is no excess. You sell all you want to sell; the crowd buys all it wants to buy; and there is no tendency for either price or quantity to change. Next week and forever you will come to the stadium and sell 25 gallons of ice cream for US$.50 a cone—that is, unless something else changes.