The Circular-Flow Diagram

Revenue Spending
Market for
Goods
Goods & Goods &
Services sold and Services
Services
bought

Firms
Households

Inputs for Labor, land,

production Market for and capital
Factors
Wages, rent, of Production Income
and profit
 Markets
 A market is a group of buyers and
sellers who interact to buy and sell a
particular good or service.
 Market Types:
Competitive and Otherwise
Perfect Competition
 Products are the same
 Numerous buyers and sellers so that each
has no influence over price
 Buyers and Sellers are price takers
 Market Types:
Competitive and Otherwise
 Monopoly
 One seller who controls price
 Oligopoly
 Few sellers
 Not always aggressive competition
 Monopolistic Competition
 Many sellers
 Slightly differentiated products
 Each seller may set price for its own product
 The Circular-Flow Diagram
Revenue Spending
Market for
Goods
Goods & Goods &
Services sold and Services
Services
bought

Firms
Households

Inputs for Labor, land,

production Market for and capital
Factors
Wages, rent, of Production Income
and profit
 The quantity demanded is the amount
of a good that a buyer is (buyers are)
willing and able to buy during a specified
period of time.

Quantity demanded refers to a particular

number of units.
 The quantity demanded by a consumer
will depend upon the following factors:

 The good’s own price.

 The consumer’s income.
 Prices of related goods.
 The consumer’s tastes and and preferences.
 Expectations and other special influences.
 price
Vanessa’s
demand schedules
for DVD rentals 14
quantity demanded
(per month) 12
price case A
10
$10 2
8
$8 4
6
$6 6
$4 8 4
$2 10 2
dv
2 4 6 8 10 12 14
quantity
Demand is the relationship between the
price of a good or service and the
quantity demanded, ceteris paribus.

Market demand is the relationship

between the price of a good or service
and the quantity demanded by all buyers
in the market, ceteris paribus.
 Demand Schedules price
for Video Rentals
quantity demanded
(per month) 14
price Kim Derrek Van- total
essa
12
$10 1 0 2 3 10
$8 2 0 4 6 a b c e
8
$6 3 1 6 10
$4 4 2 8 14 6
4 m n q r s
$2 5 3 10 18
D
2
dD dk dv
2 4 6 8 10 12 14 16
quantity
 The market demand curve is obtained
by horizontally summing the demand
curves for all buyers in the market.

Implication: An increase in the number of

buyers will result in an increase in
market demand, ceteris paribus.
 Changes in Quantity Demanded
Price of
Cigarettes
per Pack
The price of cigarettes
increases.
C
$4.00

2.00 A

D1
0 12 20 Number of Cigarettes
Smoked per Day
Change in Quantity Demanded
 Movement along the demand curve.
 Caused by a change in the price of
the product.
 Demand is the relationship between the
quantity demanded and the good’s own
price, ceteris paribus.

Other factors being held constant:

 Income.
 Prices of related goods.
 Tastes and and preferences.
 Expectations and other special influences.
A change in demand is a change in the
relationship between the quantity
demanded and price.

 A shift in the demand curve, either to the

left or right.
 Caused by a change in a
determinant other than the price.
 Example of a Decrease in Demand

price
Vanessa’s
demand schedules
for video rentals 14
quantity demanded 12
(per month)
price case A case B 10
$10 2 0 8
$8 4 1
6
$6 6 2
4
$4 8 3
$2 10 4 2
d*v dv
2 4 6 8 10 12 14
quantity
 Changes in Demand
Price of
Ice-Cream
Cone

Increase in
demand

Decrease in
demand

D2
D1
D3 Quantity of
0
Ice-Cream
Cones
 Consumer Income

 As income increases the demand for

a normal good will increase.
 As income increases the demand for
an inferior good will decrease.
 Consumer Income
Price of
Normal Good
Ice-Cream
Cone
$3.00 An increase
2.50 in income...
Increase
2.00 in demand

1.50

1.00

0.50
D2
D1 Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones
 Consumer Income
Price of
Inferior Good
Ice-Cream
Cone
$3.00

2.50 An increase
2.00
in income...
Decrease
1.50 in demand
1.00

0.50

D2 D1 Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones
 Prices of Related Goods
Substitutes & Complements
 When a fall in the price of one good
reduces the demand for another good,
the two goods are called substitutes.
 When a fall in the price of one good
increases the demand for another good,
the two goods are called complements.
 Show graphically and explain what
will happen to the demand for gasoline
when:

 The price of air travel increases.

 Automobile prices fall.
 Incomes rise.
 Highway tolls rise.
 The price of gasoline rises.
 Quantity supplied is the quantity of a
good a seller is (sellers are) willing and
able to make available in the market over
a given period of time.

Quantity supplied refers to a particular number

of units.
The quantity supplied will depend upon:
 the good’s own price
 prices of inputs used in producing the good
 technology
 prices of other goods the seller could supply
 expectations and other factors
 Supply is the relationship between the
price of a good or service and the
quantity supplied, ceteris paribus.

The law of supply states that there is a

direct (positive) relationship between
price and quantity supplied.
Price of Supply Curve
Ice-Cream
Cone
$3.00 Price Quantity
$0.00 0
2.50
0.50 0
2.00 1.00 1
1.50 2
1.50 2.00 3
2.50 4
1.00
3.00 5
0.50

Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones
 Market Supply
 Market supply refers to the sum of all
individual supplies for all sellers in a
market for a particular good or service.
 Graphically, individual supply curves
are summed horizontally to obtain the
market supply curve.
 Change in Quantity Supplied
Price of
Ice-Cream
Cone
S
C
$3.00 The price
increases from
$1.00 to $3.00

A
1.00

Quantity of
0 1 5 Ice-Cream
Cones
 Change in Quantity Supplied

Movement along the supply curve.

Caused by a change in the market price of the
product.
 Change in Supply
Price of S3
Ice-Cream
Cone
S1 S2
Decrease in
Supply

Increase in
Supply

Quantity of
0 Ice-Cream
Cones
 Change in Supply

A shift in the supply curve, either to the left or

right.
Caused by a change in a determinant other
than price.
 Factors that can cause a
change in supply:
 Changes in input prices.
 Changes in technology.
 Changes in prices of other goods that the seller
could supply.
 Changes in expectation and other factors.
 How would the supply of personal
computers be affected by:
 A decline in the prices of a computer component.
 A faster method for assembling computers is
developed.
 Dell Corporation goes out of business.
 The price of personal computers declines.
 Equilibrium
 Equilibrium is the state of balance between
opposing forces.
 In equilibrium, the system is in a state of rest
in that there is no tendency for change.
 In economics, there is an equilibrium when
economic forces are in balance so that
economic variables have no tendency to
change.
 Excess Demand
Price of
Ice-Cream
Cone

Supply

$1.50

Shortage Demand

0 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of
Ice-Cream Cones
 There is a shortage (excess demand)
when the quantity demanded exceeds
the quantity supplied.
 A shortage will result in upward
pressure on price.
Price of
Excess Supply
Ice-Cream
Cone
Supply
$3.00 Surplus

2.50

2.00

1.50

1.00

0.50 Demand
Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones
 There is a surplus (excess supply)
when the quantity demanded is less
than the quantity supplied.
 A surplus will result in downward
pressure on price.
 Equilibrium of
Price of Supply and Demand
Ice-Cream
Cone
Supply
$3.00

2.50 Equilibrium

2.00

1.50

1.00

0.50 Demand
Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones
 A market equilibrium exists when the
price of a good is such that the quantity
demanded equals the quantity supplied.
 In equilibrium, the price and number of
units traded will have no tendency to
change.
 Market Equilibrium
P
Supply

P
e

Demand
Qe Q

Factors affecting demand: Factors affecting supply:

income input prices
prices of related goods technology
tastes prices of other goods that could be produced
expectations expectations
 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

How an Increase in Demand Affects

the Equilibrium
Price of
Ice-Cream
Cone

Supply

$2.50 New equilibrium

2.00
Initial
equilibrium
D2

D1
0 7 10 Quantity of
Ice-Cream Cones
 A. An increase in demand, ceteris paribus, will result in increases in
both the equilibrium price and the equilibrium quantity.

P D2
D1 S
Effect of an increase in demand
P2
with supply unchanged
demand Supply net P1
equil. effect effect effect
quantity up -- up
price up -- up
Q1 Q2 Q 3 Q
 P
D1 S
Effect of an decrease in demand
with supply unchanged
demand Supply net P1
equil. effect effect effect P4
quantity down -- down
price down -- down D5
Q 5 Q4 Q1 Q
C. An increase in supply, ceteris paribus, will result in a reduction
in the equilibrium price and an increase in the equilibrium quantity.

P
D Sa Sb

P1

P2

Q1 Q2 Q
P D2
D1 S1
S2
P2
P1

Q1 Q3 Q

P D2
D1 S1

S2

P1
P2

Q1 Q3 Q