heo a cold snap hits Florida, the price o.f orange juice rises
W in supermarkets throughout the country. When the weather
'turns warm in New England every summer, the price of
hotel rooms in the Caribbean plummets. When a war breaks out
in the Middle East, the price of gasoline in the United States rises
and the price of a used Cadillac falls. What do these events have in
common? They all show the workings of supply and demand.
Supply and demand are the two words economists use most often-
and for good reason. Supply and demand are the forces that make The Market
market economies work. They determine the quantity of each good
produced and the price at which it is sold. If you want to know how
any event or policy will affect the economy, you must think first about
Forces of
how it will affect supply and demand.
' · .chapter introduces the theory of supply and demand. It con-
" w buyers an,d sellers behave and how they interact. It shows
Supply and
how sttBP)y and demand determine prices in a market economy
and ho\.V7'$ices, in turn, allocate the economy's scarce resources. D·emand
,62 PART II HOW MARKETS WORK
4-1 Markets and Competition
The terms supply and demand refer to the behavior of people as they interact with
one another in competitive markets. Before discussing how buyers and sellers
behave, let's first consider more fully what we mean by the terms market and
competition.
4-la What Is a Market?
market A market is a group of buyers and sellers of a particular good or service. The buyers
a group of buyers and as a group determine the demand for the product, and the sellers as a group deter-
sellers of a particular mine the supply of the product.
good or service Markets take many forms. Some markets are highly organized, such as the mar-
kets for agricultural commodities like wheat and com. In these markets, buyers and
sellers meet at a specific time and place. Buyers come knowing how much they are
willing to buy at various prices, and sellers come knowing how much they are will-
ing to sell at various prices. An auctioneer facilitates the process by keeping order,
arranging sales, and (most importantly) finding the price that brings the actions of
buyers and sellers into balance.
More often, markets are less organized. For example, consider the market for
ice cream in a particular town. Buyers of ice cream do not meet together at any
one time or at any one place. The sellers of ice cream are in different locations and
offer somewhat different products. There is no auctioneer calling out the price of
ice cream. Each seller posts a price for an ice-cream cone, and each buyer decides
how many cones to buy at each store. Nonetheless, these consumers and produc-
ers of ice cream are closely connected. The ice-cream buyers are choosing from the
various ice-cream sellers to satisfy their cravings, and the ice-cream sellers are all
trying to appeal to the same ice-cream buyers to make their businesses successful.
Even though it is not as organized, the group of ice-cream buyers and ice-cream
sellers forms a market.
4-lb What Is Competition?
The market for ice cream, like most markets in the economy, is highly competitive.
Each buyer knows that there are several sellers from which to choose, and each
seller is aware that his product is similar to that offered by other sellers. As a result,
the price and quantity of ice cream sold are not determined by any single buyer or
seller. Rather, price and quantity are determined by all buyers and sellers as they
interact in the marketplace.
competitive market Economists use the term competitive market to describe a market in which there
a market in which there are so many buyers and so many sellers that each has a negligible impact on the
are many buyers and market price. Each seller of ice cream has limited control over the price because
many sellers so that each other sellers are offering similar products. A seller has little reason to charge less
has a negligible impact than the going price, and if he charges more, buyers will make their purchases else-
on the market price where. Similarly, no single buyer of ice cream can influence the price of ice cream
because each buyer purchases only a small amount.
In this chapter, we assume that markets are perfectly competitive. To reach this high-
est form of competition, a market must have two characteristics: (1) The goods offered
for sale are all exactly the same, and (2) the buyers and sellers are so numerous that
no single buyer or seller has any influence over the market price. Because buyers and
sellers in perfectly competitive markets must accept the price the market determines,
they are said to be price takers. At the market price, buyers can buy all they want, and
sellers can sell all they want.
, CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 6.3
There are some markets in which the assumption of perfect competition applies
perfectly. In the wheat market, for example, there are thousands of farmers who
sell wheat and millions of consumers who use wheat and wheat products. Because
no single buyer or seller can influence the price of wheat, each takes the market
price as given.
Not all goods and services, however, are sold in perfectly competitive markets.
Some markets have only one seller, and this seller sets the price. Such a market
is called a monopoly. Local cable television, for instance, is a monopoly if residents
of the town have only one company from which to buy cable service. Many other
markets fall between the extremes of perfect competition and monopoly.
Despite the diversity of market types we find in the world, assuming perfect com-
petition is a useful simplification and a natural place to start. Perfectly competitive
markets are the easiest to analyze because everyone participating in them takes the
price as given by market conditions. Moreover, because some degree of competition
is present in most markets, many of the lessons that we learn by studying supply and
demand under perfect competition apply to more complex markets as well.
1. The best definition of a market is c. every seller tries to undercut the prices charged
a. a store that offers a variety of goods and services. by its rivals.
b. a place where buyers meet and an auctioneer d. one seller has successfully outcompeted its rivals
calls out prices. so no other sellers remain.
c. a group of buyers and sellers of a good or service. 3. The market for which product best fits the definition
d. a venue where the sole supplier of a good offers of a perfectly competitive market?
its product. a. eggs
2. In a perfectly competitive market, b. tap water
a. every seller tries to distinguish itself by offering a c. movies
better product than its rivals. d. computer operating systems
b. every seller takes the price of its product as set
by market conditions.
Answers at end of chapter.
4-2 Demand
We begin our study of markets by examining the behavior of buyers. To focus our
thinking, let's keep in mind a particular good-ice cream.
4-2a The Demand Curve: The Relationship between
Price and Quantity Demanded quantity demanded
The quantity demanded of any good is the amount of the good that buyers are the amount of a good that
willing and able to purchase. As we will see, many things determine the quantity buyers are willing and
demanded of a good, but in our analysis of how markets work, one determinant able to purchase
plays a central role: the goad's price. If the price of ice cream rose to $20 per scoop,
you would buy less ice cream. You might buy frozen yogurt instead. If the price of law of demand
ice cream fell to $0.50 per scoop, you would buy more. This relationship between the claim that, other
price and quantity demanded is true for most goods in the economy and, in fact, is things being equal, the
so pervasive that economists call it the law of demand: Other things being equal, quantity demanded of a
when the price of a good rises, the quantity demanded of the good falls, and when good falls when the price
the price falls, the quantity demanded rises. of the good rises
W in supermarkets throughout the country. When the weather
'turns warm in New England every summer, the price of
hotel rooms in the Caribbean plummets. When a war breaks out
in the Middle East, the price of gasoline in the United States rises
and the price of a used Cadillac falls. What do these events have in
common? They all show the workings of supply and demand.
Supply and demand are the two words economists use most often-
and for good reason. Supply and demand are the forces that make The Market
market economies work. They determine the quantity of each good
produced and the price at which it is sold. If you want to know how
any event or policy will affect the economy, you must think first about
Forces of
how it will affect supply and demand.
' · .chapter introduces the theory of supply and demand. It con-
" w buyers an,d sellers behave and how they interact. It shows
Supply and
how sttBP)y and demand determine prices in a market economy
and ho\.V7'$ices, in turn, allocate the economy's scarce resources. D·emand
,62 PART II HOW MARKETS WORK
4-1 Markets and Competition
The terms supply and demand refer to the behavior of people as they interact with
one another in competitive markets. Before discussing how buyers and sellers
behave, let's first consider more fully what we mean by the terms market and
competition.
4-la What Is a Market?
market A market is a group of buyers and sellers of a particular good or service. The buyers
a group of buyers and as a group determine the demand for the product, and the sellers as a group deter-
sellers of a particular mine the supply of the product.
good or service Markets take many forms. Some markets are highly organized, such as the mar-
kets for agricultural commodities like wheat and com. In these markets, buyers and
sellers meet at a specific time and place. Buyers come knowing how much they are
willing to buy at various prices, and sellers come knowing how much they are will-
ing to sell at various prices. An auctioneer facilitates the process by keeping order,
arranging sales, and (most importantly) finding the price that brings the actions of
buyers and sellers into balance.
More often, markets are less organized. For example, consider the market for
ice cream in a particular town. Buyers of ice cream do not meet together at any
one time or at any one place. The sellers of ice cream are in different locations and
offer somewhat different products. There is no auctioneer calling out the price of
ice cream. Each seller posts a price for an ice-cream cone, and each buyer decides
how many cones to buy at each store. Nonetheless, these consumers and produc-
ers of ice cream are closely connected. The ice-cream buyers are choosing from the
various ice-cream sellers to satisfy their cravings, and the ice-cream sellers are all
trying to appeal to the same ice-cream buyers to make their businesses successful.
Even though it is not as organized, the group of ice-cream buyers and ice-cream
sellers forms a market.
4-lb What Is Competition?
The market for ice cream, like most markets in the economy, is highly competitive.
Each buyer knows that there are several sellers from which to choose, and each
seller is aware that his product is similar to that offered by other sellers. As a result,
the price and quantity of ice cream sold are not determined by any single buyer or
seller. Rather, price and quantity are determined by all buyers and sellers as they
interact in the marketplace.
competitive market Economists use the term competitive market to describe a market in which there
a market in which there are so many buyers and so many sellers that each has a negligible impact on the
are many buyers and market price. Each seller of ice cream has limited control over the price because
many sellers so that each other sellers are offering similar products. A seller has little reason to charge less
has a negligible impact than the going price, and if he charges more, buyers will make their purchases else-
on the market price where. Similarly, no single buyer of ice cream can influence the price of ice cream
because each buyer purchases only a small amount.
In this chapter, we assume that markets are perfectly competitive. To reach this high-
est form of competition, a market must have two characteristics: (1) The goods offered
for sale are all exactly the same, and (2) the buyers and sellers are so numerous that
no single buyer or seller has any influence over the market price. Because buyers and
sellers in perfectly competitive markets must accept the price the market determines,
they are said to be price takers. At the market price, buyers can buy all they want, and
sellers can sell all they want.
, CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 6.3
There are some markets in which the assumption of perfect competition applies
perfectly. In the wheat market, for example, there are thousands of farmers who
sell wheat and millions of consumers who use wheat and wheat products. Because
no single buyer or seller can influence the price of wheat, each takes the market
price as given.
Not all goods and services, however, are sold in perfectly competitive markets.
Some markets have only one seller, and this seller sets the price. Such a market
is called a monopoly. Local cable television, for instance, is a monopoly if residents
of the town have only one company from which to buy cable service. Many other
markets fall between the extremes of perfect competition and monopoly.
Despite the diversity of market types we find in the world, assuming perfect com-
petition is a useful simplification and a natural place to start. Perfectly competitive
markets are the easiest to analyze because everyone participating in them takes the
price as given by market conditions. Moreover, because some degree of competition
is present in most markets, many of the lessons that we learn by studying supply and
demand under perfect competition apply to more complex markets as well.
1. The best definition of a market is c. every seller tries to undercut the prices charged
a. a store that offers a variety of goods and services. by its rivals.
b. a place where buyers meet and an auctioneer d. one seller has successfully outcompeted its rivals
calls out prices. so no other sellers remain.
c. a group of buyers and sellers of a good or service. 3. The market for which product best fits the definition
d. a venue where the sole supplier of a good offers of a perfectly competitive market?
its product. a. eggs
2. In a perfectly competitive market, b. tap water
a. every seller tries to distinguish itself by offering a c. movies
better product than its rivals. d. computer operating systems
b. every seller takes the price of its product as set
by market conditions.
Answers at end of chapter.
4-2 Demand
We begin our study of markets by examining the behavior of buyers. To focus our
thinking, let's keep in mind a particular good-ice cream.
4-2a The Demand Curve: The Relationship between
Price and Quantity Demanded quantity demanded
The quantity demanded of any good is the amount of the good that buyers are the amount of a good that
willing and able to purchase. As we will see, many things determine the quantity buyers are willing and
demanded of a good, but in our analysis of how markets work, one determinant able to purchase
plays a central role: the goad's price. If the price of ice cream rose to $20 per scoop,
you would buy less ice cream. You might buy frozen yogurt instead. If the price of law of demand
ice cream fell to $0.50 per scoop, you would buy more. This relationship between the claim that, other
price and quantity demanded is true for most goods in the economy and, in fact, is things being equal, the
so pervasive that economists call it the law of demand: Other things being equal, quantity demanded of a
when the price of a good rises, the quantity demanded of the good falls, and when good falls when the price
the price falls, the quantity demanded rises. of the good rises
