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Economics 14

Lecture 4: Supply and Demand, Part 1

the three basic economic questions
markets and prices
demand
supply

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The Three Basic Economic Questions

All societies must deal with scarcity and, therefore, must have some way of answering 3 basic
economic questions:

1. What goods and services are produced and in what quantities?

2. How are they produced?
3. Who gets the goods and services that are produced?

There are two extreme systems for answering these questions. In a communist economy, the
government decides all the answers. In a capitalist economy, the questions get answered through
the interaction of buyers and sellers in the market.

communist economy:

 government ownership of resources

 government allocation of resources and the goods and services produced

capitalist economy:

 private ownership of resources

  use of markets to allocate resources and the goods and services produced

Most actual economies contain a mix of private and government decisionmaking.

Markets and Prices

A market is a place or service that enables buyers and sellers to exchange goods and services.

3 functions of price:

1. provides incentives
2. means of rationing scarce supplies
3. signaling mechanism

Demand

Demand is the amount people are willing to purchase at each possible price. The amount of the
product people are willing to purchase at a specific price is called quantity demanded.

A demand schedule is a list of the quantity demanded at different prices. When constructing a
demand schedule, everything else that might affect demand is held constant. Consider the
following demand schedule for pizza:

Price Quantity Demanded

($/slice) (number of slices)

$5 2
4 5
3 8
2 12
1 17

The demand curve is a graph of the demand schedule.

Supply

Supply is the amount producers are willing to offer for sale at each possible price. The amount
sellers are willing to offer at a particular price is called quantity supplied. The supply schedule
for pizza would be constructed by adding up the quantities that each producer offers for sale at
each price, holding constant everything else that affects the supply of pizza.

Price Quantity Supplied

($/slice) (number of slices)

$5 18
4 15
3 8
2 2
1 1

The supply curve is a graph of the supply schedule.