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Introduction: Ten Principles of Economics

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 Welcome…Let’s Get To Know You ☺

Main references supporting the course:

• N. Gregory Mankiw: Principle of Economics, Eighth Edition, Cengage Learning,
2018.
• Acemoglu, D., D. Laibson & J. List, Economics, Global Edition, Pearson, 2016
 1.0 Contact Person & Assessments Dateline
Lecturers’ Name & Group:
▪ Dr Zhang Yi [email protected]

▪ Lecture
▪ Monday 3.00pm-5.00pm

▪ Tutorial
▪ (Group 1) Wednesday 12.00pm-1.00pm
▪ (Group 2) Friday 2.00pm-3.00pm
▪ (Group 3) Friday 4.00pm-5.00pm

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 Ten Principles of Economics
• Economy, “oikonomos” (Greek)
– “One who manages a household”
– Households and economies have much in common
• Households face many decisions
– Allocate scarce resources **Ability, effort, and desire
• Society faces many decisions
– Allocate resources and output
• Resources are scarce - Scarcity
– The limited nature of society’s resources
– Society has limited resources and therefore cannot produce all the
goods and services people wish to have
• Economics
– How society manages its scarce resources
– How people make decisions

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 Ten Principles of Economics
• Economists study:
– How people make decisions
• Work, buy, save, invest
– How people interact with one another
– Analyze forces and trends that affect the economy as a whole
• Growth in average income
• Fraction of the population that cannot find work
• Rate at which prices are rising

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 Ten Principles of Economics
• How people make decisions
1. People face trade-offs
2. The cost of something is what you give up to get it
3. Rational people think at the margin
4. People respond to incentives
• How people interact
5. Trade can make everyone better off
6. Markets are usually a good way to organize economic activity
7. Governments can sometimes improve market outcomes
• How the economy as a whole works
8. A country’s standard of living depends on its ability to produce
goods and services
9. Prices rise when the government prints too much money
10. Society faces a short-run trade-off between inflation and
unemployment

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 How People Make Decisions, #1
Principle 1: People face trade-offs
• “There ain’t no such thing as a free lunch”
– To get something that we like, we usually have to give up something
else that we also like (Opportunity Cost)

• Making decisions -
– Trade off one goal against another

• Trade offs
– Students: time vs Parents: income
– Society
• National defense vs. consumer goods (guns vs. butter)
• Clean environment vs. high level of income
• Efficiency vs. equality

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 How People Make Decisions, #2
• Efficiency
– Society getting the maximum benefits from its scarce resources
– Size of the economic pie
• Equality
– Distributing economic prosperity uniformly among the members of
society, How the pie is divided into individual slices

Principle 2: The cost of something is what you

give up to get it
• People face trade-offs
– Make decisions
• Compare cost with benefits of alternatives
• Opportunity cost
– Whatever must be given up to obtain some item
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 How People Make Decisions, #3
Principle 3: Rational people think at the margin
• Rational people
– Systematically and purposefully do the best they can to achieve
their objectives
• Marginal changes
– Small incremental adjustments to a plan of action
• Rational decision maker
– Make decisions by comparing marginal benefits and marginal costs
(MB vs MC)
– Take action only if:
• MB>MC
• Marginal benefits > Marginal costs

“Is the marginal benefit

of this call greater than
the marginal cost?” 9
 How People Make Decisions, #4
Principle 4: People respond to incentives
• Incentive
– Something that induces a person to act
– Higher price
• Buyers - consume less
• Sellers - produce more
– Public policy
• Change costs or benefits
• Change people’s behavior
• 2005 to 2008, price of oil in world oil markets skyrocketed
– Limited supplies, Surging demand from robust world growth
– Price of gasoline in the United States rose from about $2 to about $4 a
gallon
• Increased incentive to conserve gas - Smaller cars, scooters, bicycles,
mass transit, New, more fuel-efficient aircraft - Airbus A320 & Boeing 737
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 How People Interact, #5 & 6
Principle 5: Trade can make everyone better off
• Trade
– Allows each person to specialize in the activities
he or she does best
– Enjoy a greater variety of goods and services at
lower cost
Principle 6: Markets are usually a good way to organize
economic activity
• Communist countries, central planning
– Government officials (central planners) “For $5 a week
• Allocate economy’s scarce resources you can watch
– What goods and services were produced baseball without
– How much was produced being nagged to
– Who produced and consumed these cut the grass!”
goods and services

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 How People Interact, #6
• Market economy, allocation of resources
– Through decentralized decisions of many firms and households
– As they interact in markets for goods and services
– Guided by prices and self-interest
• Adam Smith’s “invisible hand”
– Households and firms interacting in markets
• Act as if they are guided by an “invisible hand”
• Leads them to desirable market outcomes
– Corollary: Government intervention
• Prevents the invisible hand’s ability to coordinate the decisions
of the households and firms that make up the economy

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 How People Interact, #7
Principle 7: Governments can sometimes improve market outcomes
• We need government
– Enforce rules and maintain institutions that are key to a market
economy
– Enforce property rights
– Promote efficiency, avoid market failure
– Promote equality, avoid disparities in economic wellbeing
• Property rights
– Ability of an individual to own and exercise control over scarce
resources
• Market failure
– Situation in which the market left on its own fails to allocate
resources efficiently
– Externalities
– Market power
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 How People Interact, #7

• Externality
– Impact of one person’s actions on the well-being of a bystander
– Pollution
• Market power
– Ability of a single economic actor (or small group of actors) to have
a substantial influence on market prices
• Disparities in economic wellbeing
– Market economy rewards people
• According to their ability to produce things that other people are
willing to pay for
– Government intervention, public policies
• Aim to achieve a more equal distribution of economic well-being
• May diminish inequality
• Process far from perfect

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 How the Economy as a Whole Works, #8
Principle 8: A country’s standard of living depends on its ability to produce
goods and services
• Large differences in living standards
– Among countries & Over time
• Average annual income, 2011 2015
– $48,000 (U.S.); $9,000 (Mexico) : $65,850 (U.S.); $9,480 (Mexico)
– $5,000 (China); $1,200 (Nigeria) : $10,410 (China); $2,030 (Nigeria)
– : $11,230 (Malaysia)
• Explanation: differences in productivity
• Productivity
– Quantity of goods and services produced from each unit of labor input
– Higher productivity
• Higher standard of living
– Growth rate of nation’s productivity
• Determines growth rate of its average income

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Average income around the world (2015)
WorldData@ https://www.worlddata.info/average-income.php

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https://worldpopulationreview.com/country-rankings/median-income-by-country

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 How the Economy as a Whole Works, #9 & 10

Principle 9: Prices rise when the government prints too

much money
• Inflation
– An increase in the overall level of prices in the
economy
• Causes for large or persistent inflation
– Growth in quantity of money
– Value of money falls
Principle 10: Society faces a short-run trade-off
between inflation and unemployment
• Short-run effects of monetary injections: “Well it may have
been 68 cents
– Stimulates the overall level of spending
when you got in
• Higher demand for goods and services line, but it’s 74
– Firms – raise prices; hire more workers; produce cents now!”
more goods and services
– Lower unemployment 18
 How the Economy as a Whole Works, #10

• Short-run trade-off between unemployment and inflation

– Key role – analysis of business cycle
• Business cycle
– Fluctuations in economic activity
• Employment
• Production

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 The Market Forces
of Supply and Demand

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 Demand, Supply, and Market Equilibrium
◼ Demand -- The theory of consumer behavior
❑ Utility maximization

❑ Law of demand: other things equal, when the price of a good rises, the

quantity demanded of the good falls, and vice versa; P & Qd negatively
related

◼ Supply -- The theory of the firm and market structure

❑ Profit maximization

❑ Law of supply: other things equal, when the price of a good rises, the

quantity supplied of the good also rises, and vice versa; P & Qs
positively related

◼ Market Equilibrium
❑ Individual → aggregate level: horizontal summation

◼ Prices – market mechanism

❑ Signals that guide the allocation of scarce resources 21
 Markets and Competition

• Market
– A group of buyers and sellers of a particular good or service
– Buyers as a group: determine the demand for the product
– Sellers as a group: determine the supply of the product

• Markets take many forms

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 Markets and Competition

• Perfect competition
– Goods offered for sale are all exactly the same
– Buyers and sellers are so numerous
• No single buyer or seller has any influence over the
market price ***Price takers
– At the market price
• Buyers can buy all they want
• Sellers can sell all they want

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 Markets and Competition
• Monopoly
– The only seller in the market
– Sets the price - Price Maker
• Other markets
– Between perfect competition and monopoly

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Market Structure
◼ Perfect Competition--many sellers of a standardized product,
◼ Monopolistic Competition--many sellers of a differentiated
product,
◼ Oligopoly--few sellers of a standardized or a differentiated product,
◼ Monopoly--a single seller of a product for which there is no close
substitute.

Perfect Competition Monopolistic Competition Oligopoly Monopoly

Less competitive
 Market Structure
Perfect Monopolistic
Oligopoly Monopoly
Competition Competition
number of firms Very large Many Few One

extent of standardized differentiated standardized or no close

product differentiated substitute
substitutability
ease of entry Very easy Relatively easy Significant Substantial
and exit “barriers to entry” “barriers to
entry”
control over Price taker Limited Mutual Price maker
price interdependence
example Agricultural Market, Restaurants, Automobiles, Public Service
Financial Market Clothing, Shoes, Supermarkets, (Electricity, Water,
(stock, currency, Service industries in Banking industry …)
bond) large cities
(Insurance brokers,
Estate agents,
Hairdressers, …)

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 Demand
• Quantity demanded (Qd)
- Amount of a good that buyers are willing and able to purchase
• Law of demand
– Other things equal, When the price of a good rises, the
quantity demanded of the good falls
– When the price falls, the quantity demanded rises (P & Qd)
negatively related (ordinary goods)
• Demand
– Relationship between the price of a good and quantity
demanded
– Demand schedule: a table: Demand curve: a graph
• (Price on the vertical axis, Quantity on the horizontal axis)
• An individual’s demand for a product
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 Figure 1
Catherine’s Demand Schedule and Demand Curve
Price of Ice-Cream Cones

1. A decrease
Price of Quantity of $3.00 in price . . .
Ice-Cream Cones
2.50
Cone Demanded
2. . . . increases quantity
$0.00 12 cones 2.00
of cones demanded.
0.50 10
1.00 8 1.50
1.50 6 1.00 Demand curve
2.00 4
2.50 2 0.50
3.00 0
0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones
The demand schedule is a table that shows the quantity demanded at each price. The demand
curve, which graphs the demand schedule, illustrates how the quantity demanded of the good
changes as its price varies. Because a lower price increases the quantity demanded, the
demand curve slopes downward.

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 Demand

• Market demand
– Sum of all individual demands for a good or service
• Market demand curve
– Sum the individual demand curves horizontally
– Total quantity demanded of a good varies
• As the price of the good varies
• Other things constant

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 Figure 2
Market Demand as the Sum of Individual Demands

The quantity demanded in a market is the sum of the quantities demanded by all the
buyers at each price. Thus, the market demand curve is found by adding horizontally
the individual demand curves. At a price of $2.00, Catherine demands 4 ice-cream
cones, and Nicholas demands 3 ice-cream cones. The quantity demanded in the
market at this price is 7 cones.

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 Figure 2
Market Demand as the Sum of Individual Demands

Price of
Catherine’s demand
+ Nicholas’s demand
Price of
=
Price of
Market demand

Ice-Cream Ice-Cream Ice-Cream

Cones Cones Cones

$3.00 DCatherine $3.00 $3.00

DNicholas
2.50 2.50 2.50

2.00 2.00 2.00

1.50 1.50 1.50 DMarket

1.00 1.00 1.00

0.50 0.50 0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 0 2 4 6 8 10 12 14 16 18

Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones

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 Demand
• Movement along a fixed demand curve
– Change in the quantity demanded due to a change in price

• Shifts in the demand curve (Change in demand): due to a

change in factors other than price
– Increase in demand
• Any change that increases the quantity demanded at
every price
• Demand curve shifts right
– Decrease in demand
• Any change that decreases the quantity demanded at
every price
• Demand curve shifts left
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 Figure 3
Shifts in the Demand Curve

Price of
Ice-Cream Increase in
Cones Demand

Decrease in
Demand
Demand
Demand
Demand curve, D1
curve, D2
curve, D3
0 Quantity of Ice-Cream Cones
Any change that raises the quantity that buyers wish to purchase at any given price
shifts the demand curve to the right. Any change that lowers the quantity that buyers
wish to purchase at any given price shifts the demand curve to the left.

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 Figure 4
Shifts in the Demand Curve versus Movements along the Demand Curve
(a) A Shift in the Demand Curve (b) A Movement along the Demand Curve
Price of Cigarettes, per Pack Price of Cigarettes, per Pack
A policy to discourage A tax that raises the
smoking shifts the price of cigarettes
demand curve to the left results in a movement
along the demand curve
$4.00
C

B A
$2.00 2.00
A

D1
D2 D1

0 10 20 0 12 20
Number of Cigarettes Smoked per Day Number of Cigarettes Smoked per Day
If warnings on cigarette packages convince smokers to smoke less, the demand curve for cigarettes shifts to the
left. In panel (a), the demand curve shifts from D1 to D2. At a price of $2.00 per pack, the quantity demanded falls
from 20 to 10 cigarettes per day, as reflected by the shift from point A to point B. By contrast, if a tax raises the
price of cigarettes, the demand curve does not shift. Instead, we observe a movement to a different point on the
demand curve. In panel (b), when the price rises from $2.00 to $4.00, the quantity demanded falls from 20 to 12
cigarettes per day, as reflected by the movement from point A to point C.
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 Demand

• Variables that can shift the demand curve

– Income
– Prices of related goods
– Tastes, Expectations
– Number of buyers
• Income
– Normal good
• Other things constant
• An increase in income leads to an increase in demand
– Inferior good
• Other things constant
• An increase in income leads to a decrease in demand
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 Demand
• Prices of related goods
– Substitutes, two goods (positive)
• An increase in the price of one leads to an increase in the
demand for the other
– Complements, two goods (negative)
• An increase in the price of one leads to a decrease in the
demand for the other
• Tastes
– Change in tastes: changes the demand
• Expectations about the future
– Expect an increase in income, increase in current demand
– Expect higher prices, increase in current demand
• Number of buyers, increases
– Market demand increases
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 Table 1
Variables That Influence Buyers

This table lists the variables that affect how much consumers choose to buy of any
good. Notice the special role that the price of the good plays: A change in the good’s
price represents a movement along the demand curve, whereas a change in one of
the other variables shifts the demand curve.

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 Supply
• Quantity supplied (Qs)
– Amount of a good; Sellers are willing and able to sell
• Law of supply
– Other things equal, When the price of a good rises, the
quantity supplied of the good also rises
– When the price falls, the quantity supplied falls as well
• Supply
– Relationship between the price of a good and the Qs quantity
supplied
– Supply schedule: a table; Supply curve: a graph
• Price on the vertical axis, Quantity on the horizontal axis
• Individual supply - A seller’s individual supply

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 Figure 5
Ben’s Supply Schedule and Supply Curve
Price of Ice-Cream Cones

Supply curve
Price of Quantity
$3.00
Ice-cream Of Cones 1. An increase
Cone Supplied 2.50 in price . . .
$0.00 0 cones
2.00
0.50 0
1.00 1 1.50 2. . . . increases
1.50 2 quantity of cones
2.00 3 1.00
supplied.
2.50 4
0.50
3.00 5

0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones
The supply schedule is a table that shows the quantity supplied at each price. This supply curve,
which graphs the supply schedule, illustrates how the quantity supplied of the good changes as
its price varies. Because a higher price increases the quantity supplied, the supply curve slopes
upward.
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 Supply

• Market supply
– Sum of the supplies of all sellers for a good or service
• Market supply curve
– Sum of individual supply curves horizontally
– Total quantity supplied of a good varies
• As the price of the good varies
• All other factors that affect how much suppliers want
to sell are hold constant

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 Figure 6
Market Supply as the Sum of Individual Supplies

The quantity supplied in a market is the sum of the quantities supplied by all the
sellers at each price. Thus, the market supply curve is found by adding horizontally
the individual supply curves. At a price of $2.00, Ben supplies 3 ice-cream cones,
and Jerry supplies 4 ice-cream cones. The quantity supplied in the market at this
price is 7 cones.

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 Figure 6
Market Supply as the Sum of Individual Supplies
Ben’s supply
+ Jerry’s supply
= Market supply

Price of Price of Price of

Ice-Cream Ice-Cream Ice-Cream
Cones Cones Cones
SBen
SMarket
$3.00 $3.00 SJerry $3.00

2.50 2.50 2.50

2.00 2.00 2.00

1.50 1.50 1.50

1.00 1.00 1.00

0.50 0.50 0.50

0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7 0 2 4 6 8 1012141618
Quantity of Quantity of Quantity of
Ice-Cream Cones Ice-Cream Cones Ice-Cream Cones
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 Supply
• Movement along a fixed supply curve
– Change in the quantity supplied due to a change in price

• Shifts in supply curve (Change in supply): due to a change in

factors other than price
– Increase in supply
• Any change that increases the quantity supplied at every
price
• Supply curve shifts right
– Decrease in supply
• Any change that decreases the quantity supplied at every
price,
• Supply curve shifts left

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 Figure 7
Shifts in the Supply Curve
Price of Supply Supply Supply
Ice-Cream curve, S3 curve, S1 curve, S2
Cones
Decrease
In supply

Increase in
Supply

0 Quantity of Ice-Cream Cones

Any change that raises the quantity that sellers wish to produce at any given price
shifts the supply curve to the right. Any change that lowers the quantity that sellers
wish to produce at any given price shifts the supply curve to the left.

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 Supply

• Variables that can shift the supply curve

– Input prices
• Supply is negatively related to prices of inputs
• Higher input prices: decrease in supply
– Technology
• Advance in technology: increase in supply
– Expectations about future
• Affect current supply
• Expected higher prices
– Decrease in current supply
– Number of sellers, increases
• Market supply increases

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 Table 2
Variables That Influence Sellers

This table lists the variables that affect how much producers choose to sell of any
good. Notice the special role that the price of the good plays: A change in the good’s
price represents a movement along the supply curve, whereas a change in one of the
other variables shifts the supply curve.

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 Supply and Demand Together

• Equilibrium
• Quantity supplied = quantity demanded (Qd= Qs)
– Supply and demand curves intersect
• Equilibrium price
– Balances quantity supplied and quantity demanded
– Market-clearing price
• Equilibrium quantity
– Quantity supplied and quantity demanded at the
equilibrium price

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 Figure 8
The Equilibrium of Supply and Demand
Price of
Ice-Cream
Cones Equilibrium Supply
$3.00

2.50
Equilibrium
2.00 Equilibrium
price
quantity
1.50

1.00
Demand
0.50

0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones
The equilibrium is found where the supply and demand curves intersect. At the
equilibrium price, the quantity supplied equals the quantity demanded. Here the
equilibrium price is $2.00: At this price, 7 ice-cream cones are supplied, and 7 ice-
cream cones are demanded.
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 Supply and Demand Together
• Surplus
– Quantity supplied > quantity demanded = Excess supply
– Downward pressure on price
• Movements along the demand and supply curves
• Increase in quantity demanded
• Decrease in quantity supplied
• Shortage
– Quantity demanded > quantity supplied = Excess demand
– Upward pressure on price
• Movements along the demand and supply curves
• Decrease in quantity demanded
• Increase in quantity supplied
• In most markets
– Surpluses and shortages are temporary 49
 Figure 9
Markets Not in Equilibrium
Price of (a) Excess Supply Price of (b) Excess demand
Ice-Cream Ice-Cream
Cones Surplus Supply Cones Supply

$2.50

2.00 $2.00

1.50
Demand Demand

Shortage
Quantity Quantity Quantity Quantity
demanded supplied supplied demanded

0 4 7 10 0 4 7 10
Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones
In panel (a), there is a surplus. Because the market price of $2.50 is above the equilibrium price, the
quantity supplied (10 cones) exceeds the quantity demanded (4 cones). Suppliers try to increase sales by
cutting the price of a cone, and this moves the price toward its equilibrium level. In panel (b), there is a
shortage. Because the market price of $1.50 is below the equilibrium price, the quantity demanded (10
cones) exceeds the quantity supplied (4 cones). With too many buyers chasing too few goods, suppliers
can take advantage of the shortage by raising the price. Hence, in both cases, the price adjustment moves
the market toward the equilibrium of supply and demand
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 Table 3
Three Steps for Analyzing Changes in Equilibrium

1. Decide whether the event shifts the supply

or demand curve (or perhaps both).

2. Decide in which direction the curve shifts.

3. Use the supply-and demand diagram to

see how the shift changes the equilibrium
price and quantity.

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 Figure 10
How an increase in demand affects the equilibrium
Price of 1. Hot weather increases the
Ice-Cream demand for ice cream . . .

Cones Supply
2. …resulting in
a higher price . . .
New equilibrium
$2.50
Initial equilibrium
2.00

3. …and a higher
D1 D2
quantity sold.
0 7 10 Quantity of Ice-Cream Cones

An event (One summer, very hot weather) that raises quantity demanded at any given price
shifts the demand curve to the right. The equilibrium price and the equilibrium quantity both rise.
Here an abnormally hot summer causes buyers to demand more ice cream. The demand curve
shifts from D1 to D2, which causes the equilibrium price to rise from $2.00 to $2.50 and the
equilibrium quantity to rise from 7 to 10 cones.
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 Figure 11
How a Decrease in Supply Affects the Equilibrium
Price of 1. An increase in the price of sugar reduces
Ice-Cream the supply of ice cream . . .
Cones New equilibrium S2
2. …resulting in
a higher price . . .
S1
$2.50

2.00
Initial equilibrium
3. …and a lower
quantity sold.
Demand

0 4 7 Quantity of Ice-Cream Cones

An event (One summer, a hurricane destroys part of the sugarcane crop) that reduces
quantity supplied at any given price shifts the supply curve to the left. The equilibrium price
rises, and the equilibrium quantity falls. Here an increase in the price of sugar (an input) causes
sellers to supply less ice cream. The supply curve shifts from S1 to S2, which causes the
equilibrium price of ice cream to rise from $2.00 to $2.50 and the equilibrium quantity to fall from
7 to 4 cones. 53
 Figure 12
A Shift in Both Supply and Demand
(a) Price Rises, Quantity Rises (b) Price Rises, Quantity Falls
Price of Price of
Ice-Cream New Ice-Cream Large decrease
New
equilibrium in supply
Cones Large increase Cones equilibrium
in demand S2 D2
S2
S1 D1 S1
P2 P2

P1 D2 P1
Initial equilibrium

Small
decrease Initial Small increase
in supply D1 equilibrium in demand

0 Q1 Q2 0 Q2 Q1
Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones
Here we observe a simultaneous increase in demand and decrease in supply (One summer:
hurricane and heat wave). Two outcomes are possible. In panel (a), the equilibrium price rises
from P1 to P2, and the equilibrium quantity rises from Q1 to Q2. In panel (b), the equilibrium price
again rises from P1 to P2, but the equilibrium quantity falls from Q1 to Q2.
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 Table 4
What Happens to Price and Quantity When Supply
or Demand Shifts?

As a quick quiz, make sure you can explain at least a few of the entries in this table
using a supply-and-demand diagram.
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 How Prices Allocate Resources
Supply and demand together
Determine the prices of the economy’s many different goods and services

“Two dollars” “—and seventy-five

cents.”
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 How Prices Allocate Resources
• Prices
– Signals that guide the allocation of resources
– Mechanism for rationing scarce resources
– Determine who produces each good and how much is
produced

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