The Circular Flow of Economic Activity

• A healthy market depends on a flow of resources, goods, and services

Expanding the Circular Flow

• You are involved in exchanges with multiple businesses!

• Producers (business owners) need not just labor, but land and raw materials– Also tools, machines

I. The Circular Flow of Economic Activity

• A healthy market depends on a flow of resources, goods, and services

• You are involved in exchanges with multiple businesses!

• Producers (business owners) need not just labor, but land and raw materials– Also tools, machines

III. Supply and Demand

• Producers (buisness) and Individuals (buyers) act both as buyers and sellers

• Both are involved in exchanging goods and services

• In a Free Enterprise the Market Determines:– How much is being produced– The cost of a good or service

III. Supply and Demand Cont.

• When there is competition, the market works according to the laws of supply and demand– What happens when people make choices!

–What determines the price of pizza, gasoline, a car wash, or other goods and services?

IV. The Law of Demand?

• tells us the quantity of a good that buyers wish to buy at each price

• As price of a good or service goes down the quantity consumers wish to buy will increase– Therefore, the demand curve is downward-

sloping

The Daily DemandCurve for Pizza in Chicago

Price($ per slice)

Quantity(1000s of slices per day)

4

8

2

16

3

12

Demand

Why do buyers purchase a greater quantity at lower prices and vice-versa?

1. The substitution effect

2. The income effect

3. Law of Diminishing Marginal Utility (extra satisfaction)

V. Buyers and Sellers In Markets

1. The Substitution Effect– The change in the quantity demanded of a

good that results because buyers switch to substitutes when the price of the good changes

2. The Income Effect– The change in the quantity demanded of a

good that results because a change in the price of a good changes the buyer’s purchasing power

V. Buyers and Sellers In Markets

3. Diminishing Marginal Utility– The change in the quantity demanded of a

good that results because the amount of satisfaction gained by the consumer decreases with each additional unit consumed

V. Buyers and Sellers In Markets

Will the opportunity cost of producing additional units of pizza increase or decrease?

VI. Balancing Cost and Benefits

• A producer’s cost is determined by how much it costs to produce an item

• The price a buyer pays for each item = the benefit for the producer– The higher the price the better for the

producer!

The Daily DemandCurve for Pizza in Chicago

Price($ per slice)

Quantity(1000s of slices per day)

4

8

2

16

3

12

Demand

VII. The Law of Supply

• the quantity of a good that sellers wish to sell at each price

• As price of a good or service goes up the quantity producers wish to produce will increase

The Daily SupplyCurve for Pizza in Chicago

Price($ per slice)

Quantity(1000s of slices per day)

4

2

3

8 12 16

Supply

VIII. Market Price• The Price at which buyers and sellers

agree to trade

IX. WHAT SHIFTS DEMAND?• Two kinds of changes

1. Movement along the demand curve• Change in “Quantity demanded”

2. Shift in the whole demand curve• What shifts the whole Demand Curve?

– Changes in……..• Income• Taste• Expectations• The market’s size• The price of related goods and services

IX. WHAT SHIFTS DEMAND?• Shift along the Demand curve

IX. WHAT SHIFTS DEMAND?• Movement of the WHOLE DEMAND curve

X. WHAT SHIFTS SUPPLY?• Two kinds of changes

1. Movement along the Supply curve• Change in “Quantity demanded”

2. Shift in the whole Supply curve• What shifts the whole Demand Curve?

– Changes in……..• Technology• Input prices• Expectations• The number of producers• The price of related goods and services

X. WHAT SHIFTS SUPPLY?• Shift along the supply curve

X. WHAT SHIFTS SUPPLY?• Movement of the whole supply curve