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Becaxisc every society faces scarcity, every soci- must decide what goods to produce, how to pro-; those goods, and who will get to consume them, market-oriented economies like our own, we shall that it is exactly those market mechanisms which ide answers to these problems. In command lomies like the former Soviet Union and present-Cuba and North Korea, government fiat was/is to do the job. The overwhelming inferiority of emment fiat compared to market generated solu-i is the major reason why the economies of the for-cr Soviet Union and its Eastern European satrapies nravelled at the end of the last decade. (Stay posted the basket case economies of Cuba and North torea).

In Section II we present a highly simplified erview of the competitive market systems solution »the Vhat" and "who" decisions and partially address "bow" decision as well. The analysis begins with [.the concept of demand.


In economics, demand does not refer to the j,amount of a good actually sold. Rather, demand means [ the various amounts of a good which people are will-;.,ing and able to buy at different prices when all other relevant things are held constant. Table I shows the

various quantities of pies that Larry would be willing to purchase in a year at various prices, and Figure I simi-marizes the same information in a demand curve. To read this curve, note that at a price P of $12.00, we can trace a horizontal line to the demand curve and drop a vertical line to the quanuty axis to see that the quantity demanded would be three pies. Similarly, at a price of $9.00, he will buy six pies. Although Table I doesnt show it, we also assimie for later convenience that firac-tions of pies are also available. Thus, at the price of $9.50, five and a half pies will be purchased according to the demand ctuve. Note also that total expenditure by the consumer - which is received as the total revenue (TR) of the seller - is given by price times quantity (Pq). Geometrically, total revenue at the price of $9.00 is the shaded area in Figure I, equal to $54.00 ($9 X 6). At $12 the total revenue (TR) is die rectangle with a height of $12 and a base of 3 units. Its area is $36.00.

As the price decreases, the quantity demanded in Figure I increases, all other things constant. This relationship between price and the quantity demanded is known as the law of demand. According to this law, when all other things are constant, the quantity demanded varies inversely with price. The law does not mean that every time price increases, people will buy less, only that at some - perhaps very high - price peo-

Fig. I

Table I

Lanvs Demand lor Pies


Quantity 0 0 1 2 3 4 5 6 7

6 7 > Quantity Per Period

pie will buy less. An implication is that "needs," be they urgent, pressing, critical, crucial or otherwise do not exist in economics. For example, your "need" for water at $10.00 per gallon will probably be less than your "need" at the price of $0.00010 per gallon. Moreover, the law is perfecdy general- it also means that the higher the price (in terms ofwhat must be foregone, not necessarily in money) people must pay for such things as wisdom, beauty, or getdng an "A" in this course, the less they will want of these things, all else constant.

The "all else constant" is so important in economics that we often use the Latin phrase for it, ceteris paribus (KET-er-is PAIR-i-bus). In general, we will presume conditions of ceteris paribus hereafter, often without explicitly saying so.


Table II




Note: Strictly speaking a market demand curve requires many buyers. In this example we use only three to focus on the method of horizontal sumnration.

It is now time to move from the individual i sumers demand to that of the whole market. In eral, the market demand comprises the demands of a relevant individuals. Thus to the demand schedules i Larry, we now add those of and Curly in Table 1 Presuming these three to be the only individuals in thfl market allows us to generate the market demand schedule, which represents the sum of the individt] demands. For example, at the price of $16, only Ci: will wish to buy, so the quantity demanded in the mai4 ket at this price is 1 pie. Similarly, at a price of $14, thcJ quantity demanded of 4 pies is the sum of the threcl individual quantities (1+0+3=4). Only when the pricel reaches $11 do all three individuals make a contribu-l tion to the mzu-ket demand. In this case, the quantity] demanded in the market is the sum of 4 + 1 + 6.

The data of Table II are represented in graph-l ical form in Figure II, where the individual demand! curves have been graphed and horizontally summed at] each price to generate the market demand curve. Toj see the method explicidy, consider the price of $10.! We read Larrys quantity demanded as 5 from hisl graph; Moes as 2, and Curlys as 7. We would then hor-l izontally sum these quantities to mark off a quantity 1 demanded of 14 at the price of $10 in the corre- sponding market curve. A dot marks the spot. Repeating this horizontal summation procedure at the price of $9 tells us that the three will want 17 units (6 + 3 + 8), so we would next mark off another point corresponding to 17 units and $9 along the market demand curve. Repeating this procedure with several other points and then drawing line connecting the points together would give us the rest of the market demand curve. Thats all diere is to it

-Returning to the price of $10. we see that the fitpenditure at this price is $140 (PQ= $10 x 14 = j), and that diis sum is geometrically represented he dotted area under the market demand curve, course, the total expenditure paid by buyers is as the total revenue (TR) of sellers, so we can I often will - use these two terms interchangeably, should also verify that the total expenditure under individual demand curves sums to the total aditure imder the market demand curve. fAlso, as a matter of notational convenience, we "Q" hereafter to refer to the market quantity; refer to that of the individual, household or kewise "d" will refer to the demand curve of a or individual, whereas "D" will stand for the jdemand.

»AND QUANTITY DEMANDED In deriving the demand schedule, remember lentally held "all else constant" but the price good itself. We will now consider the role of :r forces. The principal, but not exclusive, : factors affecting a goods demand curve are , and prices of odier goods. Variations in by shifting the entire demand curve left or a new posidon. Thus, changes in any one of 11 cause either an increase or decrease in i. Specifically, an increase in demand always \ that the demand curve has shifted rightward as t III, from curve Dj to a new curve such as D2, acre will be bought at each price. For example, e quantity Qj will be initially purchased; but e demand increase, will be purchased at this Moreover, after a demand increase people will

be willing to pay a higher price for every quantity. For example, in Figure III, people would initially be willing to pay Pg for Q2 units of the good. After the demand increase, they are now willing to pay the higher price of P

A decrease in demand is a leftward shift of the entire demand curve and is portrayed in Figtire IV, where less is bought at any given price such as P along the new curve, Dg, than the old one, D. For example, at the price of P buyers would initially want Qj; after the demand decrease they would want only Qg. Note also that the price people would be willing to pay for a given quantity such as Qg has fallen from P lo P. A change in demand would be either an increase or a decrease in demand. Both Figures III and FV portray changes in demand.

Before addressing the causes of demand changes, it is important to illustrate a change in the quanti demanded. While changes in demand are caused by changes in conditions other than the price of the good itself, changes in the goods own price cause changes only in the quantity demanded of that good. For example, in Figure V, a decrease in price from Pj to P2 has changed the quandty demanded from Qj to Qg. This particular change will result in an increase in the quanti demanded. On the other hand, if the price had started al Pg and then increased to Pj, we would have a decrease in the quanti demanded from Qg to Qj. In summary, a change in the quantity demanded represents a movement along the same curve and is always caused by a change in the goods own price. A change in demand represents a rightward or leftward shift of the entire curve and is always caused by a change in variables other than the

Fig. Ill The IVIarlcet Demand Curve




Q per period

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