NOTES5.201 - The Law of Supply and Demand Let's become...

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The Law of Supply and Demand Let's become acquainted with the third law of microeconomics, the law of supply and demand. Recall the other two laws that we discussed: the law of demand and the law of supply. The former is a statement about how the quantity of a good that consumers wish to purchase will change as the price of the good changes, ceteris paribus. The latter is a statement about how the quantity of a good that (competitive) firms bring to market will change as the price of the good changes, ceteris paribus. But the law of supply and demand is a statement (actually two statements) about how the price of a good will behave. Specifically, the law of supply and demand says this: If the price of a good sold in a competitive market is such that supply is greater than demand, the price of the good will fall If the price of a good sold in a competitive market is such that demand is greater than supply, the price of the good will rise Let's now think about supply when firms have U-shaped average costs curves, i.e. when the competitive supply schedule is an upward sloping line. Well, when we look at a graph of a competitive market and think about these two statements, we realize that the law of supply and demand implies that the price of a good sold in a competitive market will fall and rise until market price equals the equilibrium price of the good. Exactly why is that? Well, if, as we are now supposing, supply slopes upward, then since demand slopes downward, QS > QD if and only if market price is above the equilibrium price of the good. Therefore, when market price is above equilibrium price, market price is going to fall. So whenever (for whatever reason) market price is above
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This note was uploaded on 04/16/2008 for the course ECON 2010 taught by Professor Aljamal during the Spring '06 term at Western Michigan.

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NOTES5.201 - The Law of Supply and Demand Let's become...

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