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Unformatted text preview: 3 Demand, Supply, d M arket Equilibrium OUTLINE OF TEXT MATERIAL I. Introduction This chapter and the next discuss how markets work. Taken together they explain how individual and household decisions about demand and firms decisions about supply interact. As Adam Smith pointed out, coordination happens without any central planning or direction. Markets and prices answer the three basic questions of what to produce, how to produce, and who will get what is produced. II. Firms and Households: The Basic Decision-Making Units A. The two fundamental decision-making units in the economy are firms and households. B. Households are the consuming units in an economy. Their decisions are based on their tastes and preferences and are constrained by their limited incomes. C. Firms are the producing units in the economy. 1. A firm exists when a person or group of people decides to produce something. 2. Firms transform inputs into outputs (goods and/or services). 3. Firms can be large or small or in-between. 4. Most firms exist to make a profit for their owners. D. An entrepreneur is one who organizes, manages, and assumes the risks of a firm. III. Input Markets and Output Markets: The Circular Flow A. Households and firms interact in both input and output markets. 1. To produce goods and services firms must buy resources in input markets , the markets in which resources are exchanged. Firms buy or rent these inputs from households who own them. These resources are used to produce output which is sold in output or product markets . 22 Principles of Macroeconomics 2. Most households earn much of their income by supplying labor in the labor market . They may also earn interest or other returns by lending their wealth to firms in the capital market . Households may also supply land or other real property in exchange for rent in the land market . B. The circular flow implies that national income must equal national product. IV. Demand in Product/Output Markets A. A households decision about what quantity of a particular product to purchase depends on: 1. The price of the product. 2. The income available to the household. 3. The households accumulated net wealth. 4. The prices of other products. 5. The households tastes and preferences. 6. The households expectations about future income, wealth, and prices. B. Quantity demanded is the amount of a product that a household would buy in a given period if it could buy all it wanted at the current market price....
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- Fall '09