sam11290_ch03_1_ - Revised Confirming Pages CHAPTER Basic...

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Revised Confirming Pages 45 CHAPTER 3 What is a cynic? A man who knows the price of everything and the value of nothing. Oscar Wilde Basic Elements of Supply and Demand The f rst two chapters introduced the basic problems that every economy must solve: What shall be pro- duced? How shall goods be produced? And for whom should goods be produced? We also saw that the modern mixed economy relies primarily on a system oF markets and prices to solve the three central problems. Recall that the Fun- damental building blocks oF an economy are the dual monarchy oF tastes and technology. “Consumer sov- ereignty” operating through dollar votes determines what gets produced and where the goods go, but technologies in± uence costs, prices, and what goods are available. Our task in this chapter is to describe in detail how this process works in a market economy. Markets are like the weather—sometimes stormy, sometimes calm, but always changing. Yet a careFul study oF markets will reveal certain Forces underly- ing the apparently random movements. To Forecast prices and outputs in individual markets, you must f rst master the analysis oF supply and demand. Take the example oF gasoline prices, illustrated in ²igure 3-1 . (This graph shows the “real gasoline price,” or the price corrected For movements in the general price level.) Demand For gasoline and other oil products rose sharply aFter World War II as real gasoline prices Fell and people moved increasingly to the suburbs. Then, in the 1970s, supply restrictions, wars among producers, and political revolutions reduced production, with the consequent price spikes seen aFter 1973 and 1979. In the years that Followed, a combination oF energy conservation, smaller cars, the growth oF the inFormation economy, and expanded production around the world led to Falling oil prices. War in Iraq and growing world demand For petroleum aFter 2002 produced yet Further turmoil in oil mar- kets. As ²igure 3-1 shows, the real price oF gasoline (in 2008 prices) Fell From around $3.50 per gallon in 1980 to around $1.50 per gallon in the 1990s and then rose to $4 per gallon by the summer oF 2008. What lay behind these dramatic shiFts? Economics has a very powerFul tool For explaining such changes in the economic environment. It is called the theory of supply and demand. This theory shows how consumer preFerences determine consumer demand For com- modities, while business costs are the Foundation oF the supply oF commodities. The increases in the price oF gasoline occurred either because the demand For gasoline had increased or because the supply oF oil had decreased. The same is true For every market, From Internet stocks to diamonds to land: changes in supply and demand drive changes in output and prices. IF you understand how supply and demand work, you have gone a long way toward understand- ing a market economy.
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sam11290_ch03_1_ - Revised Confirming Pages CHAPTER Basic...

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