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How Markets Work

How Markets Work. Demand & Supply. Introduction. Economics is about choices that people make to face scarcity and how those choices are affected by incentives. Prices act as incentives.

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How Markets Work

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  1. How Markets Work Demand & Supply

  2. Introduction • Economics is about choices that people make to face scarcity and how those choices are affected by incentives. • Prices act as incentives. • The demand & supply model is the main tool of Economics . It tells us how people respond to prices and how prices are determined by demand & supply. • This model helps us to answer the economic questions : What How , and for whom are goods and services are produced?

  3. Prices And Markets • Prices of goods and services are determined by demand and supply of these goods and services in the markets. • A market has two sides : buyers & sellers. • Examples of goods and services: • Some markets are physical places where buyers & sellers meet. • Some markets are groups of people around the world who never meet , but connected through Internet. Examples: E-commerce markets and currency markets.

  4. Money Prices & Relative Prices • A Money Price of a good is the amount of money must be paid in exchange of it. • A Relative Price is the ratio of the price of one good to another and it is an opportunity cost. • Example : • If the money price of coffee is 1 SR and the money price of gum is 0.5 SR , then the relative price of coffee to gum= 1 /0.5 = 2 : 1 and it is the opportunity cost of a cup of coffee : To get one cup of coffee ,you must give up two packs of gum.

  5. Demand • If you demand something that means: • You want it. • You can afford it ,and • Plan to buy it. • Demand reflect a choice : What wants to be satisfied and by what goods and services.

  6. The Quantity Demanded • The quantity demanded of goods & services is the amount that consumer plan to buy during a period of time at a particular price. • Many factors influence buying plans and price is one of them.

  7. The Law of Demand • Other things remain the same , the higher the price of a good , the smaller the quantity demanded and the lower the price of a good , the greater the quantity demanded.

  8. Substitution Effect and Income Effect • To explain why a higher price reduce the quantity demanded ? • For two reasons: • Substitution Effect: When the price of a good rises . Other things remaining the same, its relative price ( the opportunity cost) rises. As the opportunity cost of a good rises , the incentive to reduce its use and switch to a substitute becomes stronger.

  9. Income Effect • When the price of a good rises , Other things remaining the same , people face a higher price and an unchanged income. They cannot pay for all goods and services that they used to buy. So when the price of a good rises , Other things remaining the same , they must decrease the quantities of some goods and services specially the good whose price has increased.

  10. The Demand Curve • It shows the inverse relationship between the quantity demanded of a good and its price , other things that affect demand being the same. QuantityDemanded Price

  11. A Demand Schedule • It lists the quantity demanded at each price other things that influence demand being the same. Example:

  12. The Demand Curve 2.5 2 1.5 1 0.5 2 4 6 8 10 12 14 16 22 18 20

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