The law of Demand and Supply

Text 1. What is Economics?

What do you think of when you hear the word economics? Money? Certainly, and perhaps more complicated things like business, inflation and unemployment. Knowledge of economics will help you run a business or manage your personal finances. Very simply, economics studies the decisions people make every day. Every decision we make is a trade-off. If you spend more time working, you earn more money. However, you will have less time to relax. Economists study the trade-offs people make, the reasons for their decisions. They look at the effects these decisions have on our lives and society.

Economics is a social science that seeks to analyze and describe the production, distribution, and consumption of wealth. It is characteristic of any society that while wants of people are growing constantly, the economic resources required to satisfy these wants are limited and scarce. Scarcity of resources makes it necessary to save them. As a result any economic system is trying to find most effective and efficient ways of utilizing resources for the production of goods and services. The rational solution of the problem brings about the maximum economic growth, full employment, stable prices, equitable distribution of revenues, and social security of the needy.

There are different economic systems in the world today. Many economists argue that free enterprise, or the market economy is the most effective system, because businesses are free to choose whom to buy from and sell to and on what terms, and free to choose whom to compete with. It is done through a market, which is a set of arrangements through which buyers and sellers make contact and do business. In the market individual consumers and producers act on their own behalf.

The market functions as a rationing device with the price mechanism as its principal instrument. In free markets, prices direct allocations of inputs of firms that make the most profitable use of them. The market mechanism brings about an allocation of resources that reflect two basic factors: consumer preferences and production costs. The prices which play the coordinating role of the market mechanism are determined through the interaction of demand and supply.

All businesses produce goods and services and seek profits. They all compete with other businesses for inputs of labour, capital and natural resources.

Freedom of enterprise is not total in the market economy. Businesses are subject to laws and government regulations.

Economic machines do not always run smoothly. They are subject to a business cycle that alternates between periods of rapid expansion and periods of recession in which outputs fall and unemployment rises.

Economic environment is determined by the economic policies of the government, fiscal and monetary policies being the major factors. So, if an economic system is to perform well it must deal with many economic challenges.

Task 1. Find in the text English equivalents for the Russian phrases:

Вести бизнес; управлять личными средствами; принимать компромиссные решения; оказывать влияние на нашу жизнь и общество; производство, распределение и потребление материальных благ; ресурсы, необходимые для удовлетворения потребностей людей, ограниченны; нехватка ресурсов делает необходимой их экономию; использовать ресурсы наиболее эффективным образом; производство товаров и услуг; вызывать максимальный экономический рост; справедливое распределение доходов; социальное обеспечение нуждающихся; свободное предпринимательство – наиболее эффективная экономическая система; устанавливать контакты; действовать от своего имени; распределение ресурсов; взаимодействие спроса и предложения; подчиняться законам.

Text 2. The traditional economy.

Before you read discuss questions with your partner:

1. Imagine the world without money. How do you think society would be run?

2. Would there be an economy as we understand it?

3. Can you think of any examples of situations where people don’t use money, either from the past or now?

4. Do you know what a traditional economy is?

It’s hard to imagine our lives without coins, banknotes and credit cards. Yet for most of human history people lived without money. For thousands of years human societies had very simple economies. There were no shops, markets or traders. There were no employers, paid workers or salaries. Today, we call this kind of economy the traditional economy, and in some parts of Asia, South America and Africa this system still exists.

People who live in a traditional economy don’t have money because they don’t need it. They live lives of subsistence. That means they hunt, gather or grow only enough food to live. There is almost no surplus in the traditional economy, and there is almost no property. Families may own simple accommodation, but land is shared by all the tribe. Economic decisions are taken according to the customs of the tribe. For example, every family may need to give some of the crops they grow to the tribal leader, but keep the rest for themselves. They don’t do this because it makes economic sense. They do it because the tribe has always done it. It’s simply a custom.

Custom, also, decides what jobs people do in the traditional economy. People generally do the jobs that their parents and grandparents did before them. Anyway, there aren’t many jobs to choose from in the traditional economy. Men are hunters, farmers or both. The woman’s place is at home looking after children, cooking and home-making. This division of labour between men and women is characteristic of the traditional economy. Whatever the work is, and whoever does it, you can be sure it’s hard work. This is because traditional economies have almost no technology. Physical strength and knowledge of the environment are the tools for survival.

Like any other economic system, the traditional economy has its benefits and drawbacks. Probably the biggest benefit is that these are peaceful societies. People consume almost everything they produce and own practically nothing. They are equally poor. For all these reasons, war is almost unknown in these societies.

However, people who live in traditional societies are among the poorest people in the world. Because custom decides what people do, nothing in these societies ever changes. Because there is no technology, people depend on nature to survive. They have no protection from environmental disasters like droughts and floods. They are always in danger of hunger and disease.

But the traditional economy is in danger itself. There only a few examples left on the planet. In 100 years from now, it may have disappeared forever.

Text 3. The market economy.

Before you read discuss these questions with your partner:

1. Do you think most countries have a market which is free from government management?

2.

Have you ever walked through a busy street market? People push their way through crowds of others in order to reach the stalls first. The air is full of deafening shouts. Stall owners yell to advertise their goods. Buyers cry out their orders. It’s hard to imagine, but behind this noisy confusion is a very logical economic theory: the market economy.

The market economy is sometimes called the free market. A free market is not controlled in any way by a government. It is also free from the influence of custom or tradition. In a free market, the only reason why things are bought and sold is because there is a demand for them. Prices for goods and services are simply what people are prepared to pay. The market economy is not really controlled by anyone. It controls itself.

The street market where we began has many of the characteristics of the free market. Customers arrive at the market with a shopping list of things they need. They also come with an idea of how much they are prepared to pay. Stall owners sell what customers demand, and try to get the highest price they can for it. Supply and demand control what is on the market and how much it sells for. In the wider economy, we are all customers, and the stall owners are like companies.

The role of the company in the free market is to supply what people want. However, companies need an incentive. The incentive is profit. There are two ways for companies to make a profit. The first way is to raise their prices. The second way is to reduce their production costs. And this brings us to two more features of the market economy: competition and technology.

Competition exists in a free market because, theoretically, anyone can be a producer. This means that companies have to compete with each other for a share of the market. Competition is good for consumers because it helps to control prices and quality. If customers aren’t happy with a product or service, or if they can’t afford it, they will go to a competitor.

Technology exists in a free market because producers need ways to reduce their costs. They cannot buy cheaper raw materials. Instead, they must make better use of time and labour. Technology is the use of tools and machines to do jobs in a better way. This helps companies produce more goods in less time and with less effort. The result: more profit.

People often think that most economies are free markets. However, at the macroeconomic level, a truly free market economy does not exist anywhere in the world. This is because all governments set limits in order to control the economy. Some governments set many limits, other governments set very few, but they all set some. For this reason, a true market economy is only theoretical. Nevertheless, many of the features of the market economy do exist in most societies today.

Task 1. Read the text again and answer these questions:

1. Who controls a market economy?

2. Who decides what products are for sale in a free market?

3. What do companies want?

4. Why is competition a good thing?

5. Why does technology exist in the market economy?

6. Why are there no true market economies in the world today?

Text 4. The planned economy

Before you read discuss questions with your partner:

1. You’ve learnt about the free market economy. Can you think of any disadvantages it may have?

2. Is the planned economy different in any way from the market economy? Give your ideas.

In many ways, the planned economy is the direct opposite of the market economy. In the market economy, the forces of supply and demand decide everything: what is produced, how much is produced, the methods of production and the price. In the planned economy, all of this is decided by the government. In every way that the market economy is free, the planned economy is controlled.

Unfortunately, no economic system is perfect. If there was a perfect system, economists wouldn’t have anything to argue about! Market economies have their strengths, but they have their problems, too. Planned economies try to provide solutions to these problems. For example, the free market supplies the things that people want. However, what people want and what they need are not always the same: fast food is always in demand, but it’s bad for us. In a planned economy, the government could decide to stop fast food restaurants operating in the market.

A second problem with free markets is that producers always want the highest price. Often the poor can’t afford things. In a planned economy, the government sets prices. They make sure that everyone can afford basic commodities. This is one way that planned economies try to share things equally. Another is to control how much people get paid.

In a planned economy, workers’ wages depend on the service they provide to society. If people can live without their service, you get paid less. This is very different from the free market. In the free market, someone’s salary mostly depends on the demand for his or her work. If people like what you do, you get paid more.

Before 1900, there were few examples of planned economies. During the 20th century, however, the planned economy became the standard for socialist governments like the USSR and China. These countries experienced amazing economic growth in a very short time. In a market economy, it takes a long time for big industries to grow from small companies. In a planned economy, however, huge industries can grow overnight. The government simply decides to spend money on factories and factories appear. Britain, for example, took centuries to develop her steel industry in a free market economy. China developed hers in a few decades.

But, as we said, no economic system is perfect. The planned economy has many drawbacks. One of these drawbacks is problems with supply. It is difficult for governments of planned economies to know exactly how much to produce to meet demand. In a market economy, when the price of a commodity rises, this indicates a rise in demand. Companies then supply more to the market. This warning system doesn’t work in a planned economy because price is controlled by the government. The result is shortages.

When shortages happen, governments can do two things: ration goods or raise prices. In this situation, people then start to hoard things, and the problem gets even worse. As the population gets bigger, shortages like this become more common. For this reason, China – once the world’s biggest planned economy – is rapidly moving towards another system: the mixed economy.

Task 1. Now read the text again and decide whether these statements are true or false:

1. In a planned economy, the government decides how products are made.

2. In a planned economy, suppliers can sell anything that is in demand.

3. In a planned economy, a doctor should get paid more than a footballer.

4. Planned economies grow more slowly than market economies.

5. In a market economy, greater demand for something makes it cheaper.

6. Planned economies are difficult to run in countries with large populations.

Task 2. Match the words and phrases with the definitions:

1 commodity A when the government sets a limit on how much people

can buy of something

2 standard B when there is not enough of something

3 socialist C a strongly metal made from iron

4 industry D something you can buy or sell

5 steel E what is usual or typical

6 indicate F all the businesses and companies involved in

the production of something

7 warning system G describes someone/something aiming to share

wealth equally

8 shortage H secretly storing and hiding goods for use later

9 rapidly I work

10 ration J show

11 solution K very quickly

12 hoard L money paid regularly for work done

13 operate M answer to a problem

14 wages N a system which tells us that something bad is going to happen

Text 5. The mixed economy

Before you read discuss questions with your partner:

1. Can you actually think of any examples of countries with a completely free market or a totally controlled one? Give any examples you can think of or ay why you can’t come up with any true examples.

2. How do you understand the word ‘mixed’?

3. What features does the mixed economy contain in your opinion?

Most economists would say that there are no examples in the world today of a completely free market or a completely controlled economy. Instead, every country operates a mixture of the two systems. Even in the freest economies, like the USA, there is some government control; even in the strictest planned economy there is some free enterprise.

Economies mix government control and free market values in different ways. One way is to let privately owned business exist alongside state run industries. The economy becomes divided between the state sector and the private sector. The state sector often includes industries that the government thinks are important and need protection from the risks of the free market. These could include public transport, hospitals, schools and the postal service. The state sector can also include large industries that are important for a country’s economic health, such as oil, steel or agriculture. These are sometimes called primary industries because they provide basic materials to manufacturers.

These state sector industries use money that the government collects in taxes. Often, they do not need to compete with other companies because no other company is allowed to provide the same product or service. However, many countries have recently started a process called deregulation.

Deregulation means freeing up the economy to allow private businesses to compete with state-run industries. The state sector should then run more efficiently in order to compete in the free market and because it now has less government protection.

Deregulation of services like telecommunications, transport and banking has happened in many countries in recent years. People have generally accepted these changes. However, generally the public is less happy when governments start talking about deregulation in education and health services. Many people feel that profit motivation will harm these services rather than improve them.

Another way in which economies today are mixed is that governments put limits on free enterprise. For example, governments may decide to ban trade in certain goods if they are dangerous. They may also create laws to make sure companies trade honestly or to prevent monopolies. If a company has a monopoly, normal market forces do not effect it. This is bad for consumers and the economy in general. Governments may also regulate methods of production. They do this to guarantee that products are safe for consumers and to protect the environment.

Many economists would argue that the mixed economy is the best system for consumers. This is because consumers have two ways to control the economy: by choosing to buy a company’s goods or services and by choosing to give political parties their votes.

Task 1. Now read the text again and answer the questions:

1. What do most economists believe about economies in the world today?

A There are a number of free markets

B Some countries have a completely planned economy

C A mixed economy exists in some way in all countries.

2. Why do governments choose to run some industries?

A So they can collect taxes.

B They need to be protected from the risks of the free market

C To encourage a divided economy

3. Why do governments deregulate some industries?

A To make the industries more efficient.

B To protect them

C There is too much competition.

4. According to the text, what is not very popular with the public?

A Deregulation of public transport.

B Deregulation of hospitals and schools

C Deregulation of telecommunications and banking.

5. What type of state control is not mentioned in paragraph 6?

A Controlling the way companies do business.

B Controlling what companies sell.

C Controlling the prices companies set.

The law of Demand and Supply

Task 1. Read the text and then answer the questions:

The United States has a free enterprise economy. This type of economic system depends on cooperation between producers and consumers. To make a profit, producers provide products at the highest possible price. Consumers serve their own interests by purchasing the best products at the lowest possible price.

The forces of supply and demand establish the price that best serves both producers and consumers.

Demand is the desire to have some good or service and the ability to pay for it. You may want to take a round-the-world cruise or to rent a huge apartment that overlooks the ocean. Or you may want to buy a brand-new sports car or a state-of-the-art home entertainment center. However, you may not be able to afford any of these things.

Therefore, economists would say that you have no actual demand for them. Even though you want them, you don’t have the money needed to buy them. Conversely, you may want the latest CDs by several of your favorite bands. And, at a price of between $12 and $15 each, you can afford them. Since you have both the desire for them and the ability to pay for them, you do have demand for CDs.

Price is one of the major factors that influence demand. The law of demand states that when the price of a good or service falls, consumers buy more of it. As the price of a good or service increases, consumers usually buy less of it.

EXAMPLE Price and Demand

Let’s take a look at an example of demand in action. Cheryl, a senior at Montclair High School, loves movies and enjoys collecting them on DVD. She and Malik, a friend from school, sometimes meet downtown at Montclair Video Mart to look through the DVD stacks. Rafael, the owner of the video mart, often jokes that Cheryl and Malik spend so much time at his store that he might have to give them jobs. Actually, Cheryl already has a job—stocking shelves at her neighborhood supermarket.

She worked so many hours this summer that she has extra money to spend. Let’s see how DVD prices at Montclair Video Mart affect her spending decisions.

Cheryl has been saving to buy the DVD boxed set of the original Star Wars trilogy, one of her favorite series of movies. The set costs $69.95, and Cheryl has the money to buy it this weekend. When Cheryl goes to the Montclair Video Mart, she is disappointed to learn that the Star Wars set is sold out and a new shipment won’t arrive for a week. She decides to buy some other DVDs so that she won’t go home empty-handed, but she also decides to save roughly half of her money toward a future purchase of Star Wars.

As she looks through the movie DVDs, she sees that most of those she wants sell for $15. How many will she buy at that price? Let’s say she decides to buy three and keep the rest of her money for the Star Wars trilogy. But what if each of the DVDs she wants costs just $5? Cheryl might decide that the price is such a good deal that she can buy seven. As you can see, the law of demand is more than just an economic concept. It’s also a description of how consumers behave.

Change in Demand

Consider what might happen if you lose your job. If you aren’t earning money, you aren’t likely to buy many CDs or movie tickets or magazines - no matter how low the price. Similarly, when national unemployment rises, people who are out of work are more likely to spend their limited funds on food and housing than on entertainment.

Fewer people would be buying DVDs at every price, so market demand would drop. This is an example of a change in demand, which occurs when a change in the marketplace such as high unemployment prompts consumers to buy different amounts of a good or service at every price. Change in demand is also called a shift in demand because it actually shifts the position of the demand curve.

Six factors can cause a change in demand: income, market size, consumer tastes, consumer expectations, substitute goods, and complementary goods. An explanation of each one follows.

FACTOR 1 Income

If a consumer’s income changes, either higher or lower, that person’s ability to buy goods and services also changes. For example, Tyler works at a garden center. He uses his earnings to buy baseball cards for his collection. In the fall, people garden less and buy fewer gardening products, so Tyler works fewer hours. His smaller paycheck means that he has less money to spend, so he demands fewer baseball cards at every price.

Suppose, however, that Tyler is promoted to supervisor and receives a raise of $2 an hour. Now he has more money to spend, so his demand for baseball cards increases.

As you might guess, changes in income also affect market demand curves. When the incomes of most consumers in a market rise or fall, the total demand in that market also usually rises or falls. Increased income usually increases demand, but in some cases, it causes demand to fall. Normal goods are goods that consumers demand more of when their incomes rise. Inferior goods are goods that consumers demand less of when their incomes rise. Before his raise, Tyler shopped at discount stores for jeans and T-shirts. Now that he earns more, Tyler can afford to spend more on his wardrobe. As a result, he demands less discounted clothing and buys more name-brand jeans and tees.

Discounted clothing is considered an inferior good. Other products that might be considered inferior goods are used books and generic food products.

FACTOR 2 Market Size

If the number of consumers increases or decreases, the market size also changes. Such a change usually has a corresponding effect on demand. Suppose that the town of Montclair is on the ocean. Each summer, thousands of tourists rent beachfront cottages there. As a result, the size of the population and the market grows. So what do you think happens to the market demand curve for pizza in Montclair in the summer?

Population shifts have often changed the size of markets. For example, in the last 30 years, the Northeast region of the United States lost population as many people moved to the South or the West. The causes of the population shift included the search for a better climate, high-tech jobs, or a less congested area.

One economic result of the migration is that the overall market size of the Northeast has shrunk, while the market size of the South and the West has grown. This change in market size has altered the demand for many products, from essentials such as homes, clothing, and food to nonessentials such as movie tickets. Demand for most items will grow in booming regions and decrease in regions that are shrinking.

FACTOR 3 Consumer Tastes

Because of changing consumer tastes, today’s hot trends often become tomorrow’s castoffs. When a good or service enjoys high popularity, consumers demand more of it at every price. When a product loses popularity, consumers demand less of it.

Advertising has a strong influence on consumer tastes. Sellers advertise to create demand for the product. For example, some people stop wearing perfectly good pants that still fit because advertising convinces them that the style is no longer popular and that a new style is better.

Think about your own closet. Doesn’t it contain some item of clothing that you just had to have a year ago, but would never pay money for now? You’ve just identified an instance of consumer taste changing demand. Consumer tastes also affect demand for other products besides clothing. When was the last time you saw someone buying a telephone that had to be attached to the wall by a cord?

FACTOR 4 Consumer Expectations

Your expectations for the future can affect your buying habits today. If you think the price of a good or service will change, that expectation can determine whether you buy it now or wait until later.

Automobiles usually go on sale at the end of summer because dealers want to get rid of this year’s models before the new models arrive. Would you expect demand for new cars to be higher in May, before the sales, or in August, during the sales? It is higher in August because consumers expect the sales and often choose to wait for them.

FACTOR 5 Substitute Goods

Goods and services that can be used in place of other goods and services to satisfy consumer wants are called substitutes. Because the products are interchangeable, if the price of a substitute drops, people will choose to buy it instead of the original item.

Demand for the substitute will increase while demand for the original item decreases. People may also turn to substitutes if the price for the original item becomes too high. Again, demand for the substitute rises while demand for the original item drops.

Substitutes can be used in place of each other. For example, when gasoline prices are high, some people decide to commute to school by bus or train. When gasoline prices are low, a higher number of people choose to drive instead of to take public transportation. As you can see from that example, when the price of one good rises, demand for it will drop while demand for its substitute will rise.

FACTOR 6 Complementary Goods

When the use of one product increases the use of another product, the two products are called complements. In contrast to substitutes, complements are goods or services that work in tandem with each other. An increase in demand for one will cause an increase in demand for the other. Likewise, a decrease in demand for one will cause a decrease in demand for the other.

One example is CDs and CD players. Consumers who bought CD players also demanded CDs to play on them. And, as CDs became more popular, demand for CD players grew until they began to appear in places they had never been before, such as in the family minivan.

Therefore, with complements, if the price of one product changes, demand for both products will change in exactly the same way. If the price for one product rises, demand for both will drop. Conversely, if the price for one product drops, demand for both will rise.

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