An economy is a system for coordinating society’s productive

activities.
Economics is the social science that studies the production,
distribution, and consumption of goods and services.
A market economy is an economy in which decisions about
production and consumption are made by individual producers and
consumers.
The invisible hand refers to the way in which the individual
pursuit of self- interest can lead to good results for society as a
whole.
Macroeconomics is the branch of economics that is concerned
with overall ups and downs in the economy.
Economic growth is the growing ability of the economy to
produce goods and services.
Individual choice is the decision by an individual of what to do,
which necessarily involves a decision of what not to do.

The Principles of Individual Choice

Principle #1: Choices Are Necessary Because Resources

Are Scarce.
Principle #2: The True Cost of Something Is Its
Opportunity Cost (what you must give up in order to get it—is its true
cost).

Principle #3: “How Much” Is a Decision at the Margin

(Decisions about whether to do a
bit more or a bit less of an activity are marginal
decisions).
Principle #4: People Usually Respond to Incentives,
Exploiting Opportunities to Make Themselves Better Off
(An incentive is anything that offers rewards to people who change their behavior).
The next level of economic analysis is the study
of interaction—
how my choices depend on your choices, and vice versa. When
individuals interact, the end result may be different from what
anyone intends.
Individuals interact because there are gains from trade: by
engaging in the trade of goods and services with one another, the
members of an economy can all be made better off.
Specialization—each person specializes in the task he or she is
good at—is the source of gains from trade.
Because individuals usually respond to incentives, markets
normally move toward equilibrium—
a situation in which no
individual can make himself or herself better off by taking a
different action.
An economy is efficient if all opportunities to make some people
better off without making
other people worse off are taken.
Resources should be used as efficiently as possible to achieve
society’s goals. But efficiency is not the sole way to evaluate an
economy: equity, or fairness, is also desirable, and there is often a
trade-off between equity and efficiency.
Markets usually lead to efficiency, with some well- defined
exceptions.
When markets fail and do not achieve efficiency, government
intervention can improve society’s welfare.
Because people in a market economy earn income 
by selling
things, including their own labor, one person’s spending is
another person’s income. As a result, changes in spending
behavior can spread throughout the economy.
Overall spending in the economy can get out of line with the
economy’s productive capacity. Spending below the economy’s
productive capacity leads to a recession; spending in excess of
the economy’s productive capacity leads to inflation.
Governments have the ability to strongly affect overall
spending, an ability they use in an effort to steer the economy
between recession and inflation.
A competitive market is a market in which there are many buyers and sellers of the
same good or service, none of whom can influence the price at which the good or service
is sold.

The supply and demand model is a model of how a competitive market behaves.

A demand schedule shows how much of a good or service consumers will want to buy at
different prices.

The quantity demanded is the actual amount of a good or service consumers are willing
to buy at some specific price.

A demand curve is a graphical representation of the demand schedule. It shows the

relationship between quantity demanded and price.

The law of demand says that a higher price for a good or service, other things equal,
leads people to demand a smaller quantity of that good or service.

A shift of the demand curve is a change in the quantity demanded at any given price,
represented by the change of the original demand curve to a new position, denoted by a
new demand curve.

A movement along the demand curve is a change in the quantity demanded of a good
arising from a change in the good’s price.

Two goods are substitutes if a rise in the price of one of the goods leads to an increase in
the demand for the other good.

Two goods are complements if a rise in the price of one good leads to a decrease in the
demand for the other good.

When a rise in income increases the demand for a good—the normal case—it is a normal
good.

When a rise in income decreases the demand for a good, it is an inferior good.

An individual demand curve illustrates the relationship between quantity demanded and
price for an individual consumer.

The quantity supplied is the actual amount of a good or service people are willing to sell
at some specific price.

A supply schedule shows how much of a good or service would be supplied at different
prices.

A supply curve shows the relationship between quantity supplied and price.

A shift of the supply curve is a change in the quantity supplied of a good or service at
any given price. It is represented by the change of the original supply curve to a new
position, denoted by a new supply curve.

A movement along the supply curve is a change in the quantity supplied of a good
arising from a change in the good’s price.

An input is a good or service that is used to produce another good or service.

An individual supply curve illustrates the relationship between quantity supplied and
price for an individual producer.

A competitive market is in equilibrium when price has moved to a level
at which the
quantity of a good
or service demanded equals the quantity of that good or service
supplied. The price at which this takes place is the equilibrium price, also referred to as
the market-clearing price. The quantity of the good or service bought and sold at that
price is the equilibrium quantity.

There is a surplus of a good or service when the quantity supplied exceeds the quantity
demanded. Surpluses occur when the price is above its equilibrium level.

There is a shortage of a good or service when the quantity demanded exceeds the
quantity supplied. Shortages occur when the price is below its equilibrium level.

Quick View:
• The supply and demand model is a model of a competitive market—one in which there
are many buyers and sellers of the same good or service. 


• The demand schedule shows how the quantity demanded changes as the price changes.
A demand curve illustrates this relationship. 


• The law of demand asserts that a higher price reduces the quantity demanded.
Thus, demand curves normally slope downward.
• An increase in demand leads to a rightward shift of the demand curve: the
quantity demanded rises for any given price.
• A decrease in demand leads to a leftward shift: the quantity demanded falls for
any given price.
• A change in price results in a change in the quantity demanded and a move- ment
along the demand curve

• The five main factors that can shift the demand curve are changes in (1) the price of a
related good, such as a substitute or a complement, (2) income, (3) tastes, (4)
expectations, and (5) the number of consumers. 


• The market demand curve is the hori- zontal sum of the individual demand curves of
all consumers in the market 


Quick view
• The supply schedule shows how the quantity supplied depends on the price. The supply
 curve illustrates this relationship. 


• Supply curves are normally upward sloping: at a higher price, producers are willing to
supply more of a good or service. 


• A change in price results in a movement along the supply curve and a change in the
quantity supplied. 


• Increases or decreases in supply lead to shifts of the supply curve. An increase in

supply is a rightward shift: the quantity supplied rises for any given price. A
decrease in supply is a leftward shift: the quantity sup- plied falls for any given
price. 


• The five main factors that can shift the supply curve are changes in (1) input prices, (2)
prices of related goods or services, (3) technology, (4) expectations, and (5)
number of producers. 


• The market supply curve is the horizontal sum of the individual supply curves of all
producers in the market. 


competitive market is in equilibrium when price has moved to a level
at which the
quantity of a good
or service demanded equals the quantity of that good or service
supplied. The price at which this takes place is the equilibrium price, also referred to as
the market-clearing price. The quantity of the good or service bought and sold at that
price is the equilibrium quantity.

There is a surplus of a good or service when the quantity supplied exceeds the quantity
demanded. Surpluses occur when the price is above its equilibrium level.

There is a shortage of a good or service when the quantity demanded exceeds the
quantity supplied. Shortages occur when the price is below its equilibrium level.

Quick View

Changes in the equilibrium price and quantity in a market result from shifts of the supply
curve, the demand curve, or both.

• An increase in demand increases both the equilibrium price and the equilib- rium
quantity. A decrease in demand decreases both the equilibrium price and the equilibrium
quantity.

• An increase in supply drives the equilibrium price down but increases the equilibrium
quantity. A decrease in supply raises the equilibrium price but reduces the
equilibrium quantity. 


• Often fluctuations in markets involve shifts of both the supply and demand curves.
When they shift in the same direction, the change in equilibrium quantity is
predictable but the change in equilibrium price is not. When they shift in opposite
directions, the change in equilibrium price is predictable but the change in
equilibrium quantity is not. When there are simultaneous shifts of
the demand
and supply curves, the curve that shifts the greater distance has a greater effect on
the change in equilibrium price and quantity. 


CH3 Summary
1. The supply and demand model illustrates how a competitive market, one with many
buyers and sellers, none of whom can influence the market price, works.

2. The demand schedule shows the quantity demanded at each price and is represented
graphi- cally by a demand curve. The law of demand says that demand curves slope
downward; that is, a higher price for a good or service leads people to demand a smaller
quantity, other things equal.

3. A movement along the demand curve occurs
when a price change leads to a change
in the quantity demanded. When economists talk of increasing or decreasing demand,
they mean shifts of the demand curve—a change in the quantity demanded at any given
price. An increase in demand causes a rightward shift of the demand curve. A decrease in
demand causes a leftward shift.

4. There are five main factors that shift the demand curve:

• A change in the prices of related goods or services, such as substitutes or

complements 


• A change in income: when income rises, the demand for normal goods increases and
the demand for inferior goods decreases. 


• A change in tastes 


• A change in expectations 


• A change in the number of consumers 
5. The market demand curve for a good or
service is the horizontal sum of the individual demand curves of all consumers
in the market. 
6. The supply schedule shows the quantity supplied at each
price and is represented graphically by a sup- ply curve. Supply curves usually
slope upward. 


7. A movement along the supply curve occurs when
a price change leads to a
change in the quantity sup- plied. When economists talk of increasing or
decreas- ing supply, they mean shifts of the supply curve—a change in the
quantity supplied at any given price. An increase in supply causes a
rightward shift of the sup- ply curve. A decrease in supply causes a leftward
shift. 


8. There are five main factors that shift the supply curve: • A change in input
prices
• A change in the prices of related goods and services • A change in
technology 
• A change in expectations 
• A change in the number of
producers 


9. The market supply curve for a good or service is the horizontal sum of the
individual supply curves of all producers in the market. 


10. The supply and demand model is based on the prin- ciple that the price in a
market moves to its equilib- rium price, or market-clearing price, the price at
 which the quantity demanded is equal to the quantity 


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