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How the market affects buyers and sellers

By BARBARA TRANQUILLA

© St. Petersburg Times, published November 16, 2000


Editor's note:

Welcome to the St. Petersburg Times' Newspaper in Education page! This year's series is about something we all love and wish we had more of: money. Throughout the school year in this space you will find fun and informational stories about how to earn, keep and save money. Developed by the Florida Council on Economic Education, the series explores such topics as personal finance, business etiquette and ethics, making decisions, managing your time and money and more, all geared toward you, not just your parents! We hope you enjoy this economic adventure.

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[Times art: Teresanne Cossetta]
Have you ever wondered how sellers determine the price of a product, such as a CD or a scooter? Did you know you are part of that process? Price is based on two strong forces of business: supply and demand.

You, too, can have chocolate chip cookies, provided you are willing to pay a price that chocolate chip cookie makers -- even Keebler elves -- are willing to take for their product. Chances are those practiced elves have already tested buyers to see just how much they can get for their cookies, because if the cookies are too pricey, buyers will simply go buy something else and the elves will be left with too many cookies and not enough money. Economists call this the invisible hands of competition in the free marketplace. This practice sets a price that meets the self-serving interests of both buyers and sellers.

This exchange price is what consumers pay for the product, and it is the money suppliers receive for their product to cover their costs for labor and risk-taking. Entrepreneurs, another term for owners of the business, assemble resources such as land, labor and capital to make a product. But they have no guarantee that their production will earn income. That is risk-taking. All entrepreneurs take risks and expect to be paid for the risk, as well as other costs, to produce the product. In the market system someone's income is another one's expense.

Anytime buyers and sellers come together, a market is created. It may be in the supermarket, it may be a phone call to Home Shopping Network, or it may be logging on to Amazon.com. Buyers are careful about how much they are willing to pay for a product, often shopping around for the best price for their money. Suppliers respond in the same way by moving to a price where there are no leftovers or shortages.

Buyers of the cookies will be willing and able to purchase more cookies at a low price and fewer cookies at a high price. This happens because, at higher prices, cookie buyers' dollars purchase less than at lower prices. Economists call this the income effect.

Cookie consumers are more willing to buy cookies at low prices. At high prices, cookie consumers look for other products to buy instead, such as ice cream, Popsicles, or candy bars. Economists call this the substitution effect.

Of course, cookie eaters' satisfaction with devouring cookies diminishes with each cookie consumed. Economists call this the Law of Diminishing Utility. As more cookies are eaten, consumers are willing to pay less for each additional cookie because it gives them less satisfaction than the previous cookie.

When price is high, quantity demanded is low. When price is low, quantity demanded is high. This inverse relationship is the Law of Demand.

Price is the most important reason cookie buyers, or any buyers in any market for that matter, do what they do. Price also controls suppliers' willingness and ability to bring products to the marketplace. Price must cover suppliers' costs for land, labor, capital and other costs incurred in providing the product or service. Capital, as used by economists, means equipment and machinery. At a higher price, suppliers will be more willing and able to bring more products to sell because they will make more money. When prices are low, suppliers are less willing and able to offer products. So the Law of Supply is a direct relationship between price and quantity supplied. As price goes up, quantities supplied go up and as price goes down, quantities supplied go down.

Try it out

If we divide a classroom into two groups -- chocolate chip cookie makers and chocolate chip cookie buyers -- we can create a marketplace and conduct an economic experiment to test the outcome of the laws of supply and demand. Cookie buyers in the classroom must answer a series of questions; then a demand schedule for this market of chocolate chip cookies can be made. Here are the questions: How many cookies are you willing and able to purchase at 25 cents a cookie? At 50 cents? At 75 cents? At $1 a cookie? At $1.25 a cookie? Count the quantity of cookies demanded at each price and record it. (Remember to record the number of cookies and not the number of cookie buyers.)

The following is a typical demand schedule for chocolate chip cookies. See how your class compares:

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You can draw a graph of the information above because we have two variables, price and quantity demanded. Economists place price on the y axis (vertical) and quantity demanded on the x axis (horizontal). You will notice that the independent variable, price, is on the y axis. This means if something other than price changes consumers' response to amounts of cookies purchased, the demand curve will shift to the left or right showing a change in quantities within the same price range.

Having determined the demand for cookies, the supply schedule is needed before market price can be found. Ask the suppliers in class (the cookie makers who want to earn a profit from producing cookies) a series of questions: How many cookies will you bring to market if you receive 25 cents a cookie? 50 cents? 75 cents? $1 a cookie? $1.25 a cookie? Add this information to the table.

Graph this information with the demand information. Where the two curves intersect determines equilibrium price. This example shows that equilibrium price is 75 cents and equilibrium quantity is 15 cookies. That is the best price -- the one at which both buyers and suppliers get the best deal.

Other factors affect the amounts buyers are willing and able to purchase at each price. For example, what if the number of buyers changed?

Or if buyers' income changed?

Or if buyers' get tired of chocolate chip cookies?

Or if the class added more people?

Or if everyone had $5 extra in their pockets?

Or if Tiger Woods added his endorsement to chocolate chip cookies?

Or if buyers thought cookies enhanced popularity?

Or if fudge brownies became very expensive?

Then another curve could be graphed and another intersect for supply and demand would occur.

Suppliers' behavior is affected by more than price, too, and that affects the supply of goods. Suppose these circumstances changed for suppliers and we asked how many cookies are you willing and able to bring to the market if:

The number of suppliers changed and you had more competition?

Technology to make cookies changed and it became more expensive to produce them?

Resource costs for chips, workers, flour and electricity changed, making production costs higher?

Supplier expectations changed and buyers thought cookies should be bigger?

Money Stuff: Get it! Spend it! Keep It!

Introduction and previous chapters

Government taxes, subsidies and regulations changed and added to the cost?

Then, a new supply schedule would result. If quantities increased at each price level, the supply curve would shift to the right. If quantities decreased at each price level then the supply curve would shift to the left.

Whenever the demand or supply curve shifts, the equilibrium price and equilibrium quantity change.

It's almost magical the way supply and demand work to eliminate shortages and surpluses in the market, to set price and to allocate resources to produce what consumers want. Just look at the shelves in our marketplaces. Consumers have lots of choices when lots of suppliers are competing for their dollars. Supermarket aisles offer chocolate chocolate-chip cookies, white-chocolate chip cookies, fudge-chocolate chip cookies, M&M chip cookies, chocolate chip with walnuts cookies, chocolate coconut chip cookies -- and on go the choices.

Hungry?

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Barbara Tranquilla is a longtime teacher of economics in the Dade County public school system. She has won numerous state and national economics teaching awards and in 1995 was the first to be named Florida Economics Educator of the Year by the Florida Council on Economic Education.

About the Florida Council on Economic Education

Money Stuff was developed by the Florida Council on Economic Education and project director Fonda Anderson. The council is a statewide non-profit organization founded in 1975 to educate K-12 teachers and students about the free enterprise system and to instill in them an appreciation for a market economy. For more information on the council's programs for teachers and students, please call (813) 289-8489.

About Newspaper in Education

The St. Petersburg Times devotes news space to NIE features throughout the year, including this classroom series. The Times' NIE department works with local businesses and individuals to enrich the classroom experience by providing newspapers, supplemental guides and educational services to schools in the Tampa Bay area. To find out how you can become involved in NIE, please call (727) 893-8969 or (800) 333-7505, ext. 8969. For past chapters on finance and business etiquette and ethics check out http://www.sptimes.com/nie and click on Money Stuff.

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