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3.4: Supply and Demand – A Form of Communication

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    The free market’s main benefit over alternative economic systems is that it is more efficient with factors of production. The free market can achieve higher levels of efficiency with the 2-C’s:

    Communication: Communication between market participants

    Competition: Competition between suppliers

    Communication and competition are the tools with which the free-market system achieves high levels of efficiency.

    Two very well-known topics in economics are supply and demand. The supply and demand model are simply a way of showing how two market participants communicate to get things done.

    Supply and demand are all about communication.

    It doesn’t take much economic training to know that miscommunication can cause mistakes. And mistakes cause waste. For example, what if a customer fills out an order slip for new paper for her printer and the salesclerk misreads the number in the “quantity ordered” box and ships 700 reams of paper instead of the 100 the customer really wanted? This miscommunication leads to a misallocation of resources (which is really another way of saying that a mistake led to waste).

    It Takes Two

    It takes two to tango and it also takes two to make a deal. There is a supplier and a demander involved in all free market transactions. They are considered market participants. Clear and timely communication between these two market participants is essential if they hope to get anything done.

    Who are suppliers and demanders? Most people assume businesses play the role of suppliers and households the demanders. This is true – sometimes. The role of the supplier and demander depends on the market.

    Whenever one speaks of the “free market”, they are making a bit of a mistake. The correct phrasing is “free markets.” The free-market system is really made up of two markets: product and factor. See diagram.

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    Figure 4

    Product markets are where finished goods and services are bought and sold (from Big Mac to tax preparation). Factors markets are where factors of production are bought and sold (from factory worker services to Caterpillar tractors).

    In the product market, households are the demanders (notice the arrow pointing from the product market toward households) and the business firms are the suppliers (notice the arrow pointing from businesses toward the product market).

    When we move to the factor market, the roles of the market participants reverse. Now, members of households are the suppliers (notice the arrow pointing from households toward the factor market). Households are a supplier of labor (a factor of production) to the factor market. Business firms are now the demanders (notice the arrow pointing from the factor market toward business firms).

    So, the role of supplier or demander depends on the market (product or factor). For the rest of this session, we will focus on the product market. So, households will be the demanders and business firms the suppliers.

    This page titled 3.4: Supply and Demand – A Form of Communication is shared under a not declared license and was authored, remixed, and/or curated by Martin Medeiros.

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