12

Applied Economics
Quarter 3
Module 1: Economics as an Applied
Science

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Applied Economics - Grade 12
Quarter 1 – Module 1: Economics as an Applied Science

I. Introduction:

Knowing and understanding the economic problem of the country, where everybody is
complaining of not having sufficient income to meet both ends of the family, thus family members is
suffering from scarcity. Apply and studying economics is needed nowadays. This is the reason why
people have to practice economics in daily lives, in this lesson, you are expected to understand to
make good decisions in choosing how to maximize the use of scarce resources to satisfy as many
wants as possible.

II. Objectives
At the end of the lesson you
are expected to:

ABM_AE12-Ia-d-1
 Describe the basic term’s in applied economics.
 Appreciate the importance of studying economics in one’s life.
 Recognize different economics activities existing within their locality.

III. Vocabulary List

Let’s unlock the difficulties thru the help of most common terms below that used in the topics.
 Resources- things that used to make other goods.
 Needs – stuff we must have to survive, generally: food, shelter, and clothing.
 Wants- stuff we would really like to have (fancy food, shelter, clothing, big screen TVs,
jewellery, conveniences, also known as luxuries.
 Goods- tangible (you can touch it) products we can buy.
 Sevices - works that is performed for others.
 Purchasing Power- the amount of goods and services that can be purchased with a unit of
currency
 Opportunity Cost- refers to the value of the best foregone alternative.
 Trade-offs – one thing is given up in order to get another.
 Stuff- Goods and service

www.123F.com

Economics comes from two old Greek words - ‘oiko’, which means ‘home’
and ‘nomos’ which means ‘management’. (household management).
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What is Economics?

 Economics -is the study of social behaviour guiding in the allocation of scarce resources to
meet the unlimited needs and desires of the individual members of a given society. Adam
Smith is the Father of Modern Economics.

Economics as defined by authors of Economics books

 Paul Samuelson (Economics) – the study of how people and society end up choosing, with or
without use of money, to employ scarce resources that could have alternative uses to produce
various commodities among various persons and groups in society.
 Roger Le Roy Miller (Economics, Today and Tomorrow) – “economics concerns situations in
which choices must be made about how to use limited resources, when to use them and for
what purposes. Resources can be defined as the things people use to make the commodities
they want.”
 Hall and Loeberman (Macroeconomics: Principle and Applications) – the study of choice
under the condition of scarcity.
 Economics is the study of the proper allocation and efficient use of available scarce resources
in the production of goods and services for the maximum satisfaction of human needs and
wants. (Feliciano R. Fajardo).
Economics as a science

Economics is a science because it is an organized body of truth, coordinated, arranged and

systematized with reference to certain general laws and principles. (Observation, Formulation of
theories, Gathering of data, Experimentation, Conclusion, Generalization). It is regarded as a science
because it uses scientific methods to build theories that can help to understand how individuals,
groups, and organizations interact within the social structure to address key questions about the
production and exchange of goods and services.
Economic analysis seeks to explain economic events using some kind of logic based on a set of
systematic relations. It is a social science because the subject of economics is people or societies and
their behaviour which is unpredictable in nature, a social science is, broadly speaking, the study of
society and how people behave and influence the world around them. In addition, economics study
were individual makes choices in allocating scarce resources to satisfy their unlimited wants.

Essence/ Relevance of Studying Economics

 To understand the world better

Applying the tools of economics can help you understand global and disastrous events such as wars,
famines, epidemics, and depressions. Economics has the power to help us understand these
phenomena because they result from the choices we make under the condition of scarcity.
 To gain self-confidence and become wise decisions makers
Mastery of economics will help you to understand how things work in your society thereby “feeling
equipped”.
 To achieve social change and contribute to National Development
Economics can help us understand the origins of serious social problems such as: unemployment,
hunger, poverty, disease, child abuse, drug addiction, violent crime. It will also explain why previous
efforts to solve these problems have failed, and help us to design new, more effective solutions.

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BASIC CONCEPT OF ECONOMICS

We all know that economics is a social science, which deals

with production, distribution and consumption functions. It is all
about making choices regarding the allocation of scarce resources, so
as to make their best possible use and satisfy human wants and
needs. In economics, we often go through the terms needs and wants,
but have you wondered about their differences. Needs point out
something you must have for survival.
On the other hand, wants refers to something which is good
to have, but not essential for survival. For the purpose of spending and saving money wisely, every
person must know the difference between needs and wants.
By the term needs, we mean those requirements which are extremely necessary for a human
being to live a healthy life. They are personal, psychological, cultural, social, etc that are important
for an organism to survive.
In ancient times the three basic needs of the man are food, clothing and shelter but with the
passage of time, education and healthcare also became integral, as they improve the quality of life.
They are a person’s first priority as they are the things that they keep us healthy and safe. Therefore,
if needs are not satisfied in time, it may result in illness, inability in functioning properly or even
death.
In economics, wants are defined as something that a person would like to possess, either
immediately or at a later time. Simply put, wants are the desires that cause business activities to
produce such products and services that are demanded by the economy. They are optional, i.e. an
individual is going to survive, even if not satisfied. Further, wants may vary from person to person
and time to time.
We all know that human wants are unlimited while the means to satisfy those wants are
limited. Hence, all the wants of an individual cannot be met and they must seek for alternatives.

INTRODUCTION TO ECONOMICS
(Applied Economics by: Rosemary P. Dinio, PhD , Greorge A. Villasis)

Everybody goes through a day faced with constraints or limitation. People always complain
about not having enough to meet all the family’s needs. This, in effect, is the existence of what we
call scarcity. That is, insufficiency of resources to meet the wants of customers and insufficiency of
resources of producers that hamper enough production of goods and services.
Scarcity is the reason why people have to practice economics. Part of human behavior is the
tendency of man to want to have as many goods and services as he can. However, his ability to buy
goods and services is limited by his income and purchasing power. It is therefore in this context that
man has to practice economics.
Scarcity is a condition where there are insufficient
resources to satisfy all the needs and wants of a population.
Scarcity may be relative or absolute. Relative scarcity is
when a good is scarce compared to its demand. For example,
coconuts are abundant in the Philippines since the plant
easily to grow in our soil and climate. However, coconuts
became scarce when the supply is not sufficient to meet the
needs of the people. Relative scarcity occurs not because the
good is scarce per se and is difficult to obtain but because of circumstances that surround the
availability of the goods. Bananas are abundant in the Philippines and are being grown in a lot of

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regions around the country. But when a typhoon destroys banana plants and farmer has no bananas to
harvest, then bananas become relative scarce.
On the other hand, absolute scarcity is when supply is limited. Oil is absolutely scarce in the
country since we have no oil wells from which we can source our petroleum needs, so we rely
heavily on imports from oil-producing countries like Iran and other Middle Eastern countries.
Cherries are absolutely scarce in our country since we do not have the right climate to grow them and
we have to rely on imports for our supply of cherries. This explains why cherries are very expensive
in the Philippines.

CHOICE AND DECISION-MAKING

Because of the presence of scarcity, there is a need for

man to make decisions in choosing how to maximize the use of
the scarce resources to satisfy as many wants as possible. A
homemaker who has a monthly budget needs to decide on how
to utilize it to pay the rent, to buy food, to pay the children’s
tuition fees, and to buy new clothes and shoes. She needs to
make a choice. If she decides not to buy new shoes for her children at start of the school year, then
this is the choice she gave up.
Opportunity cost refers to the value of the best foregone alternative. When land is devoted
exclusively to the cultivation of rice, we give up an output of bananas or mangoes that we could have
planted on that area. A producer, who decides to transform all his leather into shoes, gives up the
chance to produce bags with that leather. A school teacher, who could have worked in the bank, gives
up his salary as a manager. That salary is his opportunity cost. Without scarcity, a person does not
need to make choice since he/ she can have everything he/ she wants.
The concept of opportunity cost holds true for individuals, businesses and even a society. In
making a choice, trade-offs are involved. The opportunity cost of watching a movie in a cinema is the
value of other things that you could have bought with that money such as a pint of ice cream, a
combo meal in the fast food, or a simple t-shirt to be used in P.E class. Another example is giving up
work in favor of recreational activity, say you go on a week’s stay in Boracay on leave without pay.
Then you are giving up the income you would have earned had you not decided to go on trip.
Another example would be a business proprietor that withdraws Php 10, 000 from his savings
account so he can buy materials to be used in his business.

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12

Applied Economics
Quarter 3
Module 2: Basic Economic Problems

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Applied Economics - Grade 12
Quarter 1 – Module 2: Basic Economic Problems

I. Introduction:
Knowing and understanding the economic problem of the country. The existence of scarcity
creates the basic economic problem faced by every society, rich or poor; how to make the best use of
limited productive resources to satisfy human needs and wants. In this lesson, you are expected to
understand this basic problem by answering the three basic questions (What, How and for whom to
produce?).

II. Objectives
At the end of the lesson you
are expected to:

ABM_AE12-Ia-d-2
 Identify the basic economic problem of the country.
 Develop a sense of awareness about the basic economic problem.
 Complete the key concepts of basic economic problem table.

III. Vocabulary List

Let’s unlock the difficulties thru the help of most common terms below that used in the topics.
 Capital -the things we use to produce new product (tools, machinery, factories).
 Human capital -is brainpower, ideas, innovation
 Production- is the transpormation of inputs into output of a commodity that a firm can
produce per period of time with each set of input.
 Consumption- refers to the use of goods and services to satisty human wants.
 Services- things purchased by consumers that do not have physical characteristics. Ex.
doctors, teachers, actresses and shop assisstants.
 Capital goods –are used to make other goods.
 Consumer goods -final products purchased directly by consumer.
 Input- are the resources used in the production of goods and services
 Output- refers to the product created as a result of combination of inputs in the production
process.
 Purchasing power- value of a particular monetary unit in terms og the goods and services.
 Final Goods- are goods that are ready for direct consumption and are then sold to customers
for their use.
CONCEPT OF PRODUCTION

 Production is originated from the word ‘produce’. In business studies, production means the
act of producing a product, an output or a service which has values to fulfill the consumers’
wants and needs. It is also meant by the process of manufacturing goods using labour,
machines, tools, chemical and biological processing, or formulation, by converting raw
materials or components. Later, firms will add value to the final product, and the value added
is the difference between the cost of inputs and the final selling price of the product or service.
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 And this is how a business gets their profit from. https://production-and-consumption-
bs.weebly.com/production.html
 Production is defined as the process of converting the input (raw material) into output.
 Production may be an activity that generates income.

ECONOMIC RESOURCES
 Economic resources, also known as factors of production, are the resources used to produce
goods and services. These resources are, limited by nature and therefore, command a payment
that becomes the income of the resources owner.

4 Factors of Production
(C.E.L.L)
 C-apital- man-made resources used in the production of goods and services, which include
macheniries and equipment (the things we use to make another product).
The owner of capital earns an income called interest.
Human capital is brainpower, ideas, innovation.
 E-ntrepreneur- (persons) who invest time, natural resources, labor and capital that are all
risks associated with production.
 L-and- soil and natural resources that are found in nature and not man-made. Owners of land
receive a payment known as rent.
 L-abor- Physical and human effort exerted in production. It covers manual workers like
construction workers, machine operators, and production workers, as well as proffessionals
like nurses, lawyers, and doctotrs etc. The term also includes jeepney drivers, farmers,
fisherman. The income received by labors is referred to as wage.

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The Basic Economic Problem

The existence of scarcity creates the basic economic problem faced by every society, rich or
poor, and how to make the best use of limited productive resources to satisfy human needs and
wants. To solve this basic problem, every society must answer these three basic questions:

1. What to produce?
(What goods and services will be produced?)

 The system must determine the desires of the people.

 Goods and services must be based on the needs of the consumers.

Factors to consider:

a.) Availability of resources b.) Physical environment c.) Customs and traditions of people

For example:

An economy must decide whether they should produce kitchen appliances or weapons, build
and fix roads or buy textbooks for schools.

2. How to produce?
(How will goods and services be produced?)
 The system must select the proper combination of economic resources in producing
the right amount of output.
 The quality of output must comes first before the quantity.
For example

Should we use copper or plastic to make pipes? Should machines be used to make clothing
or should workers make it by hand? Should the power plant be built close to the ocean or inland?
Which fertilizer is best for growing strawberries? There are millions of decisions that need to be
made to figure out how to produce goods and services.

3. For whom shall the goods and services be produced?

(Who will consume the goods and services?)
 This has something to do with distributon.
 Once the goods are produced, how shall they be distributed?
Once the goods and services are produced, who will get to consume them? Will people
consume them on a first-come, first-served basis? Should goods be allocated or given out by height,
weight, religion, age, gender race, looks, strength, health or wealth? How should the goods and
services be distributed among the people?

Another Basic Economic Problems

1. Scarcity- refers to the tension between our limited resources and our unlimited wants and needs.
2.Unemployment- is a situation where people who are willing and able to work are seeking work but
cannot find jobs.
Common Causes:
a.)The number of people entering the job market has been greater than the number of jobs
created.
The rural-urban migration increases, due to employment opportunities.

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 www.pinterest.com

 few services  access to services

 lack of job opportunities  better job opportunities
 unhappy life  more entertainment facilities
 poor trasport links  better transport links
 natural disasters  improved
 wars  living conditions
 shortage  family links

b.) Many of the unemployed individuals are college graduates.

What can be done to solve uneployment problem?
1. Appropriate economic policies for labor-intensive industries.
2. Improve the educational system of the country especially in the rural areas.
3. Minimize rural urban migration by improving the economic environment in rural areas.
4. Proper coordination between government and the private sectors to solve the problem of
job mismatch.
5. Slowing populaltion growth. Philippine growth must increase faster than the population.
Limit the size of families.
6. Provision of more investment opportunities to encourage local and international
investment.
4. Poverty- is the state of being extremely poor. It is a condition where people’s basic needs for
food, clothing and shelter are not being met.

Common causes:

 increase in population
 increase in the cost of living
 unemployement
 income inequality

What can be done to solve the poverty problem?

1. Reduce unemployment
2. Appropriate policy on labor income
3. Provision of unemployment benefits for those who will be unemployed due to natural or
man-made calamities. (Ex. Typhoon, bombing of terrorists, Earthquake)
4. Increase social services like education, health care and food subsidies for sustainable
poverty reduction.
5. Appropriate policy on labor income.

5. Infrastructure- the basic facilities, services and installations needed for the operation of a
community or society (e.g. roads, transportation, communication, power)

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What can be done to improve the quality of infrastructure?
1. The government shall implement fiscal reform program.
2. Continue reform in key sectors- particularly power, roads and water- to improve cost
recovery, competition, and institutional credibility and sharply reduce corruption.
3. Improving central oversight of the planning and coordination of investments.
4. Focus on investments through public-private partnerships to achieve faster delivery of
services.

6. Income inequality- refers to the gap in income that exists between the rich and the poor.
Income- is the money that an individual earned from work or business received from
investments.

Major causes of income inequality

1. Political culture - “palakasan” “utang na

loob”
Example: voting for the wrong person www.slideshare.com
(cto)

during election.
2. Indirect taxes- poor people shoulder this taxes like Value Added Tax – 12%.
3. Income Taxes

What can be done to solve the problem of income inequality?

1. Policies to enforce progressive rates of direct taxation on
high wage earners and wealthy individuals.
2. Direct money transfers and subsidize food programs for the
urban and rural poor.
3. Direct government policies to keep the price of basic
commodities low.
4. Raise minimum wage.
5. Encourage profit sharing.

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 Source: Buffalo State, The State University of New York. Applied Economics,
M.A. Retrieve from https://economics.buffalostate.edu/applied-economics-
ma
12

Quarter 3 – Module 3:

The Market: Demand,

Supply and Equilibrium
Applied Economics

12
Applied Economics - Grade 12
Quarter 1 – Module 3: The Market: Demand, Supply and Equilibrium

I. INTRODUCTION

Demand identifies the needs and wants of the consumers while the supply determines the
good or service produces by the producers. The consumers and producers/sellers interact in
the market for the exchange of goods and services at a given price. When a consumer and
producer/seller do not agree with the quantity demanded and quantity supplied respectively
for the price of a product or service, how do the demand and supply determine the market
price?

II. OBJECTIVES

At the end of the lesson, you will be able to:

1. Learn the concept of market demand, the market supply, and the market equilibrium;
2. Discuss and explain the factors that affect demand and supply to the consumers and
producers respectively;
3. Analyze the effect of change in demand and supply;
4. Apply the principles of demand and supply to illustrate how prices of commodities
are determined.

III. VOCABULARY LIST

Please read the economics terminologies listed below before you proceed to the next pages to
align and guide you with the discussion of the lesson:
 Complementary Goods – two goods for which an increase in the price of one leads
to a decrease in the demand for the other.
 Demand – pertains to the quantity of a good or service that people are ready to buy
at a given price within a given period.
 Demand Curve – a graph of the relationship between the price of a good and the
quantity demanded.
 Demand Schedule – a table that shows the relationship between the price of a good
and the quantity demanded.
 Equilibrium – a situation in which supply and demand have been brought into
balance.
 Equilibrium Price – the price that balances supply and demand.
 Equilibrium Quantity – the quantity supplied and the quantity demanded when the
price has adjusted to balance supply and demand.
 Law of Supply and Demand – the claim that the price of any good adjusts to bring
the supply and demand for that goods into balance.
 Market – refers to a place where a group of buyers and sellers of a particular good or
service interacts.

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  Quantity Demanded – the amount of a good that buyers are willing and able to
purchase.
 Quantity Supplied – the amount of a goods or services that sellers are willing and
able to sell.

 Shortage – a situation in which quantity demanded is greater than quantity supplied.

 Substitute Goods – two goods for which an increase in the price of one leads to an
increase in the demand for the other,
 Supply – refers to how much of a product a business owner can supply to buyers and
at what price.
 Supply Curve – a graphical representation shows the relationship between the price
of the product sold or the factor of production and the quantity supplied per period.
 Surplus – a situation in which quantity supplied is greater than quantity demanded.
Source: Mankiw NG. Principles of Economics, 5th edition.
eBook. http://www.ccebook.cne

MARKET DEMAND

What Determines the Quantity an Individual

Demands?

When you buy goods or rendered services, what

factors affect in your decision? Here are some of
the answers you might give:
1. Price
When you buy a product or render a service,
your concern is whether it is expensive or
inexpensive. If the price of a particular product
or service rise, you buy less, and if the price fall,
you buy more. Hence, you might conclude that the quantity demanded is negatively
related to the price. As the quantity demanded of a product or service increases, the
price falls and decreases as the price rises.
2. Income
What would happen to your family's demand for grocery, if your father gets promoted,
and his salary increases? Most likely, it would rise. It is because an increase in an
individual's income, generally, increases his/her purchasing power to demand more
goods or services that one is not able to purchase in a low income. On the other hand,
an individual with low income reduces the purchasing power that makes the demand for
goods and services to decline.
3. Prices of Related Goods
When a particular price of product increases, you tend to look closely related
commodities or substitute goods. Substitute goods generally offered at a lower price,
thus, makes it more attractive to you as a buyer to buy such products, sample butter to
margarine.
The complementary goods also affect the quantity demanded of an individual. These

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 are goods which cannot exist without the other product. For instance, the jeep cannot
run without gasoline, and your cellphone cannot function if you do not have a sim card
or load.
4. Tastes and Preferences
Your buying decision-making affects your likes and dislikes about the product. Your
tastes and preferences as a consumer, frequently, decide whether you will buy or not,
or how many quantities you will buy for a product.
5. Expectation of Future Prices
Your forecast about the probability to happen in the future may affect your demand for
a product or service today. For example, you are planning to give your best friend a
perfume on his birthday next month. However, the SM Department Store announced a
50% markdown on the price of perfume next week. If you have enough money, you
may be more willing to buy the perfume next week rather than next month.
6. Occasional or Seasonal Products
There are products which sellable for a short time during the event only are called
occasional or seasonal products. For example, during Christmas season, demand
items are Christmas decors, hams, and quezo de bola, while on Valentine’s Day,
demand rises for red roses and chocolates. However, after such events, the demand
for these products go to its original level.

7. Population Change
Another way to determine for the quantity demanded on some type of goods and
services is through the size of a population in a certain area. This means that the
quantity demanded of a good and service is measure by the number of demands of
people residing in the area. When a population increases, the more goods and
services are demanded, because of the rising population. Inversely, a decrease in
population results to decline the demand. For example, if you have four (4) members in
your family, then one (1) sack of rice is enough as your consumption for a month.
However, if you have twelve (12) members in the family, one (1) sack of rice is not
enough to sustain your need. Your family demand for one-month consumption of rice is
at least three (3) sacks.

To analyze how market work, you need to determine the market demand which is the
sum of all the individual demands for a particular good or service.

Shift in the Demand Curve

Whenever any determinant of demand changes, other than the good’s price, the demand
curve shifts. Any change that increases the quantity demanded at every price, shifts the
demand curve to the right. Similarly, any change that reduces the quantity demanded at
every price, shifts the demand curve to the left.

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 Source: Pearl Matthews. Essential Question: What factors affect demand? Retrieved from
https://slideplayer.com/slide/13766856/

Demand Curve Shift to the Left (Decrease)

Demand Curve Shift to the Right (Increase)

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 MARKET SUPPLY
What Determines the Quantity an Individual
Supplies?
What determines the quantity of a product the
sellers are willing to produce and offer for sale?
Here are some of your possible answers:
1. Price
The sellers sell more products at a higher price
than at a lower price. These are because higher
sales result in higher profits. If your family has
farmland and a mini-grocery store and you are selling rice, you are more willing to sell
rice at a high price because selling it is profitable. By contrast, when the price of rice is
low, you sell less rice because your family business is less profitable.
2. Input Prices
The cost of production of rice, like the cost of seeds, equipment, and fertilizer, affects
the price of rice. Hence, when the price of one or more of these inputs rises, your store
becomes less profitable; consequently, your store supplies less rice. If input prices rise
substantially, your family might stop or sell no rice at all. Hence, the quantity supplied
and the input prices of production have a negative relationship.
3. Technology
New technology makes increases the production of a product. Using harvest
automation and autonomous tractors technology makes farms more efficient and
productive. By reducing production costs, the advance in technology raised the supply
of rice in the market.
4. Future Expectation
This factor impacts sellers as much as buyers. If you foresee an increase in the price of
rice, you may decide to discontinue the current supply to take advantage of the future
rise in price, thus decreasing market supply. If you, however, expect a decline in the
rate of rice, you will increase the current quantity supplied of rice.
5. Number of Sellers
The number of sellers is another determinant to determine the quantity supplied in the
market. If you are more sellers there are in the market, the more the supply of goods
and services will be available. If more farmers plant rice instead of other crops, then the
quantity supplied of rice in the market will increase due to an increase in production,
assuming that no destructive calamities strike the country.
6. Weather Conditions
Natural disasters – typhoons, drought, and others – reduce the supply of agricultural
commodities while good weather has an opposite impact. If your farm or riceland
destroys by a calamity, the quantity supplied of rice in the market will decline.
7. Government Policy
The government also influences the market supply through policies like trade
agreements, farm subsidies, tariffs, property taxes, and conservation programs. For
instance, through government programs like the Conservation Reserve Program

17
 (CRP), your family can be paid not to plant crops for a certain number of years. The
more number of acres enrolled in CRP will reduce the supply of the commodities
commonly grown in your land.

To analyze how market work, you have to determine the market supply by the sum of
all of the supplies of the sellers.

Shift in the Supply Curve

Whenever there is a change in any determinant of supply, other than the good’s price, the
supply curve shifts. Any change that raises the quantity supplied at every price shifts the
supply curve to the right. Similarly, any change that reduces the quantity supplied at every
price shifts the supply curve to the left.

Supply Curve Shift to the Right (Increase)

`
Source: Pearl Matthews. Essential Question: What factors affect demand? Retrieved from

Supply Curve Shift to the Left (Decrease)

https://slideplayer.com/slide/13766856/

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 MARKET EQUILIBRIUM

You learned the different factors affecting demand and

supply now you try to combine the demand and supply
curve to see how to determine the quantity of a good sold in
a market and its price. You will notice that the two lines
have intersected across the point, and this is called the
market equilibrium. The price at which the demand and
supply curve meet is called the equilibrium price and the
quantity is called the equilibrium quantity.

At the equilibrium price, the quantity of the good that buyers are willing and able to buy is the
same as the quantity that sellers are willing and able to sell. The equilibrium price sometimes
called the market-clearing price because, at this price, everyone in the market has been
satisfied. Buyers have bought all they want to buy, and the sellers have sold all they want to
sell. (N. Gregory Mankiw)

The behavior of buyers and sellers naturally drives markets toward their equilibrium. When
the market price is above the equilibrium price, there is a surplus of the good, which causes
the market price to fall. When the market price is below the equilibrium price, there is a
shortage, which causes the market price to rise. (N. Gregory Mankiw)

Three Steps to Analyze Changes in Equilibrium

To analyze how any event influences or how the determinants of demand and supply affect
the market, you have first to draw the demand curve and the supply curve at the same
graph. Then, examine how the event affects the equilibrium price and the quantity by
performing the following three (3) steps:
1. Decide whether the event shifts the supply curve or the demand curve (or both).
2. Decide which direction the curve shifts – to the right or to the left.
3. Compare the new equilibrium with the old equilibrium
(N. Gregory Mankiw)
Illustration:
Suppose that one summers the weather is very hot. How does this event affect the
market for ice cream?
To answer this question, you must draw a demand and
supply curve and apply and follow the three steps to
analyze changes in equilibrium:
1. The hot weather affects the demand curve by
changing people’s taste for ice cream. That is, the
weather changes the amount of ice cream that
people want to buy at any given price. The supply
curve is unchanged because the weather does not
directly affect the firms that sell ice cream.

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2. Because hot weather makes people want to eat more ice cream, the demand curve
shifts to the right. The increase in demand as the shift in the demand curve to the right
indicates that the quantity of ice cream demanded is higher at every price.
3. The increase in demand raises the equilibrium price and the equilibrium quantity. In
other words, the hot weather increases the price of ice cream and the quantity of ice
cream sold.

Source: N. Gregory Mankiw. Principle of Economics. E-book CCebook.

http://www.ccebook.cn

What Happens to Price and Quantity When Supply or Demand Shifts?

If you are confused with your answer, whether the demand and supply will increase, or
decrease, or no change at all, herein the table that you can use to check your answer. But,
before you proceed to use this table, you have to draw the demand and supply curve first,
then apply and follow the three (3) steps to analyze the changes in equilibrium.
The table shows the predicted outcome for any combination of shifts in the demand curve
and supply curve. In order to answer the above question for any certain situation, pick an
entry in this table and make sure you can explain to yourself why the table contains the
prediction it does.
No Change An Increase A Decrease
in Supply in Supply in Supply
No Change in Demand 𝑷 𝐬𝐚𝐦𝐞 𝑷 𝐝𝐨𝐰𝐧 𝑷 𝐮𝐩
𝑸 𝐬𝐚𝐦𝐞 𝑸 𝐮𝐩 𝑸 𝐝𝐨𝐰𝐧
An increase in Demand 𝑷 𝐮𝐩 𝑷 𝐚𝐦𝐛𝐢𝐠𝐮𝐨𝐮𝐬 𝑷 𝐮𝐩
𝑸 𝐮𝐩 𝑸 𝐮𝐩 𝑸 𝐚𝐦𝐛𝐢𝐠𝐮𝐨𝐮𝐬
A Decrease in Demand 𝑷 𝐝𝐨𝐰𝐧 𝑷 𝐝𝐨𝐰𝐧 𝑷 𝐚𝐦𝐛𝐢𝐠𝐮𝐨𝐮𝐬
𝑸 𝐝𝐨𝐰𝐧 𝑸 𝐚𝐦𝐛𝐢𝐠𝐮𝐨𝐮𝐬 𝑸 𝐝𝐨𝐰𝐧

𝑷 − 𝒑𝒓𝒊𝒄𝒆 𝑸 − 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚
Source: N. Gregory Mankiw. Principle of Economics. Retrieved from
http://www.ccebook.cn

MARKET EQUILIBRIUM: A MATHEMATICAL APPROACH

There are three (3) ways to determine the market equilibrium: using the table/schedule,
graphical representation, and the mathematical approach. You have already learned two of
these three (3) methods from the previous discussion of this module.
You can also determine the market equilibrium by using your basic knowledge in algebra or
using the mathematical approach. To do this, you need the three (3) sets of equations as
follows:
1. Demand Equation: 𝑸𝒅 = 𝒂 − 𝒃(𝑷)
2. Supply Equation: 𝑸𝒔 = 𝒄 + 𝒅(𝑷)
3. Equilibrium Equation: 𝑸 𝒅 = 𝑸𝑺

𝑸𝒅 = 𝒂 − 𝒃(𝑷) 𝑸𝒅 = quantity demanded at a particular price

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 𝒂 = intercept of the demand curve
𝒃 = slope of the demand curve
𝑷 = price of the good at a particular time period

𝑸𝒔 = 𝒄 + 𝒅(𝑷) 𝑸𝒔 = quantity supplied at a particular price

𝒂 = intercept of the supply curve
𝒃 = slope of the supply curve
𝑷 = rice of the good sold

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