Prices are created through interactions between sellers and buyers. Supply (sellers) and demand (buyers) is the first, most recognized model in economics. Demand represents the various numbers of items that consumers are willing and able to purchase at a series of different prices at a particular point in time. The downward slope of the line illustrates the “Law of Demand”: as prices decrease, the quantity demanded increases and vice versa. You have likely experienced this in your own life.
Let’s use school supplies as an example. Imagine that you need pencils. If the price of a pencil is $1, you buy one. However, you are willing to purchase more pencils if the price is lowered, as shown in the table below.
The pattern for supply is the opposite. Supply represents the various numbers of items that producers are willing and able to sell at a series of different prices at a particular point in time. Producers are motivated by profits. Therefore, as the prices drop, they are less and less motivated to produce quantities. The “Law of Supply” states that as the price drops, the quantity supplied also drops. The relationship is direct, creating an upward slope for the supply line.
The interaction of supply and demand is what establishes market prices.
The prices at the grocery store, sandwich shop, or online music downloading site are established by the forces of supply and demand.
The price of a twelve-inch sandwich is $5 because at that price, consumers are willing to buy 500 subs and the business is willing to sell 500 subs. The price settles at $5 not through government policymakers setting prices, but naturally. It is called the equilibrium price and is the most efficient method of allocating resources.
The price is not always correct at first. If a business marks an item too expensively, consumers react by not buying the item. A surplus emerges, and shelves become overstocked. How does the store owner react? By lowering the price. The price will spontaneously find its equilibrium.
Likewise, the price can be too low. The day after Thanksgiving is referred to as Black Friday and is famous for its low sale prices. Stores advertise products at deeply discounted rates. However, at the low prices, there are generally a limited supplies available. How do excited consumers respond? They line up, sometimes for hours in advance, before the store opens in order to get the deals. The store sells out quickly. A shopper entering the store at 4p.m. on Black Friday finds empty shelves. That condition is called a shortage.
When the price is at equilibrium rather than too low, there are appropriate numbers of items available for sale, and shoppers do not have to incur added costs of hours spent in line or searching around at many stores.
Conditions that shift the demand line are changes in consumer tastes and preferences, incomes, market size, expectations of future prices, and the prices of related goods.
Another demand shifter is a change in consumer incomes. If there is an overall decrease in wages due to a recession, buyers demand fewer normal goods. The line shifts to the left. With this new condition, the equilibrium price and quantity decrease.
The other determinants of demand also change equilibrium. If the number of buyers changes, it shifts the entire demand line. More shoppers shift the line right, and fewer shoppers shift it to the left. If consumers expect prices to change, they react by trying to buy items when they have the lowest prices. For example, a drought in much of the U.S. led many to predict that the price of beef would increase. The overall number of cows raised for beef decreased and prices went up dramatically. Expecting the increase in beef prices, many consumers stocked freezers before prices could increase. However, these predictions are not infallible. Incorrect predictions can lead quickly to surpluses and shortages. If, for example, the drought mentioned above did not have the expected impact on the cattle population, a surplus would result causing prices to drop. This is because consumers would have already stocked their freezers with the beef they needed, causing a decrease in demand.
Finally, there are two types of related goods that shift the demand line: prices of substitutes and of complements.
Many items have substitutes: a red sweatshirt instead of a blue sweater, a pork chop instead of a steak. When the price of an item increases, the demand for the substitute increases, and vice versa. A complement is an item that goes with something else: peanut butter goes with jelly, tennis shoes go with socks. According to the law of demand, if the price of one item increases, less of the item will be purchased. And if you don’t buy one item, you don’t need its complement. If the price of peanut butter increases, consumers buy less of it. That causes the demand for jelly to go down and the line shifts leftward. As a result, the price and quantity exchanged of jelly decrease when the price of its complement, peanut butter, increases.
The supply line can also shift, creating an entirely new equilibrium price and quantity.
Determinants of supply have to do with changes by producers. Conditions that shift the supply line are changes in resource costs, prices of alternate goods, technology, number of suppliers, expectations of future prices, and government policies.
If the price of resources needed for production or distribution increase, fewer items can be produced at each price level. The price of oil is an important example. Since many items are made from petroleum, when the price increases for oil, it becomes more expensive to produce. The entire supply line shifts left. The result is an increase in price and a decrease in quantity. On the other hand, new technology reduces the cost of production, causing the supply to increase, decreasing prices and increasing the quantity exchanged.
Another determinant is the price of alternate goods.
If a producer could either make luggage or purses with the same capital it already has, the company will choose to produce the item which will bring the highest prices. If the price of luggage goes up due to a change in consumer demand, the firm will choose to use its resources making suitcases instead of handbags. In turn, the supply of purses will shift to the left. As a result, the price increases and quantity decreases for the market of purses.
The number of suppliers shifts the entire supply line too. If more firms enter the market for restaurants, the supply of restaurants food increases. The increased competition has the effect of lowering prices and increasing the quantity of restaurants meals sold. On the other hand, if several landscaping companies in a region close, the outdoor services become more scarce. Supply shifts to the left, increasing the price and decreasing the quantity of landscaping on the market.
Prices may seem objective enough—after all, they appear as specific dollars and cents—but that doesn’t mean they represent the same degree of value to all of us. There’s a great deal of subjective (or personal) value in the prices we pay for things.
Think of a price as an exchange ratio. It’s the point at which a buyer and seller come together and agree to make a trade. It’s tempting to think that each party must equally value the good, service or money that’s being exchanged but that’s not the case at all. Each party values what he’s getting more than what he’s giving up or the trade wouldn’t happen in the first place.
When I buy a newspaper for one dollar, I don’t value the newspaper the same as the dollar. If that were the case, why bother to trade? I actually value the paper more than the dollar. In contrast, the person who sells it to me would rather have the dollar because he values it more than the paper.
We’ve all had the experience of buying something at a bargain price. Sure, that was the exchange ratio but we might have wanted that item badly enough that we would have gladly paid twice the price and still thought we got a bargain. So the exchange ratio just tells us the terms of an exchange; it doesn’t tell us any more about value than the fact that both sides to the trade believe they’re better off for having made it.
When economists speak of value, they are dealing with something that’s highly subjective, a concept captured by the old phrase, “Value is in the eye of the beholder.” Each of us has our own, ever-changing, impossible-to-quantify, scale of values. You like a blue shirt, I prefer a white one. Maybe we’ll change our minds tomorrow. The one thing for certain is, the more we already have of something, the less we’re likely to value one more unit of it. Economists call that marginal utility, and it’s based on our personal, subjective valuations of goods and services.
The first bite of the ice cream provides the greatest satisfaction. Likewise, I may not pay for a bottle of water if I’m already drowning in it but if I’m in a hot desert, I might pay almost any price for one. How we personally assess our situation at any given moment and how much satisfaction we think we’ll get if we make a trade will go a long way to affecting the price at which we’re willing to buy. The same goes for the seller.
Bottom line: Don’t think of price as a measure of value because it isn’t. Value is just too personal to be so precisely measured.
In a market system, the equilibrium price is only partially dependent on the costs involved in producing an item. Certainly, a business needs to earn enough money to cover all of its expenses. But the actual value of goods and services is more subjective. When a boy trades $150 for a new cell phone that tells us the boy prefers the cell phone over the $150 and that the store prefers to have $150 rather than the cell phone. The fact that overall wealth can be added just through the transfer of property from someone who values it less to someone who values it more proves the economic theory that people gain from voluntary trade.
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Law of Demand
As prices decrease, the quantity demanded increases or as prices increase, the quantity demanded decreases.
Rights which belong to us by nature and can only be justly taken away through due process.
Rights which belong to us by nature and can only be justly taken away through due process.
Except where authorized by people through the Constitution, government does not have the authority to limit freedom.
The power of government flows from the people.
Separation of powers
A system of distinct powers built into the constitution, to prevent an accumulation of power in one branch.
Checks and balances
Powers distributed among the branches of government allowing each to limit the application of power of the other branches and to prevent expansion of power of any branch.
The people delegate certain powers to the national government, while the states retain other powers; and the people, who authorize the states and national government, retain all freedoms not delegated to the governing bodies.
Fairness or reasonableness in the way people are treated or decisions are made.
The natural right of all individuals to create, obtain, and control their possessions, beliefs, faculties, and opinions, as well as the fruits of their labor.
Citizens are best able to pursue happiness when government is confined to those powers which protect their life, liberty, and property.
(or republican government) Form of government in which the people are sovereign (ultimate source of power) and authorize representatives to make and carry out laws.
(or representative government)Form of government in which the people are sovereign (ultimate source of power) and authorize representatives to make and carry out laws.
Reasoned and respectful sharing of ideas between individuals is the primary way people influence change in society/government, and is essential to maintain self-government.
The fundamental principles by which a state or nation is governed. The United States Constitution, written in 1787, lays out the roles and powers of each of the three branches of government (legislative, executive, and judicial), the protections of due process and rule of law in the states, a republican form of government, and the manner in which to amend the document.
Jefferson was a Virginia plantation owner who was the principle author of the Declaration of Independence. Jefferson served as a legislator and governor in Virginia, as well as an ambassador to France, Secretary of State under George Washington, Vice President under John Adams, and the third President of the United States. During his political career, Jefferson founded the Democratic-Republican Party with James Madison, and he bought the Louisiana Purchase from France. After his presidency, Jefferson started the University of Virginia near his home, Monticello.
Bill of Rights
The first ten amendments to the Constitution, ratified in 1791, which limit government power and protect individual liberties, including the freedoms of speech, press, religion, petition, and assembly, as well as protections against cruel and unusual punishment, unreasonable search and seizure, and other due process rights.
Ratified in 1791, it protects citizens’ rights to create a militia and to bear arms. “A well regulated militia, being necessary to the security of a free state, the right of the people to keep and bear arms, shall not be infringed.”
The government must interact with all persons according to the duly-enacted laws; applying these rules equally among all persons.
Every individual is equal to every other person with respect to natural rights and treatment before the law.
Consent of the governed
The authority of the government must come from the people through elections and through the people’s interaction with government.
Individuals must take care of themselves and their families, and be vigilant to preserve their liberty and the liberty of others.
Rule of law
Government officials and citizens all abide by the same laws regardless of political power.
Declaration of Independence
The document written in 1776 by the Founders to send to Britain’s King George III in which independence from Britain was declared and the reasons for the separation were explained.
Articles of Confederation
The first national government document developed in 1781 by the Founders. The Articles created a federal legislative branch, but there was no executive or judiciary. The states retained most of the governmental powers.
The group of people who wrote and influenced the Declaration of Independence, the Articles of Confederation, the United States Constitution, and the United States Bill of Rights. These men were instrumental in establishing the nation and its governmental documents and practices.
A series of 85 essays written to convince the people of New York to ratify the Constitution. The authors were James Madison, Alexander Hamilton, and John Jay. These documents are considered to be the most authoritative explanation of the political theory of the Constitution.
Ratified in 1791, it protects the freedom of speech, the freedom of religion, freedom of the press, freedom to assemble, and freedom to petition the government.
“Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the government for a redress of grievances.”
Law of Supply
As the price drops, the quantity supplied also drops.
Ratified in 1791, it protects citizens’ rights against unreasonable searches and seizures of property and explains that warrants must be issued with probable cause. “The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no warrants shall issue, but upon probable cause, supported by oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized.”
Ratified in 1791, it protects the right indictment by a jury, against double jeopardy, self-incrimination, loss of life, liberty, or property without due process, and just compensation for private property taken for public use. “No person shall be held to answer for a capital, or otherwise infamous crime, unless on a presentment or indictment of a grand jury, except in cases arising in the land or naval forces, or in the militia, when in actual service in time of war or public danger; nor shall any person be subject for the same offense to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.”
Ratified in 1791, it states that the powers not enumerated or delegated in the Constitution are reserved for the states and the people. “The powers not delegated to the United States by the Constitution, nor prohibited by it to the states, are reserved to the states respectively, or to the people.”
Ratified in 1791, it protects against excessive bail and fines and cruel and unusual punishments. “Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted.”
Ratified in 1791, the listing of certain rights protected by the Constitution cannot be used to deny rights not enumerated in the document. “The enumeration in the Constitution, of certain rights, shall not be construed to deny or disparage others retained by the people.”
One of the Founding Fathers of the United States, Alexander Hamilton served as General Washington’s chief of staff, promoted the ratification of the Constitution in the Federalist Papers, and founded the nation’s financial system and first political party.
Madison was a Framer who was instrumental in writing the Constitution and Bill of Rights. He is known as the “Father of the Constitution.” Madison partnered with Alexander Hamilton and John Jay to write the Federalist Papers in support of the ratification of the Constitution. He also served as a member of the Virginia House of Delegates, the United States House of Representatives, Secretary of State under Thomas Jefferson, and the fourth president of the United States.
First President of the United States, George Washington served as commander-in-chief of the Continental Army during the American Revolution and was one of the Founding Fathers of the United States.
An English philosopher and physician, John Locke was one of the most influential Enlightenment thinkers and is known today as the Father of Classical Liberalism.
The Continental Congress, comprised of delegates from 12 of the 13 American colonies, represented the colonists during and after the American Revolution. The Continental Congress issued the Declaration of Independence and ratified the Articles of Confederation.
King George III
King George III was the King of Great Britain at the time of the American Revolution. His actions towards the American colonies, outlined in the Declaration of Independence, spurred the American Revolution.
Spanning ten years from 1929 to 1939, the Great Depression was one of the longest-lasting economic downturns in the history of the United States affecting the U.S. and most of the world.
An introductory statement, preface, or introduction.
Cruel and unfair treatment by people with power over others.
Using power over people in a way that is cruel and unfair.
Before becoming the second President of the United States, John Adams served as the country’s first Vice President under George Washington. Adams was an advocate of American independence from Britain and a Federalist.
Founding Father John Jay was one of the signers of the Treaty of Paris and served as the first Chief Justice of the United States. He was also one of the authors of the Federalist Papers.
Ratified in 1791, it protects citizens against the quartering of soldiers in private homes without their approval. “No soldier shall, in time of peace be quartered in any house, without the consent of the owner, nor in time of war, but in a manner to be prescribed by law.”
Ratified in 1791, it protects the rights of impartial jury trials, the right to be informed of the accusations against you, the right to be confronted by witness, and the right to be assisted by counsel. “In all criminal prosecutions, the accused shall enjoy the right to a speedy and public trial, by an impartial jury of the state and district wherein the crime shall have been committed, which district shall have been previously ascertained by law, and to be informed of the nature and cause of the accusation; to be confronted with the witnesses against him; to have compulsory process for obtaining witnesses in his favor, and to have the assistance of counsel for his defense.”
Ratified in 1791, it protects the right of jury trials in law suits dealing with more than twenty dollars and protects against reexamination of the trial in any court if decided by a jury. “In suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by a jury, shall be otherwise reexamined in any court of the United States, than according to the rules of the common law.”
Alexis de Tocqueville
French political thinker and historian, Alexis de Tocqueville is best known for his works Democracy in America and The Old Regime and the Revolution. He visited the U.S. in the 1830s and wrote admiringly about many aspects of American law and society.
Democracy in America
Written by Alexis de Tocqueville after visiting the United States, Democracy in America contains de Tocqueville’s analysis of and reflections on the United States’ democratic system and society. The first volume was published in 1835 and the second in 1840.
Written in 1215, it is the oldest document in the British and American heritage of rights. Contributed to the adoption of the First, Third, Fourth, Fifth, Sixth, and Eighth Amendments of the Bill of Rights, and speaks of these rights as ancient.
Two Treatises of Civil Government
Written by John Locke in 1690, the Two Treatises of Civil Government criticize absolute power for kings and outline Locke’s suggestions for a more civilized society based on natural rights and the social contract.
The Thirteenth Amendment to the Constitution abolished slavery and involuntary servitude, except as punishment for a crime. “Section 1. Neither slavery nor involuntary servitude, except as a punishment for crime whereof the party shall have been duly convicted, shall exist within the United States, or any place subject to their jurisdiction. Section 2. Congress shall have power to enforce this article by appropriate legislation.”
The group of people who actually attended the Constitutional Convention and participated in writing the Constitution.
Ratified in 1868, it states that all people born or naturalized in the United States are citizens and ensures that “No state shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any state deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.”
Ratified in 1913, the Sixteenth Amendment gave Congress the ability to collect income taxes. “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census of enumeration.”
atified in 1919, the Eighteenth Amendment introduced Prohibition, the period of United States history when the manufacture, sale, and transportation of alcohol was made illegal throughout the country. “Section 1. After one year from the ratification of this article the manufacture, sale, or transportation of intoxicating liquors within, the importation thereof into, or the exportation thereof from the United States and all territory subject to the jurisdiction thereof for beverage purposes is hereby prohibited. Section 2. The Congress and the several states shall have concurrent power to enforce this article by appropriate legislation. Section 3. This article shall be inoperative unless it shall have been ratified as an amendment to the Constitution by the legislatures of the several states, as provided in the Constitution, within seven years from the date of the submission hereof to the states by the Congress.”
The Twentieth Amendment was ratified in 1933, and it establishes procedures for presidential succession and the start and end of federal officials’ terms of office.
“Section 1. The terms of the President and Vice President shall end at noon on the 20th day of January, and the terms of Senators and Representatives at noon on the 3rd day of January, of the years in which such terms would have ended if this article had not been ratified; and the terms of their successors shall then begin.
In 1933, the Twenty-First Amendment repealed the Eighteenth Amendment, ending Prohibition. “Section 1. The eighteenth article of amendment to the Constitution of the United States is hereby repealed. Section 2. The transportation or importation into any state, territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited. Section 3. This article shall be inoperative unless it shall have been ratified as an amendment to the Constitution by conventions in the several states, as provided in the Constitution, within seven years from the date of the submission hereof to the states by the Congress.”
English Bill of Rights
Passed by the British Parliament in 1689, the English Bill of Rights limited the power of the British monarch, outlined the rights of the Parliament, and guaranteed Protestants the right to bear arms.
The legislative body of the United Kingdom (known as Great Britain or England during the Founding era).
One of the Founding Fathers of the United States, Benjamin Franklin was a statesman, author, publisher, scientist, inventor and diplomat. He served in the Second Continental Congress during the American Revolution and helped draft the Declaration of Independence. In addition, Franklin helped negotiated the Treaty of Paris which ended the Revolutionary War and later served as a delegate to the convention that produced the U.S. Constitution.
The right to vote.
A government in which the power belongs to citizens through the right to vote.
Ratified in 1870, it states that the right could not be restricted based on “race, color, or previous condition of servitude.” “Section 1. The right of citizens of the United States to vote shall not be denied or abridged by the United States or by any state on account of race, color, or previous condition of servitude. Section 2. The Congress shall have power to enforce this article by appropriate legislation.”
Ratified in 1913, the Seventeenth Amendment introduced direct election of Senators. “The Senate of the United States shall be composed of two Senators from each state, elected by the people thereof, for six years; and each Senator shall have one vote. The electors in each state shall have the qualifications requisite for electors of the most numerous branch of the state legislatures. When vacancies happen in the representation of any state in the Senate, the executive authority of such state shall issue writs of election to fill such vacancies: Provided, that the legislature of any state may empower the executive thereof to make temporary appointments until the people fill the vacancies by election as the legislature may direct. This amendment shall not be so construed as to affect the election or term of any Senator chosen before it becomes valid as part of the Constitution.”
Ratified in 1920, the amendment stated that a citizen’s right to vote must not be restricted based on gender. “The right of citizens of the United States to vote shall not be denied or abridged by the United States or by any state on account of sex. Congress shall have power to enforce this article by appropriate legislation.”
Direct democracy is a political system in which the people vote directly on policies or laws, as opposed to voting for representatives who enact laws on their behalf.
Not planned or chosen for a particular reason; done without concern for what is fair or right.
The process by which courts analyze the constitutionality of an act of government.
Majority rule/minority rights
laws may be made with the consent of the majority, but only to the point where they do not infringe on the inalienable rights of the minority.
An arbitrary order or decree.
Something that is owned by a person, business, etc. This includes possessions, beliefs, faculties, and opinions, and the fruits of one's labor.
A government in which the power is held by the people.
A body of electors chosen by each state to vote for the president and vice president of the United States.
Conduct that reflects universal principles of moral and ethical excellence essential to leading a worthwhile life and to effective self-government. For many leading Founders, attributes of character such as justice, responsibility, perseverance, etc., were thought to flow from an understanding of the rights and obligations of men. Virtue is compatible with, but does not require, religious belief.