CHAPTER 4
SUPPLY–DEMAND EQUILIBRIA AND MICROECONOMIC SYSTEMS ANALYSIS AND ASSESSMENT MODELS
4.1 INTRODUCTION
In Chapters 2 and 3, we studied the behavior of firms and consumers under the assumption that prices and wages are fixed. The producer was able to obtain a given price for a product and had to pay given prices and/or wages for the inputs required for the production process. The primary economic objective of a firm is to maximize profit. The consumer must pay a fixed (known) price for a commodity and purchase commodities to maximize a utility function. These assumptions are a bit artificial. In reality, prices are determined in a competitive marketplace where firms and consumers meet to exchange their given products. The consumer who has been paid wages for labor trades these wages for the final products or outputs of firms. Firms may also act as consumers, since the input to one firm may be the output of another. Similarly, consumers own a set of factors, primarily their labor, and obtain wages by trading these factors on a factor market. Figure 4.1 illustrates the general flow that results from the supply–demand interactions of firms and consumers. We will expand upon this diagram considerably as we move from the microeconomic analysis of individual firms and consumers to the economic analysis of the aggregate behavior of large groups of firms and consumers and government interactions with them.
Figure 4.1. A Simple Supply–Demand Market Conceptualization.
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