Understanding and creating graphs are critical skills in macroeconomics. In this article, you’ll get a quick review of the market model, including:
- what it’s used to illustrate
- key features of the model
- some examples of questions that can be answered using that model.
What the market model illustrates
The market model is used to illustrate how the forces of supply and demand interact to determine prices and the quantity that is sold. This model is important because many other models are variations of it, such as the market for loanable funds and the foreign exchange market.
Key features of the market model
- Two axes: a vertical axis labeled “Price” or “P” and a horizontal axis labeled “Quantity” or “Q”
- Two curves: A downward sloping demand curve labeled “D” and an upward sloping supply curve labeled “S.” If you’re showing changes in supply or demand, be sure to label initial curves and new curves with numbers indicating the order of a change. For example, label an initial demand curve and a new demand curve .
- An equilibrium price and an equilibrium quantity: These should be labeled as indicated in the prompt.
Helpful hints for the market model
- If both supply and demand curves shift, it might look as though either price or quantity stayed the same. But because we do not know for sure if price or quantity have increased, decreased, or stayed the same, we can’t assert that they “stayed the same”. Instead, the correct answer in that situation is that we do not know or the change is indeterminate.
- Always label your equilibrium price and quantity on the appropriate axis, not on the “inside” of the curve, and draw a dashed line from the intersection point to the axes:
|YES - A correctly labeled equilibrium||NO - An incorrectly labeled equilibrium|
- Use arrows to indicate the direction of any shifts and numbers to indicate the order of any shifts
- Use the TIRES mnemonic to remember what shifts demand: Tastes, Income, Related prices (complements and substitutes), Expected prices, and Size of the market (how many buyers).
- Use the POISE mnemonic to remember what shifts supply: Productivity/technology, prices of some Other good a seller could produce instead, Input prices, Size of the market (how many sellers), Expected prices.