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1
Markets Specific location where buying and selling takes
place, such as Supermarket or a flea market
In economics, a market is not a place but rather A group of buyers and sellers with the potential to trade
with each other Economists think of the economy as a collection of
individual markets First step in an economic analysis is to define and
characterize the market or collection of markets to analyze
2
How Broadly Should We Define the Market
Defining the market often requires economists to group things together Aggregation is the combining of a group of
distinct things into a single whole Markets can be defined broadly or narrowly,
depending on our purpose How broadly or narrowly markets are defined is
one of the most important differences between Macroeconomics and Microeconomics
Aggregation
3
Figure 4.2Individual and Market Demand CurvesFigure 4.2Individual and Market Demand Curves
An Introduction to Demand (cont.)Figure 4.1The Demand for Compact DiscsFigure 4.1The Demand for Compact Discs
Diminishing Marginal utility helps to describe why the curve is downward sloping. The price must be lowered to meet your decreased satisfaction.
The principle of diminishing marginal utility states that the satisfaction we gain from buying a product lessens as we buy more of the same product.
Marginal utility is the extra usefulness or satisfaction a person receives from getting or using one more unit of a product.
5
Buyers and Sellers Buyers and sellers in a market can be
Households Business firms Government agencies
All three can be both buyers and sellers in the same market, but are not always
For purposes of simplification this text will usually follow these guidelines In markets for consumer goods, we’ll view business firms
as the only sellers, and households as only buyers In most of our discussions, we’ll be leaving out the
“middleman”
6
Competition in Markets In imperfectly competitive markets, individual buyers or
sellers can influence the price of the product In perfectly competitive markets (or just competitive
markets), each buyer and seller takes the market price as a given
What makes some markets imperfectly competitive and others perfectly competitive? Perfectly competitive markets have many small buyers and sellers
• Each is a small part of the market, and the product is standardized Imperfectly competitive markets have just a few large buyers and
sellers• Or else the product of each seller is unique in some way
7
Using Supply and Demand Supply and demand model is designed to
explain how prices are determined in perfectly competitive markets Perfect competition is rare but many markets
come reasonably close Perfect competition is a matter of degree rather
than an all or nothing characteristic Supply and demand is one of the most
versatile and widely used models in the economist’s tool kit
8
Demand
A household’s quantity demanded of a good Specific amount household would choose to buy over
some time period, given• A particular price that must be paid for the good
• All other constraints on the household
Market quantity demanded (or quantity demanded) is the specific amount of a good that all buyers in the market would choose to buy over some time period, given A particular price they must pay for the good All other constraints on households
9
Quantity Demanded Implies a choice
How much households would like to buy when they take into account the opportunity cost of their decisions?
Is hypothetical Makes no assumptions about availability of the good How much would households want to buy, at a specific price, given
real-world limits on their spending power?
Stresses price Price of the good is one variable among many that influences
quantity demanded We’ll assume that all other influences on demand are held constant,
so we can explore the relationship between price and quantity demanded
10
The Law of Demand
States that when the price of a good rises and everything else remains the same, the quantity of the good demanded will fall The words, “everything else remains the same” are
important• In the real world many variables change simultaneously
• However, in order to understand the economy we must first understand each variable separately
• Thus we assume that, “everything else remains the same,” in order to understand how demand reacts to price
11
The Demand Schedule and the Demand Curve
Demand schedule A list showing the quantity of a good that consumers
would choose to purchase at different prices, with all other variables held constant
The market demand curve (or just demand curve) shows the relationship between the price of a good and the quantity demanded , holding constant all other variables that influence demand Each point on the curve shows the total buyers would
choose to buy at a specific price Law of demand tells us that demand curves
virtually always slope downward
12
Figure 1: The Demand Curve
Number of Bottles per Month
Price per Bottle
A
B
$4.00
2.00
D
40,000 60,000
At $2.00 per bottle, 60,000 bottles are demanded (point B).
When the price is $4.00 per bottle, 40,000 bottles are demanded (point A).
13
Figure 2: A Shift of the Demand Curve
B C$2.00
D1D2
60,000 80,000
An increase in income shifts the demand curve for maple syrup from D1 to D2. At each price, more bottles are demanded after the shift.
Number of Bottles per Month
Price per Bottle
14
Dangerous Curves: “Change in Quantity Demanded” vs. “Change in Demand”
Language is important when discussing demand “Quantity demanded” means
• A particular amount that buyers would choose to buy at a specific price
• It is a number represented by a single point on a demand curve• When a change in the price of a good moves us along a demand
curve, it is a change in quantity demand
The term demand means• The entire relationship between price and quantity demanded—
and represented by the entire demand curve• When something other than price changes, causing the entire
demand curve to shift, it is a change in demand
15
Income: Factors That Shift the Demand Curve
An increase in income has effect of shifting demand for normal goods to the right However, a rise in income shifts demand for
inferior goods to the left A rise in income will increase the demand for
a normal good, and decrease the demand for an inferior good
16
Wealth: Factors that Shift the Demand Curve
Your wealth—at any point in time—is the total value of everything you own minus the total dollar amount you owe
An increase in wealth will Increase demand (shift the curve rightward) for a
normal good Decrease demand (shift the curve leftward) for
an inferior good
17
Prices of Related Goods: Factors that Shift the Demand Curve
Substitute—good that can be used in place of some other good and that fulfills more or less the same purpose A rise in the price of a substitute increases the
demand for a good, shifting the demand curve to the right
Complement—used together with the good we are interested in A rise in the price of a complement decreases
the demand for a good, shifting the demand curve to the left
20
Other Factors that Shift the Demand Curve
Population As the population increases in an area
• Number of buyers will ordinarily increase• Demand for a good will increase
Tastes Combination of all the personal factors that go into determining how
a buyer feels about a good When tastes change toward a good, demand increases, and the
demand curve shifts to the right When tastes change away from a good, demand decreases, and the
demand curve shifts to the left
Expectations
A higher expected future price will increase current demand.
A lower expected future price will decrease current demand.
A higher expected future income will increase the demand for all normal goods.
A lower expected future income will reduce the demand for all normal goods.
22
Figure 3(a): Movements Along and Shifts of the Demand Curve
Quantity
Price
P2
Q2 Q1 Q3
P1
P3
Price increase moves us leftward along demand curve
Price increase moves us rightward along demand curve
23
Figure 3(b): Movements Along and Shifts of the Demand Curve
Quantity
Price
D2
D1
Entire demand curve shifts rightward when:• income or wealth ↑• price of substitute ↑• price of complement ↓• population ↑• expected price ↑• tastes shift toward good
24
Figure 3(c): Movements Along and Shifts of the Demand Curve
Quantity
Price
D1
D2
Entire demand curve shifts leftward when:• income or wealth ↓• price of substitute ↓• price of complement ↑• population ↓• expected price ↓• tastes shift toward good
25
Supply A firm’s quantity supplied of a good is the specific
amount its managers would choose to sell over some time period, given A particular price for the good All other constraints on the firm
Market quantity supplied (or quantity supplied) is the specific amount of a good that all sellers in the market would choose to sell over some time period, given A particular price for the good All other constraints on firms
26
Quantity Supplied Implies a choice
Quantity that gives firms the highest possible profits when they take account of the constraints presented to them by the real world
Is hypothetical Does not make assumptions about firms’ ability to sell the good How much would firms’ managers want to sell, given the price of the
good and all other constraints they must consider? Stresses price
The price of the good is just one variable among many that influences quantity supplied
We’ll assume that all other influences on supply are held constant, so we can explore the relationship between price and quantity supplied
27
The Law of Supply States that when the price of a good rises
and everything else remains the same, the quantity of the good supplied will rise The words, “everything else remains the same”
are important• In the real world many variables change
simultaneously• However, in order to understand the economy we
must first understand each variable separately• We assume “everything else remains the same” in
order to understand how supply reacts to price
28
The Supply Schedule and The Supply Curve
Supply schedule—shows quantities of a good or service firms would choose to produce and sell at different prices, with all other variables held constant
Supply curve—graphical depiction of a supply schedule Shows quantity of a good or service supplied at
various prices, with all other variables held constant
29
Figure 4: The Supply Curve
F
G
2.00
S
40,000 60,000
$4.00
At $4.00 per bottle, quantity supplied is 60,000 bottles (point G).
When the price is $2.00 per bottle, 40,000 bottles are supplied (point F).
Number of Bottles per Month
Price per Bottle
30
Figure 5: A Shift of the Supply Curve
S2
GJ
S1
60,000
$4.00
80,000
A decrease in transportation costs shifts the supply curve for maple syrup from S1 to S2.
Number of Bottles per Month
Price per Bottle
At each price, more bottles are supplied after the shift
31
Factors that Shift the Supply Curve
Input prices A fall (rise) in the price of an input causes an increase
(decrease) in supply, shifting the supply curve to the right (left)
Price of Related Goods When the price of an alternate good rises (falls), the
supply curve for the good in question shifts rightward (leftward)
Technology Cost-saving technological advances increase the supply
of a good, shifting the supply curve to the right
32
Factors that Shift the Supply Curve
Number of firms An increase (decrease) in the number of sellers
—with no other changes—shifts the supply curve to the right (left)
Expected price An expectation of a future price increase
(decrease) shifts the current supply curve to the left (right)
33
Factors that Shift the Supply Curve
Changes in weather Favorable weather
• Increases crop yields
• Causes a rightward shift of the supply curve for that crop
Unfavorable weather • Destroys crops
• Shrinks yields
• Shifts the supply curve leftward
Other unfavorable natural events may effect all firms in an area Causing a leftward shift in the supply curve
34
Figure 6(a): Changes in Supply and in Quantity Supplied
P2
Q3 Q1 Q2
P1
P3
Quantity
Price Price increase moves us rightward along supply curve
S
Price increase moves us leftward along supply curve
35
Figure 6(b): Changes in Supply and in Quantity Supplied
Quantity
Price
S2
S1Entire supply curve shifts rightward when:• price of input ↓• price of alternate good ↓• number of firms ↑• expected price ↑• technological advance• favorable weather
36
Figure 6(c): Changes in Supply and in Quantity Supplied
Quantity
Price
S1
S2Entire supply curve shifts rightward when:• price of input ↑• price of alternate good ↑• number of firms ↓• expected price ↑• unfavorable weather
37
In Summary: Factors that Shift the Supply Curve
The short list of shift-variables for supply that we have discussed is far from exhaustive
In some cases, even the threat of such events can cause serious effects on production
Basic principle is always the same Anything that makes sellers want to sell more or
less of a good at any given price will shift supply curve
38
Equilibrium: Putting Supply and Demand Together
When a market is in equilibrium Both price of good and quantity bought and sold have
settled into a state of rest The equilibrium price and equilibrium quantity are values
for price and quantity in the market but, once achieved, will remain constant
• Unless and until supply curve or demand curve shifts
The equilibrium price and equilibrium quantity can be found on the vertical and horizontal axes, respectively At point where supply and demand curves cross
39
Figure 7: Market Equilibrium
E
HJ1.00
$3.00
D
S
50,000 75,00025,000
Excess Demand
4. until price reaches its equilibrium value of $3.00
.
2. causes the price to rise . . .
3. shrinking the excess demand . . .
1. At a price of $1.00 per bottle an excess demand of 50,000 bottles . . .
Number of Bottles per Month
Price per Bottle
40
Excess Demand: Putting Supply and Demand Together
Excess demandAt a given price, the excess of quantity
demanded over quantity supplied Price of the good will rise as buyers
compete with each other to get more of the good than is available
41
Figure 8: Excess Supply and Price Adjustment
3. shrinking the excess supply . . .
K L
E3.00
D
S
$5.00
50,00035,000 65,000
Excess Supply at $5.00
2. causes the price to drop,
4. until price reaches its equilibrium value of $3.00.
Number of Bottles per Month
Price per Bottle
1. At a price of $5.00 per bottle an excess supply of 30,000 bottles . . .
42
Excess Supply: Putting Supply and Demand Together
Excess Supply At a given price, the excess of quantity supplied
over quantity demanded Price of the good will fall as sellers compete
with each other to sell more of the good than buyers want
43
Income Rises: What Happens When Things Change
Income rises, causing an increase in demand Rightward shift in the demand curve causes
rightward movement along the supply curve Equilibrium price and equilibrium quantity both
rise Shift of one curve causes a movement along
the other curve to new equilibrium point
44
Figure 9: A Shift in Demand and a New Equilibrium
1. An increase in demand . . .E
F'
3.00
D1
D2
S
$4.00
50,000 60,000
3. to a new equilibrium.
5. and equilibrium quantity increases too.
2. moves us along the supply curve . . .
Number of Bottles of Maple Syrup per Period
Price per Bottle
4. Equilibrium price increases
45
An Ice Storm Hits: What Happens When Things Change
An ice storm causes a decrease in supply Weather is a shift variable for supply curve
• Any change that shifts the supply curve leftward in a market will increase the equilibrium price
And decrease the equilibrium quantity in that market
46
Figure 10: A Shift of Supply and a New Equilibrium
E'
E3.00
D
$5.00
50,00035,000
S2 S1
Number of Bottles
Price per Bottle
47
Figure 11: Changes in the Market for Handheld PCs
1. An increase in supply . . .
2. and a decrease in demand . . .
5. and quantity decreased as well.
A
B$400
D2003
S2002
S2003
D2002
$500
2.45 3.33 Millions of Handheld PCs per Quarter
Price per Handheld
PC
4. Price decreased . . .
3. moved the market to a new equilibrium.
48
Both Curves Shift
When just one curve shifts (and we know the direction of the shift) we can determine the direction that both equilibrium price and quantity will move
When both curves shift (and we know the direction of the shifts) we can determine the direction for either price or quantity—but not both Direction of the other will depend on which curve
shifts by more
49
The Principle of Markets and Equilibrium
The supply-and-demand model is just one example of a more general approach To identify a market and examine its equilibrium
Basic Principle #4: Markets and Equilibrium To understand how the economy behaves, economists
organize the world into separate markets and then examine the equilibrium in each of those markets
This approach helps us predict important changes in the economy and prepare for them And it helps us predict important changes in the economy
our social goals and avoid policies that are likely to backfire
50
Price Ceilings Government-imposed maximum price that prevents the
price of a good from rising above a certain level in a market Short side of the Market
Smaller of quantity supplied and quantity demanded at a particular price
When quantity supplied and quantity demanded differ, short side of market will prevail
Price ceiling creates a shortage and increases the time and trouble required to buy the good While the price decreases, the opportunity cost may rise
Black Market A market created by unintended consequences of government
intervention• Goods are sold illegally at a price above the legal ceiling
51
Figure 12: A Price Ceiling in the Market for Maple Syrup
60,00050,00040,000
TE
VR
D
S
$4.00
3.00
2.002. increases quantity
demanded
3. and decreases quantity supplied.
4. The result is a shortage – the distance between R and V.
Number of Bottles of Maple Syrup per Period
Price per Bottle
1. A price ceiling lower than the equilibrium price . . .
5. With a black market, the lower quantity sells for a higher price than initially.
52
Price Floors
Government imposed minimum amount below which price is not permitted to fall Price floors for agricultural goods are commonly called price support
programs When sellers produce more of the good than buyers want at
the price floor Remaining goods become a surplus that no one wants at the
imposed price Government responds by maintaining price floors
Uses taxpayer dollars to buy up entire excess supply of the good in question
Prevents excess supply from doing what it would ordinarily do• Drive price down to its equilibrium value
53
The Principle of Policy Tradeoffs
In our discussion of government intervention in markets, you may have noticed something interesting A policy designed to help us achieve one goal causes us
to compromise on some other goal
In fact, as you will see throughout this text, there are virtually always tradeoffs involved in government policy making For this reason, we consider government policy tradeoffs
to be one of the basic principles of economics
54
The Principle of Policy Tradeoffs
Basic Principle #5: Policy Tradeoffs Government policy is constrained by the
reactions of private decision makers As a result, policy makers face tradeoffs
• Making progress toward one goal often requires some sacrifice of another goal
Economics is famous for making the public aware of policy tradeoffs
55
Using Supply and Demand: The Invasion of Kuwait
Why did Iraq’s invasion of Kuwait cause the price of oil to rise? Immediately after the invasion, United States led
a worldwide embargo on oil from both Iraq and Kuwait
A significant decrease in the oil industry’s productive capacity caused a shift in the supply curve to the left• Price of oil increased
57
Using Supply and Demand: The Invasion of Kuwait
Why did the price of natural gas rise as well?Oil is a substitute for natural gasRise in the price of a substitute increases
demand for a goodRise in price of oil caused demand curve
for natural gas to shift to the right• Thus, the price of natural gas rose