Micro Economics Lecture 03

7/28/2019 Micro Economics Lecture 03

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Microeconomics

Lecture 3


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Overview of the Previous

Lecture Scarcity & Choices

Factors of Production

Natural Resources

Labor

Physical Capital Human Capital

Entrepreneurship

Production Possibility Frontier


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Topics Under Discussion

Real Prices vs. Nominal PricesSupply and Demand: Basic Concepts

Market Mechanism


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Real Versus Nominal PricesNominal price is the absolute orcurrent

dollar price of a good or service when itis sold.

Real price is the price relative to an

aggregate measure of prices orconstant dollar price.


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Real Versus Nominal Prices

The Consumer Price Index (CPI) is anaggregate measure.

Real prices are emphasized to permit

the analysis of relative prices.


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Real Versus Nominal PricesCalculating Real Prices

yearcurrent

yearcurrent

yearbasePriceNominalx

CPI

CPIPriceReal

(base year = 100)


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Calculating the Real Price of

Milk

1970 .40 38.8 .40=38.8/38.8x .40

1980 .65 82.4 .31=38.8/82.4x .65

1999 1.05 167.0 .24=38.8/167.0x 1.05

Nominal Price Real Price of MilkYear of Milk CPI in 1970 dollars


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Calculating Real Prices:An Example - Eggs & College

Consumer Price Index

(1983 = 100) 38.8 53.8 82.4 107.6 130.7 163.0

Nominal Prices

Grade A Large Eggs $0.61 $0.77 $0.84 $0.80 $0.98 $1.04

College Education $2,530 $3,403 $4,912 $8,156 $12,800 $19,213

Real Prices ($1970)Grade A Large Eggs $0.61 $0.56 $0.40 $0.29 $0.30 $0.25College Education $2,530 $2,454 $2,313 $2,941 $3,800 $4,573

1970 1975 1980 1985 1990 1998


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Calculating Real Prices:

An Example - Eggs & College

$4,573$19,213x163.0

38.8 Real Price of aCollege Education

1998(1970 = 100)

1.04x163

38.8

EggsofPriceReal19701998 (1970 = 100)


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Supply and DemandThe Supply Curve

The supply curve shows how much of agood producers are willing to sell at agiven price, holding constant other

factors that might affect quantitysupplied


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Supply and DemandThe Supply Curve

This price-quantity relationship can beshown by the equation:

)(PQQ Ss


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Horizontal axis measuresquantity (Q) supplied innumber of units pertime period

Vertical axis measuresprice (P) received

per unit in dollars

Supply and DemandThe Supply

Curve Graphically

Quantity

Price($ per unit)


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Supply and Demand

S

The supply curve slopesupward demonstrating that

at higher prices firms

will increase output

The SupplyCurve Graphically

Quantity

Price($ per unit)

P1

Q1

P2

Q2


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Supply and Demand

Non-price Determining Variables ofSupply

Costs of Production

Labor

Capital

Raw Materials


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Supply and Demand

The cost of rawmaterials falls

At P1, produce

Q2At P2, produce

Q1

Supply curveshifts right to S

More producedat any price onS than on S

PS

Change in Supply

Q

P1

P2

Q1Q0

S

Q2


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Supply and Demand

Supply - A Review

Supply is determined by non-pricesupply-determining variables as suchas the cost of labor, capital, and raw

materials. Changes in supply are shown by

shifting the entire supply curve.


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Supply and Demand

The Demand Curve The demand curve shows how much of

a good consumers are willing to buy asthe price per unit changes holding non-price factors constant.

This price-quantity relationship can beshown by the equation:

(P)QQDD


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Supply and Demand

Quantity

Horizontal axis measuresquantity (Q) demanded innumber of units pertime period

Vertical axis measuresprice (P) paid

per unit in dollars

Price($ per unit)


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Supply and Demand

D

The demand curve slopesdownward demonstratingthat consumers are willing

to buy more at a lower priceas the product becomes

relatively cheaper and theconsumers real income

increases.

Quantity

Price($ per unit)


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Supply and Demand

Non-price Determining Variables ofDemand

Income

Consumer Tastes

Price of Related GoodsSubstitutes

Complements


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DP

QQ1

P2

Q0

P1

D

Q2

Change in Demand

Supply and Demand

Income Increases

At P1, produce Q2At P2, produce Q1

Demand Curve

shifts rightMore purchased at

any price on D

than on D


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Shifts in Supply and Demand

Demand - A Review

Demand is determined by non-pricedemand-determining variables, such

as, income, price of related goods, andtastes.

Changes in demand are shown by

shifting the entire demand curve. Changes in quantity demandedare

shown by movements along the

demand curve.


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The Market Mechanism

Quantity

D

S

The curves intersect atequilibrium, or market-

clearing, price. At P0thequantity supplied is equalto the quantity demanded

at Q0.

P0

Q0

Price($ per unit)


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Quantity

D

S

P0

Q0

If price is above equilibrium:

1) Price is above themarket clearing price

2) Qs > Qd3) Price falls to the

market-clearingprice

P1

Surplus

Price($ per unit)

A Surplus


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The market price is above equilibrium

There is excess supply

Producers lower prices

Quantity demanded increases andquantity supplied decreases

The market continues to adjust until theequilibrium price is reached.


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D

S

Q1

Assume the price is P1 , then:

1) Qs : Q1 > Qd : Q22) Excess supply is Q1:Q2.3) Producers lower price.4) Quantity supplied decreases

and quantity demandedincreases.

5) Equilibrium at P2Q

3

P1

Surplus

Q2 Quantity

Price($ per unit)

P2

Q3

Surplus - Review:


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The market price is above equilibrium:

There is excess supply Producers lower prices

Quantity demanded increases and

quantity supplied decreases The market continues to adjust until

the equilibrium price is reached


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D

S

Q1 Q2

P2

Shortage

Quantity

Price($ per unit)

Assume the price is P2 , then:

1) Qd : Q2 > Qs : Q12) Shortage is Q1:Q2.3) Producers raise price.4) Quantity supplied increases

and quantity demandeddecreases.

5) Equilibrium at P3, Q3

Q3

P3

Shortage


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The market price is below equilibrium:

There is a shortage

Producers raise prices

Quantity demanded decreases and

quantity supplied increases The market continues to adjust until

the new equilibrium price is reached.


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Upcoming Topics

Changes in Market Equilibrium

Elasticities of Supply and Demand

Short Run vs. Long Run Elasticities


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Microeconomics

Lecture 3

Documents

Micro Economics Lecture 03