International Economics –Micro Review 1Jhuato.sfc@gmail.com

Micro review 1A simple (competitive) market

Demand, supply, and equilibrium Shifts in demand or supply Algebra and graphs Consumer & producer surpluses

Markets Markets are defined by the good traded Markets are social structures – people

relating to one another in certain ways (in this case, respecting their property and cooperating with one another via trade)

In our simple model, we assume the market to be competitive: Homogeneous good Many buyers & sellers (no market power)

Market model1. We split the market into two groups: (1) buyers

and (2) sellers2. Study the behavior of buyers (demand)3. Study the behavior of sellers (supply)4. Study demand and supply together (equilibrium)5. Study the model’s reactions to changes in the

economic environment (comparative statics)6. Insofar as the model’s implications match our

observations of the real world, we view the model as reliable – helpful in practical applications

DemandWhat makes buyers buy (consumers consume) more of a good?

A lower price of the good Higher income or wealth Enhanced taste for the good Suitable changes in prices of related goods Expectations Etc.

Demand graph

Demand graph

SupplyWhat makes sellers sell (producers produce) more of a good?

A higher price of the good Lower input prices (e.g. wages) Improved technology Expectations Etc.

Supply graph

Supply graph

Equilibrium graph

Demand equation

where 12 is the vertical intercept and -0.8 is the slope.

Supply equation

where 2 is the vertical intercept and 0.25 is the slope.

Solving the system

Equilibrium:10 units of the good, $4/unit.

Demand:Supply:

Leftward shift in supply

New equilibrium

New equilibrium:8 units of the good, $5.6/unit.

Demand:New supply:

Welfare analysis The market model allows us to study the

implications of trade in a market to the welfare (well-being) of buyers and sellers.

We will be using this analysis once we study international trade.

First, we study the welfare of buyers. This measure is called “consumer surplus.”

Second, we study the welfare of sellers. This measure is called “producer surplus.”

Finally, we study the welfare of the market as a whole. This measure is the “total surplus.”

Consumer surplus The demand curve shows the different prices

at which buyers are willing to buy a good The price that a buyer is willing to pay for a

good is a measure of how much the buyer values the benefits from having the good

The area under the demand curve shows the gross benefits that buyers in the market receive from having a given amount of the good

The area under the demand curve but above the expenditure rectangle is the consumer surplus.

Consumer surplus

Producer surplus The supply curve shows the different prices

at which sellers are willing to sell a good The price that a seller is willing to charge for

a good is a measure of the cost of the good to the seller

The area below the supply curve shows the total cost that sellers in the market incur from producing a given amount of the good

The area of the “triangle” inside the revenue quadrangle but above the cost

Producer surplus

Total surplus The sum of the consumer surplus and

the producer surplus is a measure of the total welfare that results from the existence of the market

Total surplus