Presentation on theme: "Dr. Duffy Microeconomics"— Presentation transcript:
1Dr. Duffy Microeconomics Notes fromCHAPTER 3 ofFrank and Bernanke
2Three Problems All Economic Systems Must Address Three Basic QuestionsThree Problems All Economic Systems Must AddressWhat should be produced?How should it be produced?For whom will it be produced?
3Types of EconomiesCommand Economy: government makes all important decisions about production and distribution.Market Economy: individuals and private firms make the major decisions. Extreme case (no government intervention) is called “laissez-faire” economy.Mixed Economy has elements of both. All modern economies are mixed.
4. . .has never existed. The closest to it A Pure Market Economy. . .. . .has never existed. The closest to itwas probably England in the 19th century.There has never been a pure “command economy” either,although some of the older communist regimes (Stalin,Pol Pot) may have been close.
5U.S. Economic SystemLargely a market systemHowever, we do have some laws and regulations that affect market decisions.Can you think of some policies (state, federal or local) that affect certain markets?
6Price DeterminationAssuming no or little government intervention in a market, what determines price?Explaining prices is a fundamental question that drove the development of modern economics.It is only recently (late 19th century) that a good understanding of price determination developed.
7Supply and DemandSupply and Demand determine prices inindividual markets.Price is the mechanism that brings supplyand demand together.
8Rationing by pricesThrough prices, the market rations thescarce goods of society among possibleuses.
9The Demand ScheduleThe demand schedule (demand curve)shows the relationship between a commodity’s market price and the quantity of that commodity that consumers are willing and able to purchase, other things held constant.Generally, the higher the price, the less thequantity demanded.
10The Dailey Demand Schedule for Pizza in Chicago Price($/slice)Quantity Demanded(1000s of slices per day)$5 44 83 122 161 20
11The Daily Demand Curve for Pizza in Chicago Price($ per slice)Demand48312216Quantity(1000s of slices per day)
12Law of Downward Sloping Demand When the price of a commodity is raised(and other things are held constant), buyerstend to buy less of the commodity. Similarly,when the price is lowered, other things beingconstant, quantity demanded increases.There are two explanations for downwardsloping demand curves.
13Reason 1: Substitution Effect When the price of a good rises, I willsubstitute other similar goods for it.For example, if the price of beef rises,I will eat more chicken and pork.
14Reason 2: Income EffectAs the price of a commodity rises, my incomewill not stretch as far as it used to. I amtherefore “poorer” in a relative sense,than before the price increase and can’t buyas many things as I did before.
15Demand and Cost-Benefit The reservation price is the benefit the buyer receives from the goodThe cost of the good is its market priceIf the reservation price (benefit) exceeds the market price (cost) the consumer will purchase the goodAt higher prices, benefit will exceed cost for a smaller quantity than at lower prices
16Buyers and Sellers In Markets Horizontal InterpretationPrice($ per slice)Price determines quantity demanded432Demand81216
17Buyers and Sellers In Markets Vertical InterpretationPrice($ per slice)Quantity measures the marginal buyer’s reservation price432Demand81216
18Market Demand CurveThe market demand curve “adds up”all the quantities demanded by individualconsumers at a given price.It shows the total amount of a commodityconsumers are willing and able to buy ata given price.
19The Supply ScheduleThe supply schedule (or supply curve) fora commodity shows the relationship betweenthe market price and the amount of thatcommodity that producers are willing and ableto produce and sell, other things heldconstant. Generally, the higher the price themore producers will supply.
20The Daily Supply Schedule for Pizza in Chicago Price($ per slice)Quantity(1000s of slices per day)$4 163 122 8
21The Daily Supply Curve for Pizza in Chicago Price($ per slice)Supply42381216Quantity(1000s of slices per day)
22Opportunity Costs and Quantity Produced QuestionWill the opportunity cost of producing additional units of pizza increase or decrease?Hint:Low-hanging-fruit principle
23Supply Slopes UpSupply slopes up because of the “law ofdiminishing returns.” To get extra outputusually requires proportionally more extrainput.
24Seller’s Reservation Price The smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost
25Opportunity Costs and Upward Sloping Supply Sellers must receive a higher price to produce additional units of product to cover the higher opportunity costs of each additional unit
26The Daily Supply Curve for Pizza in Chicago Horizontal InterpretationPrice($ per slice)Supply4Shows the quantity produced for each price32Quantity(1000s of slices per day)81216
27The Daily Supply Curve for Pizza in Chicago Vertical InterpretationPrice($ per slice)Supply4Shows the marginal cost (reservation price) for producing each additional unit32Quantity(1000s of slices per day)81216
28Supply and Demand: Equilibirum A market equilibrium comes at the placewhere quantity demanded equals quantitysupplied.Equilibrium takes place at the intersectionof the supply and demand curves.
29Market Equilibrium Equilibrium Market Equilibrium A system is in equilibrium when there is no tendency for it to changeMarket EquilibriumOccurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price
30Equilibrium Price and Equilibrium Quantity The values of price and quantity for which quantity supplied and quantity demanded are equal
31The Equilibrium Price and Quantity of Pizza In Chicago ($ per slice)SupplyDemand4Equilibrium at $3Quantity Demanded =Quantity Supplied32Quantity(1000s of slices per day)81216
32Market Equilibrium What Do You Think? Is the market equilibrium always an ideal outcome for all market participants?
33Market Equilibrium What Do You Think? Would buyers prefer a lower price than the equilibrium price?Would sellers prefer a higher price than the equilibrium price?
34Points Along the Demand and Supply Curves of a Pizza Market Demand for pizzaSupply of pizzaPrice($/slice)Quantity demanded(1000s of slices/day)Quantity supplied182643Note: There is no point in the table where price would make quantitydemanded equal quantity supplied. Our equilibrium price must fallbetween $2 and $3.
35Graphing Supply and Demand and Finding the Equilibrium Price and Quantity ($per slice)Supply54The Equilibrium Price = $2.50The Equilibrium Quantity = 532.5021DemandQuantity(1000s of slices per day)2468105When we graph the curves, we can find the equilibrium price andquantity.
36Excess Demand: If price is below equilibrium ($ per slice)Supply4Excess demand = 8,000slices per day32DemandQuantity(1000s of slices per day)816This situation is called a shortage.
37Excess Supply: If price is above equilibrium Excess supply = 8,000 slices per dayPrice($ per slice)SupplyDemand432Quantity(1000s of slices per day)81216This situation is called a surplus.
38When economists use the word “surplus” or “shortage” they mean that Caution!When economists use the word“surplus” or “shortage” they mean thatthe market is not in equilibrium. If thereis a surplus, products pile up,un-purchased.If there is a shortage, many consumerscannot find the product to buy.
39What is a shortage? Example. The Christmas of 2000, there was ashortage of the PlayStation II. Consumerscould not find the item on store shelves.Gas prices rose this summer, but therewas no shortage because consumerscould find the gas to buy, although ata higher price than before.
40Factors Affecting Demand Size of market, e.g. how many consumers.Income levels of consumers.Prices and availability of related goods.Tastes and preferences.Special influences, e.g. climate and conditions.
41Factors Affecting supply Changes in costs of inputsTechnological changePrices of alternative products that could be produced with same resources.Government policySpecial factors (climate, culture)
42Shifts of Supply or Demand If one of the factors affecting a demandor supply curve changes, the curve willshift. This means the entire curve movesto a new position on the graph.
43Example: Shift of the demand curve For most products, demand shifts outward as income rises.PD'DQ
44An ExampleWhen students come back to school in the fall,more pizzas are sold locally.This is an increase in demand caused by an increase in the size of the market!
45Another ExampleWhen low-carb diets were popular,fewer loaves of bread were sold.This is a decrease in demand causedby a change in tastes and preferences.
46Demand Increase or Decrease? What happens to demand for sunblock in the summer?What happens to demand for fish when chicken prices increase?What happens to the demand for luxury cars when incomes fall?What will happen to the demand for sugar if diabetes increases?
47Normal Good vs. Inferior Good If, when income rises, consumers purchasemore of a good, that good is called a “normalgood.”Sometimes consumers may buy less of a certain item when their incomes rise. That good is called an “inferior good.”Most items are normal goods. Can you think of some inferior goods?
48Shift of supply curve P S S’ Q If the price of an input falls, the supply curve shifts out.SS’Q
49Shifts in curves change equilibrium price and quantity Supply increasesS’S’’P’P”DQQ’Q’’
50Shifts in curves change equilibrium PSupply decreasesS’’S’P’’P’DQQ”Q’
51Shifts in curves change equilibrium PDemand IncreasesSP”P’D”D’QQ’Q”
52Shifts in curves change equilibrium PSDemand DecreasesP’P”D’D”QQ”Q’
53There are four possibilities Price Up, Quantity Down Supply decreasePrice Down, Quantity Up -- Supply increasePrice Up, Quantity Up -- Demand increasePrice Down, Quantity Down -- Demand decrease
54An Unregulated Housing Market Monthly Rent($/apartment)SupplyWhat Do You Think?Is $1600 more than some people can afford?1,600DemandQuantity(Millions of apartments/day)2
55Excess demand = 2 million apartments per month Rent ControlsMonthly Rent($/apartment)Supply2,400Excess demand = 2 million apartments per month1,600Controlled = 800DemandQuantity(Millions of apartments/day)123
56Rent Control Other consequences of rent controls Maintenance will decline and housing quality will fallIllegal paymentsCreation of co-ops and conversion to condominiumsReduction in household mobilityDiscrimination
57Affordable Housing What do you think? How can we make housing affordable for poor people without using rent ceilings?
58Price Controls In The Pizza Market ($ per slice)Supply4Excess demand = 8,000 slices per day3Price ceiling = 2DemandQuantity(1000s of slices per day)81216
59Market Equilibrium Pizza Price Controls? Market responses to a pizza price ceilingLong linesPreferential treatment to selected customersAlternative pricing strategiesPoorer quality ingredientsBlack-market pizzas(We can look to old USSR for real-life examples.)
60Predicting and Explaining Changes In Prices and Quantities Distinguishing Between:A change in the quantity demandedA movement along the demand curve that occurs in response to a change in priceA change in demandA shift of the entire demand curve
61An Increase In Quantity Demanded vs. An Increase In Demand Price($/can)6Increase in quantity demandedD54321Quantity(1000s of cans/day)24681012
62An Increase In Quantity Demanded vs. An Increase In Demand Price($/can)D’D654Increase in demand32D’1DQuantity(1000s of cans/day)12
63Predicting and Explaining Changes In Prices and Quantities Change in the quantity suppliedA movement along the supply curve that occurs in response to a change in priceChange in supplyA shift of the entire supply curve
64An Increase In Quantity Supplied vs. An Increase In Supply Price($/can)S65Increase in quantity supplied4321Quantity(1000s of cans/day)246810
65An Increase In Quantity Supplied vs. An Increase In Supply Price($/can)6SS’543Increase in supply21SS’Quantity(1000s of cans/day)246810