1. Markets – The Basics Wants: Wish Lists Scarcity: Wants exceed Possibilities Limited Resources: Limited labor, limited natural resources, limited plants, factories, …  Possibilities Each individual’s wish list is huge. When we added the wish lists of all individuals together we would have an astronomically long list of wants. It is utterly impossible for our economy to produce enough goods and services to meet everyone’s wants given that we only have a limited number of workers, factories, farms, etc. Review: The Economics Problem  Scarcity Scarcity exists in all economies; that is, wants exceed possibilities everywhere. Different economies have used different allocation mechanisms to cope with scarcity. Conclusions

2. Investment Goods Consumption Goods All resources used to produce investment goods: tools, factories, plants, etc. All resources used to produce consumption goods: food, clothing, beer, etc. Resources from the production of investment goods to the production of consumption goods. Production Possibility Curve: An Illustration of the Possibilities – A Conceptual Tool Opportunity Cost: What is foregone when an activity is pursued. Investment Goods Consumption Goods Question: What would happen over time? Rich Poor Production Possibility Curve: All the combinations of consumption goods and investment goods that are possible for an economy to produce with its limited resources Question: How does a society decide where to operate on its production possibility curve? That is, what allocation mechanism is used to determine where on an economy’s production possibility frontier it operates? Decision: Every society faces the problem of scarcity and hence must “decide” on the combination of consumption goods and investment goods to produce. Question: What difference does if make?

3. Central Planning versus Markets: Deciding where to operate on the production possibility curve Investment Goods Consumption Goods 1985 1920 Central Planning: Former Soviet Union from 1920 to 1985 Markets A central planning bureau decides explicitly where to operate on the production possibility curve and devises a detailed plan to implement its decision. A very different way for an economy to determine where to operate on its production possibility curve. Central Plan x bushels of wheat y ingots of steel z tractors etc. 1920 Decision: Rapid industrialization 1985 Decision: Increase the production of consumer goods Bad news: Few consumption goods were produced Good news: Many investment goods were produced  Production possibility curve shifted out dramatically A problem serious became evident Soviet Union collapsed and market reforms occurred in the Soviet Union and eastern Europe For example, many workers simply did not show up at their job. Some of those who did showed up drunk.

4. Project: Market for Personal Computers in the 1980's Personal ComputersCost of 16 BitNew PriceQuantityProcessorsOperatingWordNew Year($ per PC)(millions)($ per bit)SystemsProcessorsSpreadsheets 19821,7003.518WordStarMultiplan 1983WindowsWordLotus 1-2-3 19841,9007.512 1985Windows 1.0WordPerfect 19862,7007.018 1987Windows 2.0Excel 19882,9009.59 Between 1982 and 1984Between 1984 and 1986Between 1986 and 1988 Price rose by $200 Price rose by $800 Price rose by $200 Quantity rose by 4 million Quantity fell by.5 million Quantity rose by 2.5 million Question: How can we explain this erratic behavior?

5. Market demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____, given that everything else relevant to the demand for beer remains the same? Market supply curve: How many cans of beer would firms produce (the quantity supplied), IF the price of beer were _____, given that everything else relevant to the supply of beer remains the same? Equilibrium: Quantity Demanded = Quantity Supplied P Q S Market Demand and Supply Curves P Q D S P* Q* P Q D If P =.50 If P = 1.00 If P = 1.50 If P = 2.00 If P =.50 If P = 1.00 If P = 1.50 If P = 2.00 2.00 1.501.00.50 2.00 1.501.00.50 Question: Does the market demand curve by itself tell us what the price will equal? Question: Does the market supply curve by itself tell us what the price will equal? Answer: No. Question: Why then have we gone to the trouble of introducing the demand and supply curves? Question: Why is the demand curve downward sloping? Question: Why is the supply curve upward sloping? Claim: When we combine the two curves we can determine what the price will equal. P*= Equilibrium price Q*= Equilibrium quantity Question: Why is the equilibrium important?

6. Actual Price, Equilibrium Price, and Market Forces Market demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____, given that everything else relevant to the demand for beer remains the same? Market supply curve: How many cans of beer would firms produce (the quantity supplied), IF the price of beer were _____, given that everything else relevant to the supply of beer remains the same? Equilibrium: Quantity Demanded = Quantity Supplied P Q D S P* Q* If Actual Price < Equilibrium Price  Quantity Demanded > Quantity Supplied  Shortage exists  Actual Price rises If Actual Price > Equilibrium Price  Quantity Demanded < Quantity Supplied  Surplus exists  Actual Price falls Shortage Surplus Market Forces  Inventories fall  Inventories rise  Until the equilibrium is reached and the actual price equals the equilibrium price  Size of shortage decreases  Size of surplus decreases Market Forces: Actual Price equals Equilibrium Price 

7. Review: Actual Price, Equilibrium Price, and Market Forces Market demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____, given that everything else relevant to the demand for beer remains the same? Market supply curve: How many cans of beer would firms produce (the quantity supplied), IF the price of beer were _____, given that everything else relevant to the supply of beer remains the same? Equilibrium: Quantity Demanded = Quantity Supplied P Q D S P* Q* If Actual Price < Equilibrium Price  Quantity Demanded > Quantity Supplied  Shortage exists  Actual Price rises If Actual Price > Equilibrium Price  Quantity Demanded < Quantity Supplied  Surplus exists  Actual Price falls Shortage Surplus Review: Market Forces  Inventories fall  Inventories rise  Until the equilibrium is reached and the actual price equals the equilibrium price  Size of shortage decreases  Size of surplus decreases Market Forces: Actual Price equals Equilibrium Price 

8. Market demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____, given that everything else relevant to the demand for beer remains the same? Market supply curve: How many cans of beer would firms produce (the quantity supplied), IF the price of beer were _____, given that everything else relevant to the supply of beer remains the same? Equilibrium: Quantity Demanded = Quantity Supplied P Q S “Given That Everything Else … Remains the Same” – Shifts of a Curve P Q D S P* Q* P Q D If P =.50 If P = 1.00 If P = 1.50 If P = 2.00 If P =.50 If P = 1.00 If P = 1.50 If P = 2.00 2.00 1.501.00.50 Price of wine rises. D’ P** Q** Question: Would this affect demand or supply or neither? At the old equilibrium price, P*, Quantity Demand > Quantity Supplied  A shortage exists.  Price rises until Quantity Demanded = Quantity Supply An equilibrium is reestablished

9. Market demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____, given that everything else relevant to the demand for beer remains the same? Market supply curve: How many cans of beer would firms produce (the quantity supplied), IF the price of beer were _____, given that everything else relevant to the supply of beer remains the same? Equilibrium: Quantity Demanded = Quantity Supplied P Q S “Given That Everything Else … Remains the Same” – Shifts of a Curve P Q D S P* Q* P Q D If P =.50 If P = 1.00 If P = 1.50 If P = 2.00 If P =.50 If P = 1.00 If P = 1.50 If P = 2.00 2.00 1.501.00.50 Price of barley, hops, etc. falls S’ P** Q** Question: Would this affect demand or supply or neither? At the old equilibrium price, P*, Quantity Demand < Quantity Supplied  A surplus exists.  Price falls until Quantity Demanded = Quantity Supply An equilibrium is reestablished

10. Summary Market demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____, given that everything else relevant to the demand for beer remains the same? Market supply curve: How many cans of beer would firms produce (the quantity supplied), IF the price of beer were _____, given that everything else relevant to the supply of beer remains the same? Equilibrium: Quantity Demanded = Quantity Supplied Shifts  Change in something OTHER THAN the price of beer ITSELF Movements along  Change in the price of beer ITSELF The demand curve for beer can SHIFT ONLY if something that affects demand OTHER THAN the BEER PRICE changes. The supply curve for beer can SHIFT ONLY if something that affects supply OTHER THAN the BEER PRICE changes.  The slopes of the demand and supply curves for beer capture the effect of a change in the BEER PRICE itself; a change in the price of beer leads to a MOVEMENT ALONG the demand and supply curves for beer

11. A Dated but Instructive Example: Electronic Pocket Calculators in the 1970’s CalculatorsProduction Cost Data PriceQuantitySemiconductorDisplayAssembly Year($/calculator)(millions)chip ($/chip)($/digit)time (min) 19713201 1972200515.001.0030 197310012 19745020 19754023 197635243.00.305 100 200 300 510152025 P Q 1971 1972 1973 1974 1975 1976 Questions: As a consequence of market forces, how would you expect the quantity demanded and quantity supplied in each year to be related? Consider the graph below that plots the quantity and price for each year. As a consequence of market forces, what does each year’s point in the graph represent? For each year, where do the market demand curve and market supply curve intersect?

12. Electronic Pocket Calculators in the 1970’s – Demand CalculatorsProduction Cost Data PriceQuantitySemiconductorDisplayAssembly Year($/calculator)(millions)chip ($/chip)($/digit)time (min) 19713201 1972200515.001.0030 197310012 19745020 19754023 197635243.00.305 100 200 300 510152025 P Q 1971 1972 1973 1974 1975 1976 First the market demand curve. Question: Did the demand curve have to shift? Question: Do we have any information suggesting that the demand curve shifted? D 1971-1976 Answer: No – The demand curve is a downward sloping curve. We can draw a downward sloping curve through the points. Answer: No – The production data should not affect the demand for calculators.

13. Electronic Pocket Calculators in the 1970’s – Supply CalculatorsProduction Cost Data PriceQuantitySemiconductorDisplayAssembly Year($/calculator)(millions)chip ($/chip)($/digit)time (min) 19713201 1972200515.001.0030 197310012 19745020 19754023 197635243.00.305 100 200 300 510152025 P Q 1971 1972 1973 1974 1975 1976 Now the market supply curve S 1971 S 1972 S 1973 S 1974 S 1975 S 1976 Question: Did the supply curve have to shift? Question: What caused the supply curve to shift? Answer: Yes – The supply curve is upward sloping. We can’t draw an upwards sloping curve through the points.

14. Electronic Pocket Calculators in the 1970’s CalculatorsProduction Cost Data PriceQuantitySemiconductorDisplayAssembly Year($/calculator)(millions)chip ($/chip)($/digit)time (min) 19713201 1972200515.001.0030 197310012 19745020 19754023 197635243.00.305 100 200 300 510152025 P 1971 1972 1973 1974 1975 1976 Putting the demand and supply curves together. S 1971 S 1972 S 1973 S 1974 S 1975 S 1976 Q D 1971-1976

15. The U.S. Corn Industry – 2011-2013 Year Corn Price (dollars per bushel) Corn Quantity (billions of bushels) July & August rainfall in Akron, Iowa (inches) Cattle Herds (millions of heads) Ethanol (millions of barrels per day) Beef exports (billions of pounds) 20116.2212.44.710046.72.79 20126.8910.81.39844.72.45 20134.5013.95.49844.42.58 Q P 4.00 5.00 6.00 7.00 10.012.011.013.014.0 2012 2011 2013 D 2012 D 2011 D 2012-2013 S 2012 S 2011 S 2013 Now the market supply curve 2011-2012 Shifts left 2012-2013 Shifts right First the market demand curve 2011-2012 Shifts left 2012-2013 Remained about stationary Putting the market demand and the market supply curves together