1. Longwood University Personal Finance Scott Wentland wentlandsa@longwood.edu 434-395-2160 Longwood University 201 High Street Farmville, VA 23901

2. Longwood University Markets Part 1 – What are markets?

3. Longwood University Individuals and Value Where does value really come from? – Individuals (last lecture) Looked at how individuals determine value for themselves (subjective value for goods we consume) Individuals think “on the margin” – Diamonds are more valuable than water, because an additional diamond makes us much happier than an additional bottle of water (assuming we’re not in desert) – But this story is incomplete… Diamonds would be valuable to you, even if you didn’t like diamonds…

4. Longwood University Markets and Value Even if you didn’t like diamonds, you could always sell a diamond on the market… – Markets (this lecture) Markets are made up of individuals (consumers and producers) who trade with one another – Buying/selling is the market’s way to address scarcity – Prices help buyers and sellers make good decisions and help make the market “efficient” Markets can be best understood by understanding the laws of supply and demand

5. Longwood University What is a market? Markets are everywhere and anywhere, where people buy and sell something for a price – This is a VERY general definition – Examples: Stock market Shopping mall or flea market Grocery store Street corner (illegal or black markets are still markets) Ebay or Amazon (markets don’t have to even be a physical place) Labor market (selling your services…wage = price) – Prices don’t even have to be in cash, they can be barter exchanges

6. Longwood University Why markets? Why do we have markets? – We don’t live in a world where everyone begins with everything he or she will ever want/need – We learn this at lunch in grade school Mom packed pudding, I want chips Joe’s mom packed chips, Joe wants pudding – I trade my pudding for Joe’s chips – We’re both happier  a more efficient allocation Markets help us allocate resources efficiently – (This is just one of many things markets do…) Why is resource allocation important?

7. Longwood University Scarcity We live in a world of scarcity – Humans have infinite wants and needs Our resources are finite. – In economics, scarcity is the idea that our wants/needs exceed our resources Even if our physical resources were infinite, we would still be constrained by time  we cannot escape scarcity Markets help us get the most out of what we’ve got – Also provide incentives for advancement (more on this later)

8. Longwood University Markets vs. Central Planning An economy that lets markets (i.e. buyers/sellers) produce, control, and allocate resources is a market economy. – Goods and services are freely traded at mutually agreeable prices – Factors of production (land, labor, capital) or inputs are primarily owned privately (not by government) – Low government involvement in the day-to-day economy – Also called capitalism, free market capitalism, or laissez faire capitalism Are markets the only way to allocate resources?

9. Longwood University Markets vs. Central Planning Planned (or command) economy – The government (or “The People”): Decides what to produce, who produces it, and who gets it Decide how resources are allocated Own the factors of production (land/natural resources, labor, capital) and plan how they are used Buying and selling in markets are largely prohibited – Also called central planning or communism

10. Longwood University A Spectrum of Economies

11. Longwood University A Spectrum of Economies

12. Longwood University A Spectrum of Economies

13. Longwood University A Spectrum of Economies Also called “mixed economies”…most economies are “mixed” Next lecture: how do markets work?

14. Longwood University Markets Part 2 – How do markets work? A (very brief) intro to supply & demand

15. Longwood University How do markets work? Supply and demand – Supply  represents the sellers In a pure free market  many sellers – Demand  represents the buyers In a pure free market  many buyers In markets, buyers and sellers come together to exchange – For any given good, a price emerges as a market price, as a result of negotiations between them

16. Longwood University Demand Consumer have a limited income and want to maximize utility (or happiness) – Buyers always want the lowest price they can get – When something becomes cheap, consumers tend to buy more – When something becomes expensive, consumers economize and cut back on quantity of that Common sense, right?

17. Longwood University Law of Demand Law of demand: “an increase in a product’s price results in a decrease in quantity demanded” holding all else constant 1.Income 2.# of buyers in the market 3.Prices of other goods 1.Substitutes 2.Complements 4.Expectations 5.Tastes These may “shift demand” if they change – More about that in a full microeconomics course…

18. Longwood University Demand Curve The Demand Curve for Oil is a Function Showing the Quantity of Oil Demanded at Different Prices Price of Oil per Barrel Quantity of Oil (MBD) $55 $5 $20 55025 Demand Price Quantity Demanded $55 5 $2025 $550

19. Longwood University Supply Producers/sellers want to maximize profit – Profit margin = Price – Average Cost They always want the highest price they can get – When something becomes more expensive, businesses want to supply/sell more of their product

20. Longwood University Law of Supply Law of supply: “an increase in a product’s price will result in an increase in quantity supplied by the market” holding all else constant Holding what else constant? 1.Technological Innovations 2.Input Prices 3.Taxes and Subsidies 4.Expectations 5.Entry or Exit of Producers 6.Changes in Opportunity Costs

21. Longwood University Supply Curve The Supply Curve for Oil is a Function Showing the Quantity of Oil Supplied at Different Prices Quantity of Oil (MBD) Price of Oil per Barrel Supply Curve for Oil 50 30 10 $5 $20 $55 Price Quantity Supplied $5550 $2030 $510

22. Longwood University Equilibrium Buyers want the lowest price Sellers want the highest price – When they come together, they generally meet somewhere in the middle – They work out mutually beneficial exchanges and a market price emerges Supply = Demand

23. Longwood University Equilibrium Demand Curve Supply Curve 65 $30 Equilibrium Price Equilibrium Quantity Quantity of Oil (MBD) Price of Oil per Barrel Price is Determined by Supply and Demand

24. Longwood University In Equilibrium An optimal price emerges out of buyers and sellers interacting in the market Why is this price optimal or efficient? # Supplied = # Demanded (at the equilibrium price) – The lowest cost, most efficient sellers are the ones who supply at that price – The highest valued buyers are the ones who buy at that price – All possible mutually beneficial trades have taken place at that price There are no sellers left who want to sell at a price that another buyer would agree to.

25. Longwood University In Equilibrium If we were to design an allocation of stuff at the beginning we would want: – The people who are best, lowest cost producers to make stuff We don’t want people in Alaska to grow oranges  wasteful and inefficient – The people who have the highest value for stuff to get it and consume it We don’t want people who don’t like oranges to get them  wasteful and inefficient Markets get us this efficient outcome, without anyone planning it

26. Longwood University Equilibrium An equilibrium will emerge in any free market – Check Ebay for the price of a specific product Buyers bid until a price settles on some equilibrium price If a similar item goes up for auction, it sells for about the same amount (assuming nothing else has changed) – Compare travel sites for any given flight Equilibrium price is very close That equilibrium may change, as other things that affect supply and demand change – Supply and demand conditions constantly change – Markets are dynamic  prices change

27. Longwood University Value Back to our diamond/water paradox… – Diamonds are also valuable because they have a high market price as a result of supply and demand In the last lecture, we talked about from an individual buyer’s perspective Here, we take the entire market perspective – Diamonds have a: Low supply – very rare, hard to find, labor intensive, few sellers High demand – Many uses, many buyers want them relative to supply High price. – Water’s low market price is largely due to high supply

28. Longwood University Conclusions Understanding markets through supply and demand helps us understand – Value and prices in a market economy – How market economies allocate resources efficiently Full microeconomics course – Learn a lot more about supply and demand How to use supply and demand to understand markets better Predict prices based on particular events Predict how certain government policies (e.g. minimum wage) affects markets

29. Longwood University Thank You http://en.wikipedia.org/wiki/Scarcity http://en.wikipedia.org/wiki/Market_economy http://en.wikipedia.org/wiki/Social_market_economy http://en.wikipedia.org/wiki/Planned_economy http://en.wikipedia.org/wiki/Factors_of_production http://en.wikipedia.org/wiki/Supply_and_demand