1. Decision-making and Demand and Supply Analysis

2. Thinking Economically: Marginal Analysis Optimization Assumption: an assumption that suggests that the person in question is trying to maximize some objective Marginal Benefit: the increase in the benefit that results from an action Marginal Cost: the increase in the cost that results from an action Total Net Benefits: the difference between all benefits and all costs

3. Maximizing Total Net Benefits Total Way – select the level of the activity that maximizes the difference between total benefits and total costs Marginal Way – set the marginal benefit of to the marginal cost of an extra unit Economist prefer the later because many decisions are not all or nothing. Most times people are deciding to increase or decrease the amount of something that they are doing.

4. Marginal Way in Action The example of the boxes If the marginal benefit of an extra unity of the activity is greater than its marginal cost, increasing the activity will increase total net benefits. If the marginal cost of an extra unit of the activity is greater than its marginal cost, increasing the activity will decrease total net benefits. Therefore, to maximize total net benefits the level of an activity that maximizes total net benefits is where the marginal benefit equals the marginal cost of an extra unit of the activity.

5. Boxes If an extra unit of the activity (trades) results in getting more boxes (MB) than are being given up (MC) the stack of boxes grows (TNB). If an extra unit of the activity (trades) results in getting less boxes (MB) than are being given up (MC) the stack of boxes shrinks (TNB). If an extra unit of the activity (trades) results in getting the same amount of boxes (MB) that are being given up (MC) the stack of boxes is at its tallest ( maximum TNB).

7. Markets: The power of Demand and Supply Competitive Markets –identical or homogeneous goods –many sellers and buyers –perfect Information –free entry and exit Non-Competitive Markets –Monopoly – one seller –Oligopoly – few sellers –Monopolistically Competitive – differentiated products

8. Demand The demand curve –Price and the quantity demanded Rational behavior –Utility maximization (MB=MC all over again) Law of diminishing marginal utility –Jelly bean example –MB fall as activity level increases Income and substitution effects –Demand schedule –Individual demand curve –Market demand curve

9. Catherine’s Demand Schedule

10. Figure 1 Catherine’s Demand Schedule and Demand Curve Copyright © 2004 South-Western Price of Ice-Cream Cone 0 2.50 2.00 1.50 1.00 0.50 1234567891011 Quantity of Ice-Cream Cones $3.00 12 1. A decrease in price... 2....increases quantity of cones demanded.

11. The demand function –Income –Price of related goods Complements Substitutes –Tastes –Expectations –Number of Buyers

12. Movement along and shifts of the demand curve –Curve versus function –Schedules –Graphs

13. Figure 3 Shifts in the Demand Curve Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone Quantity of Ice-Cream Cones Increase in demand Decrease in demand Demand curve,D 3 Demand curve,D 1 Demand curve,D 2 0

14. Supply Price and the quantity supplied –Rational behavior an the profit motive –Law of diminishing returns The production example MC rise as production increases in the short-run Supply schedule Individual supply curve Market supply curve

15. Ben’s Supply Schedule

16. Figure 5 Ben’s Supply Schedule and Supply Curve Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0 2.50 2.00 1.50 1.00 1234567891011 Quantity of Ice-Cream Cones $3.00 12 0.50 1. An increase in price... 2.... increases quantity of cones supplied.

17. The supply function –Input prices –technology –expectations –number of sellers

18. Figure 7 Shifts in the Supply Curve Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 Increase in supply Decrease in supply Supply curve,S 3 curve, Supply S 1 curve,S 2

19. Market Equilibrium Equilibrium price and quantity = market clearing price and quantity Disequilibrium prices and quantities –Shortage – Excess Demand –Surplus – Excess Supply Comparative static analysis: changes in equilibrium prices and quantities Shifts in curves versus movement along revisited Changes in demand and supply

20. Figure 8 The Equilibrium of Supply and Demand Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0123456789101112 Quantity of Ice-Cream Cones 13 Equilibrium quantity Equilibrium price Equilibrium Supply Demand $2.00

21. Figure 9 Markets Not in Equilibrium Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0 Supply Demand (a) Excess Supply Quantity demanded Quantity supplied Surplus Quantity of Ice-Cream Cones 4 $2.50 10 2.00 7

22. Figure 8 The Equilibrium of Supply and Demand Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0123456789101112 Quantity of Ice-Cream Cones 13 Equilibrium quantity Equilibrium price Equilibrium Supply Demand $2.00

23. Figure 9 Markets Not in Equilibrium Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0 Supply Demand (a) Excess Supply Quantity demanded Quantity supplied Surplus Quantity of Ice-Cream Cones 4 $2.50 10 2.00 7

24. Figure 9 Markets Not in Equilibrium Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones Supply Demand (b) Excess Demand Quantity supplied Quantity demanded 1.50 10 $2.00 7 4 Shortage

25. Figure 10 How an Increase in Demand Affects the Equilibrium Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones Supply Initial equilibrium D D 3....and a higher quantity sold. 2.... resulting in a higher price... 1. Hot weather increases the demand for ice cream... 2.00 7 New equilibrium $2.50 10

26. Figure 11 How a Decrease in Supply Affects the Equilibrium Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones Demand New equilibrium Initial equilibrium S1S1 S2S2 2.... resulting in a higher price of ice cream... 1. An increase in the price of sugar reduces the supply of ice cream... 3....and a lower quantity sold. 2.00 7 $2.50 4

27. The Invisible Hand Economic Agents are motivated by self-interest –consumers by utility maximization –Producers by profit maximization Market prices as signals for resource allocation and coordinate consumer and producer behavior Market or the Price System and Efficiency