Economics 10 1 2017 September Lecture 3 Chapter 3 2017 Economics 101 CCC

Step 1 - Thinking like an economist

content Economic model Market equilibrium, supply and demand Demand Graphs, Shift, Movement, Math Supply Graphs, Shift, Movement, Math Equilibrium Shortage Surplus Predicting Price when D or S changes

What is a economic model?

What is an economic model? An economic model is simplified framework designed to illustrate complex processes, often but not always using mathematical techniques. simplified description of reality abstraction from details to understand clearly the main forces driving the economy. useful in describing and predicting how the world works.

What is an economic model? Model Assumptions Models rely on simplifying assumptions Drive the conclusions of the model. When analyzing a model it is crucial to spell out the assumptions underlying the model. Good assumptions help build a model that accounts for the observations and predicts well.

What is an economic model? Variables dependent variable – the one that is being explained independent variables as they provide the explanation that causes the change Example: Quantity Demanded of a product (Q) is influenced by Available Income (I) Preference for the product (T) Price of the product (P) Q is dependent .. The others are independent

What is an economic model? Example: supply and demand purpose - explain and analyze prices and quantities traded in a competitive market. T model’s mathematical equations - level of supply and demand as a function of price Assumptions: market-clearing price is determined by the requirement that supply equal demand at that price. demand is assumed to decline as price increases supply is assumed to increase with price increases

What is an economic model? Hurricane Irma has decreased expected yields of oranges. Does this affect supply or demand of orange juice?

What is an economic model? A new study has shown that orange juice makes you very very smart in university. Does this affect supply or demand of orange juice?

Supply and Demand

Economic Coordination To make coordination work, four complimentary social institutions have evolved over the centuries: Firms Markets Property rights Money

Economic Coordination A firm is an economic unit that hires factors of production and organizes those factors to produce and sell goods and services. A market is any arrangement that enables buyers and sellers to get information and do business with each other. Property rights are the social arrangements that govern ownership, use, and disposal of resources, goods or services. Money is any commodity or token that is generally acceptable as a means of payment.

Economic Coordination Circular Flows Through Markets illustrates how households and firms interact in the market economy. Factors of production, and … goods and services flow in one direction. Money flows in the opposite direction.

Economic Coordination Coordinating Decisions Markets coordinate individual decisions through price adjustments.

Economic Coordination terms In some cases – markets work well as they match what consumers want with what firms produce markets do not work well no matching .. Shortage .. Excess…Market Failure Economics tries to explain why and why not and how best to organize markets

Economic Coordination Competitive Market and Price Competitive market is a market that has many buyers and many sellers so no single buyer or seller can influence the price. Invisible hand in play Money price - amount of money needed to buy a good. Relative price - ratio of its price of a good relative the price of the next best alternative good—is its opportunity cost. Ex: price of orange juice: price of apple $4/$2

How are prices Set? Why are these goods expensive?

Why are some goods cheap and others expensive?

Market equilibrium, supply and demand

How is the market price of a good determined? Using demand curve … The quantity of a good that buyers are willing and able to buy at each price Using supply curve … The quantity of a good that sellers are willing to sell at each price Review price where Qs = Qd that is Market equilibrium

How is the market price of a good determined? Applied in a market for a specific type and quality Ex: coffee - gourmet blend, 12 oz., caffeinated, dark roast particular period of time ceteris paribus. Market Equilibrium Qd= Qs Meaning no product in excess and no product in shortage Does not mean everyone is happy or fair

Demand, Supply & Market Equilibrium: An economic model

Demand

Demand If you demand something, then you 1. Want it, 2. Can afford it, and 3. Have made a definite plan to buy it. Wants are the unlimited desires or wishes people have for goods and services. Demand reflects a decision about which wants to satisfy. The quantity demanded of a good or service is the amount that consumers plan to buy during a particular time period, and at a particular price.

Demand & Type of Goods Normal Goods are goods for which quantity demanded goes up when income is higher and vice versa Inferior Goods are goods for which quantity demanded falls when income rises. Substitutes are goods that can serve as replacements for one another; when the price of one increases, people switch to the substitute. Perfect substitutes (rare) are almost identical products. Complements are goods that “go together”; a decrease in the price of one results in an increase in quantity demanded for the other, and vice versa.

Example: Demand & Type of Goods Coffee price increases?? What happens to quantity demanded of tea? Recession occurs ( and thus income levels decrease) What happens to quantity demanded for normal goods? What happens to quantity demanded for inferior goods? Price of hot dogs and fries increases What happens to quantity demanded for ketchup?

Demand Curve Demand Curve and Demand Schedule demand refers to the entire relationship between the price of the good and quantity demanded of the good. demand curve shows the relationship

Demand Curve Characteristics Downward sloping - law of demand – Quantity demanded of a good changes as the price of the good changes – all else held he same Why ? Two reasons: Substitution effect Income effect

Demand Substitution Effect When the relative price (opportunity cost) of a good or service rises, people seek substitutes for it, so the quantity demanded of the good or service decreases. Ex: coffee increases – buy tea Income Effect When the price of a good or service rises relative to income, people cannot afford all the things they previously bought, so the quantity demanded of the good or service decreases. $20 feels like less if price of everything increases

Demand Curve & Math Show me the math! All demand curves follow this general equation.. QD = c – dP c = intercept So if If P = 0 how many demanded by consumers? d = slope of demand curve QD = 24 - 4P 24

Demand example

Demand Movement Along the Demand Curve rise in the price decrease in the quantity demanded and a movement up along the demand curve. fall in the price increase in the quantity demanded and a movement down along the demand curve. All else held the same

Demand What would make you change your demand?

Demand Shift of the Demand Curve The prices of related goods Expected future prices Income Expected future income and credit Population Preferences All else held the same

Demand Prices of Related Goods A substitute is a good that can be used in place of another good. A complement is a good that is used in conjunction with another good. Examples??

Demand Expected Future Prices If the price of a good is expected to rise in the future, current demand for the good increases and the demand curve shifts rightward. Income When income increases, consumers buy more of most goods and the demand curve shifts rightward. A normal good is one for which demand increases as income increases. An inferior good is a good for which demand decreases as income increases.

Demand Expected Future Income and Credit When income is expected to increase in the future or when credit is easy to obtain, the demand might increase now. Population The larger the population, the greater is the demand for all goods. Preferences (Tastes) People with the same income have different demands if they have different preferences.

Note the difference … Change in price of a good or service leads to Change in quantity demanded (Movement along the curve) due to shift in supply curve. Change in six factors leads to Change in demand (Shift of curve)

Supply

Supply The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price. If a firm supplies a good or service, then the firm 1. Has the resources and the technology to produce it, 2. Can profit from producing it, and 3. Has made a definite plan to produce and sell it. Resources and technology determine what it is possible to produce. Supply reflects a decision about which technologically feasible items to produce.

Supply Supply Curve and Supply Schedule The term supply refers to the entire relationship between the quantity supplied and the price of a good. The supply curve shows the relationship between the quantity supplied of a good and its price

Supply Curve Characteristics Upward sloping basis law of supply (positive relationship between price and quantity) law of supply Why is this the case? Principle of Increasing Opportunity Cost The higher the price, the more firms are willing to produce and sell.. because any higher opportunity costs can be covered by the higher price So more product is supplied to the market.

Supply Curve Characteristics 2. Rising marginal cost of production As more units are produced, costs of producing one more unit rises.. increasing marginal cost of production That means that firms need to sell their extra output at a higher price to cover this rising marginal cost of production The upward slope reflects the higher price needed to cover the higher marginal cost of production Producers are willing to supply a good only if they can at least cover their marginal cost of production.

Supply Curve & Math Show me the math! All supply curves follow this general equation.. Qs = a + bP a = intercept if P =0 how many supplied to the market by firm? b = inverse slope of curve Slope = rise over run but this is an inverse as the P & Q are switched in the graph. (b=4 means what???) Qs = 0 + 4P

Supply A rise in the price, other things remaining the same, brings an increase in the quantity supplied.

Supply A Change in Supply– Shift of the Curve Six main factors The six main factors that change supply of a good are The prices of factors of production The prices of related goods produced Expected future prices The number of suppliers Technology State of nature

Supply Prices of Factors of Production If the price of a factor of production used to produce a good rises, the minimum price that a supplier is willing to accept for producing each quantity of that good rises. So a rise in the price of a factor of production decreases supply and shifts the supply curve leftward. What are those factors of production?

Supply Prices of Related Goods Produced A substitute in production for a good is another good that can be produced using the same resources. The supply of a good increases if the price of a substitute in production falls. Goods are complements in production if they must be produced together. The supply of a good increases if the price of a complement in production rises.

Supply Expected Future Prices If the price of a good is expected to rise in the future, supply of the good today decreases and the supply curve shifts leftward. The Number of Suppliers The larger the number of suppliers of a good, the greater is the supply of the good. An increase in the number of suppliers shifts the supply curve rightward.

Supply Technology Advances in technology create new products and lower the cost of producing existing products. So advances in technology increase supply and shift the supply curve rightward. The State of Nature The state of nature includes all the natural forces that influence production—for example, the weather. A natural disaster decreases supply and shifts the supply curve leftward.

Supply A Shift of the Supply Curve main factors (6 items) changes supply changes and the supply curve shifts

Note the difference … Change in price of a good or service leads to Change in quantity supplied (Movement along the curve Because the demand curve has shifted) Change in costs, input prices, technology, or prices of related goods and services leads to Change in supply (Shift of curve)

Market equilibrium

Market Equilibrium So how does a market work then? interaction between buyers and sellers. Market Equilibrium occurs when Qd= Qs Meaning no product in excess and no product in shortage no tendency for the market price to change Does not mean everyone is happy

Market Equilibrium Who is happy? Who is no happy? Consider the first economic question

Market Equilibrium Is this the invisible hand at work?

Example: Market Equilibrium

Example: Market Equilibrium

Using the model – predicting the effects of change

Predicting Changes in Price and Quantity

When Demand or Supply shifts..what happens to equilibrium

Questions How do markets work? Right products … Right place .. Right time .. Right amount .. Etc. etc. What are the tradeoffs for these three types of markets? Can you get market equilibrium using the equation? How are the curves developed? Are they different for each market or product? Can there be upward demand curves? Can there be downward supply curves? Is price always on the Vertical axis and Quantity on the horizontal? Why?

Questions How do these curves relate to a equation .. That Y = a + bX? Can you get market equilibrium using the equation? How are the curves developed? Are they different for each market or product? Can there be upward demand curves? Can there be downward supply curves? Is price always on the Vertical axis and Quantity on the horizontal? Why?

Define markets incl free and centrally planned Define supply curve & the equation especially the slope! Define demand curve & the equation especially the slope! Understand market equilibrium and how it gets out of equilibrium

Define excess supply (surplus) & excess demand (shortage) & calculate amounts Explain how market returns to equilibrium under surpluses and shortages. Explain difference between change in quantity demanded and change in demand. Explain difference between change in quantity supplied and change in supply. Identify factors which shift supply curve. Identify factors which shift demand curve Practice to keep all the D and S shifts straight and what happens with P and Q then as well.

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