ECON 160 Week 4 The functioning of Markets: The interaction of buyers and sellers. (Chapter 4)

Review Economic competition: We compete for goods by offering to trade $ dollars. Circular flow diagram: Shows the interaction of households and firms in two kinds of markets.

Circular Flow Diagram of the Exchange Economy     Goods & Services Goods & Services Product Markets $'s $'s Revenue HOUSEHOLDS FIRMS $'s $'s Income Inputs Resources   Resource Markets

NEW: Study of Markets Markets are the interaction of buyers and sellers. Some markets are local, some worldwide. Focus on buyers and sellers separately: Separate graphs for each group. Ceteris paribus: look at one thing at a time; All other things held equal.

Marginal Value Focusing on a buyer, we measure the personal marginal value of a good as the most $’s you are willing to give up to acquire an additional unit. (How much you are willing to trade) Graph the marginal value as a height above each additional unit per time period.

Marginal Value Declines Plot the marginal value as a height above additional units. As you have more of any good, the marginal value declines.

Marginal Value = The Most you are willing to pay for each additional unit

Marginal Value MVx $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Marginal Value The height above each additional unit = the most you are willing to pay Qtyx/T 1 2 3 4 5 6 7 8 9 10

How much are you willing to Buy? By comparing the marginal value with the $ Price at which the good is available, we can read the quantity you are willing to buy at each $ price. (horizontal distance) Demand: A schedule of the alternative quantities that an individual is willing and able to buy at alternative $ prices.

Demand Curve $Price x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 MVx = Demand X Qtyx/T 1 2 3 4 5 6 7 8 9 10

Demand for X $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx Demand shows the amounts purchased at alternative prices (horizontal distances at each price) Demand x Dx 1 2 3 4 5 6 7 8 9 10 Qtyx /T

First Law of Demand The higher the price of a good, the smaller the quantity demanded; the lower the price of a good, the greater the quantity demanded. Demand is downward sloping. A change in price leads to a change in quantity demanded = a movement along the function

Change in Price Vrs. Change in Demand A change in price is a move on the demand schedule. A change in demand is a shift of the function due to something else changing.

Increase in Demand $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx’ $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Dx’ Dx Increase in demand is a rightward shift (greater quantity demanded at each price.) Dx’ Dx 1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T

Determinants of Demand What factors determine the position of demand ? What changes in other factors will cause demand to increase (shift right) or decrease (shift left)?

Determinants of Demand: (Shift Factors) Taste & preference: how much you like the good. If T&P increase, demand increases. (Rightward shift). Income: a change in income affects demand. Normal good: increase in income increases demand. (Right Shift) Inferior good: increase in income decreases demand. (Left Shift)

Determinants of Demand, Continued Price of other goods: Substitutes: most other goods are substitutes; An increase in the price of a substitute increases demand (rightward shift). Complements: Goods used together; an increase in the price of complements decreases demand (leftward shift).

Determinants of Demand, Continued Future Price Expectations: an increase in the expected future price will increase demand today.

Market Demand The market demand is the sum of the individual demands of the buyers. An increase in the number of buyers will increase market demand.

Market Supply Supply is a schedule of the alternative quantities which sellers are willing and able to sell at alternative prices.

Market Supply Supply is a schedule of the alternative quantities which sellers are willing and able to sell at alternative prices. Supply is generally a positive relationship: at higher prices the quantity supplied is larger.

Supply Curve $Price $10 8 6 4 2 2 4 6 8 10 12 14 16 Qty x/ T

The Height of the Supply Curve is based on Marginal Cost of Production $Price $10 8 6 4 2 2 4 6 8 10 12 14 16 Qty x/ T

Change in Quantity Vrs Shift in Supply If sellers can get a higher price, the increase in quantity supplied is a movement on the supply curve. If some other factor changes, the supply curve will shift. An increase in supply is a rightward shift. A decrease in supply is a leftward shift.

Determinants of Supply: (Shift Factors) 1. Price of inputs: an increase in price of inputs will decrease supply (leftward shift). 2. Value of Alternative Outputs: As the value of alternative outputs increases, supply decreases. 3. Change in technology: an increase in technology will increase supply (rightward shift). 4. Number of sellers: as more sellers enter a market the supply shifts rightward.

The Market $Price $ 4 3 2.50 2.00 1.50 1.00 .50 .25 Demand Surplus at this $ Price Supply 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T

$Price The Market $ 4 3 2.50 2.00 1.50 1.00 .50 .25 Demand Supply Shortage at this $ Price 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T

Market Equilibrium $Price 4 3 Demand Dx = Sx at Pe 2.50 2.00 1.50 .25 Demand Supply 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T Qe

Market: Demand & Supply $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Demand Supply At the equilibrium Price, the Dx = Sx Pe Sx Total Revenue = Price x Quantity $6 x 5 = $30 Dx 1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T Qe

Effects of Increase in Demand on Price and Quantity $ P x D1 $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Do Supply Increases Price and Quantity Pe D1 Sx Total Revenue = Price x Quantity $6 x 5 = $30 Do 1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T Qe

Demand Determines Price $ P x D3 $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Supply: Response D2 Demand pulls forth output D1 D3 Sx D2 Total Revenue = Price x Quantity $6 x 5 = $30 D1 1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T

Effects of an Increase in Supply on Price and Quantity $ P x $ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1 Demand S0 S1 Pe Price decreases and Quantity increases S0 Total Revenue = Price x Quantity $6 x 5 = $30 Dx S1 1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T Qe