Economics for Leaders Lesson 3: Open Markets

Economic Reasoning Principle # 3: People respond to incentives in predictable ways. Choices are influenced by incentives, the rewards that encourage and the punishments that discourage actions. When incentives change, behavior changes in predictable ways.

Economic Reasoning Principle # 4: Institutions are the “rules of the game” that influence choices. Laws, customs, moral principles, superstitions, and cultural values influence people’s choices. These basic institutions controlling behavior set out and establish the incentive structure and the basic design of the economic system.

Choose Between Alternatives People do things that make them better off. Do it if…… MB > MC

Where do prices come from? Prices are the result of interaction between buyers and sellers (demanders and suppliers). Prices are determined in the marketplace. We just saw this happen! MB > MC

Production (Supply) MB > MC People do things that make them better off. For a producer, the benefit is the price received from selling the good. For the producer, the cost is the opportunity cost of the materials and risk involved in producing the good. MB > MC

The World is Full of People

The World is Full of People

Let’s Graph it

Law Of Supply Sellers sellers could produce other things price → opportunity cost high price → produce more higher price means more incentive to produce this good relative to what else you could do supply represents marginal (opportunity) cost willingness to sell (corn/ethanol) Sellers

Consumption (Demand) MB > MC People do things that make them better off. For a buyer, the benefit is the satisfaction from consuming the good. For a buyer, the cost is the price paid for the good (what is given up). MB > MC

The World is Full of People

The World is Full of People

Let’s Graph it

Law Of Demand Buyers consumers could purchase other things price → opportunity cost high price → purchase less higher price means less incentive to consume this good relative to what else you could do demand represents value (compared to alternatives) willingness to pay (gasoline) Buyers

How Do Markets Work? Buyers Sellers Buyers and sellers each perform cost/benefit analysis. Price is a measure of relative scarcity. Price represents opportunity cost. Price sends signals/incentives to players. Buyers Sellers

Buyers Sellers Equilibrium

Buyers Sellers Equilibrium

Buyers Sellers Dis-quilibrium

Buyers Sellers Dis-quilibrium

Equilibrium Buyers Sellers Property rights, information, interaction and competition. Price squeezes to where Qs = Qd & market clears. This price facilitates all transactions that can make both a buyer and a seller better off.

What If Something Changes? price income, price of other goods, tastes & preferences Recall the market for ice cream. Suppose the weather gets hotter. What would you expect to happen? Buyers

↑ T&P D shifts right shortage at P1 Δ D Disequilibrium P adjusts Qs responds Law of S P ↑ to restore equilibrium (sellers respond, Qs ↑) new equilibrium: higher P & higher Q

What If Something Changes? price price of inputs, technology, weather Recall the market for ice cream. Suppose the price of sugar increases. What would you expect to happen? Sellers

↑ P input S shifts left shortage at P1 Δ S Disequilibrium P adjusts Qd responds Law of D P ↑ to restore equilibrium (buyers respond, Qd ↓) new equilibrium: higher P & lower Q

Big Ideas Scarcity implies/necessitates rationing. Rationing implies/necessitates competition. Markets coordinate information & competition. Markets allocate scarce resources to the production of the goods and services. Markets distribute produced goods and services to society.

Big Ideas Goods go to consumers with the highest value. Goods are produced by sellers with the lowest opportunity cost. The well-being of society is maximized.

Big Ideas Markets dynamically adjust to reflect changes in relative scarcity and preferences. People respond to incentives in predictable ways. Profit is the Motivator! Competition is the Regulator!