1. Economics for Leaders
Lesson 3: Open Markets

2. 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.

3. 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.

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

5. 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

6. 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

7. The World is Full of People

8. The World is Full of People

9. Let’s Graph it

10. 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

11. 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

12. The World is Full of People

13. The World is Full of People

14. Let’s Graph it

15. 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

16. 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

17. Buyers
Sellers
Equilibrium

18. Buyers
Sellers
Equilibrium

19. Buyers
Sellers
Dis-quilibrium

20. Buyers
Sellers
Dis-quilibrium

21. 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.

22. 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

23. ↑ 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

24. 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

25. ↑ 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

26. 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.

27. 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.

28. 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!