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Markets Specific location where buying and selling takes

place, such as Supermarket or a flea market

In economics, a market is not a place but rather A group of buyers and sellers with the potential to trade

with each other Economists think of the economy as a collection of

individual markets First step in an economic analysis is to define and

characterize the market or collection of markets to analyze

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How Broadly Should We Define the Market

Defining the market often requires economists to group things together Aggregation is the combining of a group of

distinct things into a single whole Markets can be defined broadly or narrowly,

depending on our purpose How broadly or narrowly markets are defined is

one of the most important differences between Macroeconomics and Microeconomics

Aggregation

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Figure 4.2Individual and Market Demand CurvesFigure 4.2Individual and Market Demand Curves

An Introduction to Demand (cont.)Figure 4.1The Demand for Compact DiscsFigure 4.1The Demand for Compact Discs

Diminishing Marginal utility helps to describe why the curve is downward sloping. The price must be lowered to meet your decreased satisfaction.

The principle of diminishing marginal utility states that the satisfaction we gain from buying a product lessens as we buy more of the same product.

Marginal utility is the extra usefulness or satisfaction a person receives from getting or using one more unit of a product.

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Buyers and Sellers Buyers and sellers in a market can be

Households Business firms Government agencies

All three can be both buyers and sellers in the same market, but are not always

For purposes of simplification this text will usually follow these guidelines In markets for consumer goods, we’ll view business firms

as the only sellers, and households as only buyers In most of our discussions, we’ll be leaving out the

“middleman”

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Competition in Markets In imperfectly competitive markets, individual buyers or

sellers can influence the price of the product In perfectly competitive markets (or just competitive

markets), each buyer and seller takes the market price as a given

What makes some markets imperfectly competitive and others perfectly competitive? Perfectly competitive markets have many small buyers and sellers

• Each is a small part of the market, and the product is standardized Imperfectly competitive markets have just a few large buyers and

sellers• Or else the product of each seller is unique in some way

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Using Supply and Demand Supply and demand model is designed to

explain how prices are determined in perfectly competitive markets Perfect competition is rare but many markets

come reasonably close Perfect competition is a matter of degree rather

than an all or nothing characteristic Supply and demand is one of the most

versatile and widely used models in the economist’s tool kit

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Demand

A household’s quantity demanded of a good Specific amount household would choose to buy over

some time period, given• A particular price that must be paid for the good

• All other constraints on the household

Market quantity demanded (or quantity demanded) is the specific amount of a good that all buyers in the market would choose to buy over some time period, given A particular price they must pay for the good All other constraints on households

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Quantity Demanded Implies a choice

How much households would like to buy when they take into account the opportunity cost of their decisions?

Is hypothetical Makes no assumptions about availability of the good How much would households want to buy, at a specific price, given

real-world limits on their spending power?

Stresses price Price of the good is one variable among many that influences

quantity demanded We’ll assume that all other influences on demand are held constant,

so we can explore the relationship between price and quantity demanded

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The Law of Demand

States that when the price of a good rises and everything else remains the same, the quantity of the good demanded will fall The words, “everything else remains the same” are

important• In the real world many variables change simultaneously

• However, in order to understand the economy we must first understand each variable separately

• Thus we assume that, “everything else remains the same,” in order to understand how demand reacts to price

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The Demand Schedule and the Demand Curve

Demand schedule A list showing the quantity of a good that consumers

would choose to purchase at different prices, with all other variables held constant

The market demand curve (or just demand curve) shows the relationship between the price of a good and the quantity demanded , holding constant all other variables that influence demand Each point on the curve shows the total buyers would

choose to buy at a specific price Law of demand tells us that demand curves

virtually always slope downward

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Figure 1: The Demand Curve

Number of Bottles per Month

Price per Bottle

A

B

$4.00

2.00

D

40,000 60,000

At $2.00 per bottle, 60,000 bottles are demanded (point B).

When the price is $4.00 per bottle, 40,000 bottles are demanded (point A).

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Figure 2: A Shift of the Demand Curve

B C$2.00

D1D2

60,000 80,000

An increase in income shifts the demand curve for maple syrup from D1 to D2. At each price, more bottles are demanded after the shift.

Number of Bottles per Month

Price per Bottle

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Dangerous Curves: “Change in Quantity Demanded” vs. “Change in Demand”

Language is important when discussing demand “Quantity demanded” means

• A particular amount that buyers would choose to buy at a specific price

• It is a number represented by a single point on a demand curve• When a change in the price of a good moves us along a demand

curve, it is a change in quantity demand

The term demand means• The entire relationship between price and quantity demanded—

and represented by the entire demand curve• When something other than price changes, causing the entire

demand curve to shift, it is a change in demand

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Income: Factors That Shift the Demand Curve

An increase in income has effect of shifting demand for normal goods to the right However, a rise in income shifts demand for

inferior goods to the left A rise in income will increase the demand for

a normal good, and decrease the demand for an inferior good

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Wealth: Factors that Shift the Demand Curve

Your wealth—at any point in time—is the total value of everything you own minus the total dollar amount you owe

An increase in wealth will Increase demand (shift the curve rightward) for a

normal good Decrease demand (shift the curve leftward) for

an inferior good

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Prices of Related Goods: Factors that Shift the Demand Curve

Substitute—good that can be used in place of some other good and that fulfills more or less the same purpose A rise in the price of a substitute increases the

demand for a good, shifting the demand curve to the right

Complement—used together with the good we are interested in A rise in the price of a complement decreases

the demand for a good, shifting the demand curve to the left

Change in the price of a substitute good

Price of coffee rises:

Change in the price of a complementary good

Price of DVDs rises:

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Other Factors that Shift the Demand Curve

Population As the population increases in an area

• Number of buyers will ordinarily increase• Demand for a good will increase

Tastes Combination of all the personal factors that go into determining how

a buyer feels about a good When tastes change toward a good, demand increases, and the

demand curve shifts to the right When tastes change away from a good, demand decreases, and the

demand curve shifts to the left

Expectations

A higher expected future price will increase current demand.

A lower expected future price will decrease current demand.

A higher expected future income will increase the demand for all normal goods.

A lower expected future income will reduce the demand for all normal goods.

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Figure 3(a): Movements Along and Shifts of the Demand Curve

Quantity

Price

P2

Q2 Q1 Q3

P1

P3

Price increase moves us leftward along demand curve

Price increase moves us rightward along demand curve

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Figure 3(b): Movements Along and Shifts of the Demand Curve

Quantity

Price

D2

D1

Entire demand curve shifts rightward when:• income or wealth ↑• price of substitute ↑• price of complement ↓• population ↑• expected price ↑• tastes shift toward good

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Figure 3(c): Movements Along and Shifts of the Demand Curve

Quantity

Price

D1

D2

Entire demand curve shifts leftward when:• income or wealth ↓• price of substitute ↓• price of complement ↑• population ↓• expected price ↓• tastes shift toward good

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Supply A firm’s quantity supplied of a good is the specific

amount its managers would choose to sell over some time period, given A particular price for the good All other constraints on the firm

Market quantity supplied (or quantity supplied) is the specific amount of a good that all sellers in the market would choose to sell over some time period, given A particular price for the good All other constraints on firms

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Quantity Supplied Implies a choice

Quantity that gives firms the highest possible profits when they take account of the constraints presented to them by the real world

Is hypothetical Does not make assumptions about firms’ ability to sell the good How much would firms’ managers want to sell, given the price of the

good and all other constraints they must consider? Stresses price

The price of the good is just one variable among many that influences quantity supplied

We’ll assume that all other influences on supply are held constant, so we can explore the relationship between price and quantity supplied

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The Law of Supply States that when the price of a good rises

and everything else remains the same, the quantity of the good supplied will rise The words, “everything else remains the same”

are important• In the real world many variables change

simultaneously• However, in order to understand the economy we

must first understand each variable separately• We assume “everything else remains the same” in

order to understand how supply reacts to price

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The Supply Schedule and The Supply Curve

Supply schedule—shows quantities of a good or service firms would choose to produce and sell at different prices, with all other variables held constant

Supply curve—graphical depiction of a supply schedule Shows quantity of a good or service supplied at

various prices, with all other variables held constant

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Figure 4: The Supply Curve

F

G

2.00

S

40,000 60,000

$4.00

At $4.00 per bottle, quantity supplied is 60,000 bottles (point G).

When the price is $2.00 per bottle, 40,000 bottles are supplied (point F).

Number of Bottles per Month

Price per Bottle

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Figure 5: A Shift of the Supply Curve

S2

GJ

S1

60,000

$4.00

80,000

A decrease in transportation costs shifts the supply curve for maple syrup from S1 to S2.

Number of Bottles per Month

Price per Bottle

At each price, more bottles are supplied after the shift

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Factors that Shift the Supply Curve

Input prices A fall (rise) in the price of an input causes an increase

(decrease) in supply, shifting the supply curve to the right (left)

Price of Related Goods When the price of an alternate good rises (falls), the

supply curve for the good in question shifts rightward (leftward)

Technology Cost-saving technological advances increase the supply

of a good, shifting the supply curve to the right

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Factors that Shift the Supply Curve

Number of firms An increase (decrease) in the number of sellers

—with no other changes—shifts the supply curve to the right (left)

Expected price An expectation of a future price increase

(decrease) shifts the current supply curve to the left (right)

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Factors that Shift the Supply Curve

Changes in weather Favorable weather

• Increases crop yields

• Causes a rightward shift of the supply curve for that crop

Unfavorable weather • Destroys crops

• Shrinks yields

• Shifts the supply curve leftward

Other unfavorable natural events may effect all firms in an area Causing a leftward shift in the supply curve

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Figure 6(a): Changes in Supply and in Quantity Supplied

P2

Q3 Q1 Q2

P1

P3

Quantity

Price Price increase moves us rightward along supply curve

S

Price increase moves us leftward along supply curve

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Figure 6(b): Changes in Supply and in Quantity Supplied

Quantity

Price

S2

S1Entire supply curve shifts rightward when:• price of input ↓• price of alternate good ↓• number of firms ↑• expected price ↑• technological advance• favorable weather

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Figure 6(c): Changes in Supply and in Quantity Supplied

Quantity

Price

S1

S2Entire supply curve shifts rightward when:• price of input ↑• price of alternate good ↑• number of firms ↓• expected price ↑• unfavorable weather

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In Summary: Factors that Shift the Supply Curve

The short list of shift-variables for supply that we have discussed is far from exhaustive

In some cases, even the threat of such events can cause serious effects on production

Basic principle is always the same Anything that makes sellers want to sell more or

less of a good at any given price will shift supply curve

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Equilibrium: Putting Supply and Demand Together

When a market is in equilibrium Both price of good and quantity bought and sold have

settled into a state of rest The equilibrium price and equilibrium quantity are values

for price and quantity in the market but, once achieved, will remain constant

• Unless and until supply curve or demand curve shifts

The equilibrium price and equilibrium quantity can be found on the vertical and horizontal axes, respectively At point where supply and demand curves cross

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Figure 7: Market Equilibrium

E

HJ1.00

$3.00

D

S

50,000 75,00025,000

Excess Demand

4. until price reaches its equilibrium value of $3.00

.

2. causes the price to rise . . .

3. shrinking the excess demand . . .

1. At a price of $1.00 per bottle an excess demand of 50,000 bottles . . .

Number of Bottles per Month

Price per Bottle

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Excess Demand: Putting Supply and Demand Together

Excess demandAt a given price, the excess of quantity

demanded over quantity supplied Price of the good will rise as buyers

compete with each other to get more of the good than is available

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Figure 8: Excess Supply and Price Adjustment

3. shrinking the excess supply . . .

K L

E3.00

D

S

$5.00

50,00035,000 65,000

Excess Supply at $5.00

2. causes the price to drop,

4. until price reaches its equilibrium value of $3.00.

Number of Bottles per Month

Price per Bottle

1. At a price of $5.00 per bottle an excess supply of 30,000 bottles . . .

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Excess Supply: Putting Supply and Demand Together

Excess Supply At a given price, the excess of quantity supplied

over quantity demanded Price of the good will fall as sellers compete

with each other to sell more of the good than buyers want

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Income Rises: What Happens When Things Change

Income rises, causing an increase in demand Rightward shift in the demand curve causes

rightward movement along the supply curve Equilibrium price and equilibrium quantity both

rise Shift of one curve causes a movement along

the other curve to new equilibrium point

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Figure 9: A Shift in Demand and a New Equilibrium

1. An increase in demand . . .E

F'

3.00

D1

D2

S

$4.00

50,000 60,000

3. to a new equilibrium.

5. and equilibrium quantity increases too.

2. moves us along the supply curve . . .

Number of Bottles of Maple Syrup per Period

Price per Bottle

4. Equilibrium price increases

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An Ice Storm Hits: What Happens When Things Change

An ice storm causes a decrease in supply Weather is a shift variable for supply curve

• Any change that shifts the supply curve leftward in a market will increase the equilibrium price

And decrease the equilibrium quantity in that market

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Figure 10: A Shift of Supply and a New Equilibrium

E'

E3.00

D

$5.00

50,00035,000

S2 S1

Number of Bottles

Price per Bottle

47

Figure 11: Changes in the Market for Handheld PCs

1. An increase in supply . . .

2. and a decrease in demand . . .

5. and quantity decreased as well.

A

B$400

D2003

S2002

S2003

D2002

$500

2.45 3.33 Millions of Handheld PCs per Quarter

Price per Handheld

PC

4. Price decreased . . .

3. moved the market to a new equilibrium.

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Both Curves Shift

When just one curve shifts (and we know the direction of the shift) we can determine the direction that both equilibrium price and quantity will move

When both curves shift (and we know the direction of the shifts) we can determine the direction for either price or quantity—but not both Direction of the other will depend on which curve

shifts by more

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The Principle of Markets and Equilibrium

The supply-and-demand model is just one example of a more general approach To identify a market and examine its equilibrium

Basic Principle #4: Markets and Equilibrium To understand how the economy behaves, economists

organize the world into separate markets and then examine the equilibrium in each of those markets

This approach helps us predict important changes in the economy and prepare for them And it helps us predict important changes in the economy

our social goals and avoid policies that are likely to backfire

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Price Ceilings Government-imposed maximum price that prevents the

price of a good from rising above a certain level in a market Short side of the Market

Smaller of quantity supplied and quantity demanded at a particular price

When quantity supplied and quantity demanded differ, short side of market will prevail

Price ceiling creates a shortage and increases the time and trouble required to buy the good While the price decreases, the opportunity cost may rise

Black Market A market created by unintended consequences of government

intervention• Goods are sold illegally at a price above the legal ceiling

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Figure 12: A Price Ceiling in the Market for Maple Syrup

60,00050,00040,000

TE

VR

D

S

$4.00

3.00

2.002. increases quantity

demanded

3. and decreases quantity supplied.

4. The result is a shortage – the distance between R and V.

Number of Bottles of Maple Syrup per Period

Price per Bottle

1. A price ceiling lower than the equilibrium price . . .

5. With a black market, the lower quantity sells for a higher price than initially.

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Price Floors

Government imposed minimum amount below which price is not permitted to fall Price floors for agricultural goods are commonly called price support

programs When sellers produce more of the good than buyers want at

the price floor Remaining goods become a surplus that no one wants at the

imposed price Government responds by maintaining price floors

Uses taxpayer dollars to buy up entire excess supply of the good in question

Prevents excess supply from doing what it would ordinarily do• Drive price down to its equilibrium value

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The Principle of Policy Tradeoffs

In our discussion of government intervention in markets, you may have noticed something interesting A policy designed to help us achieve one goal causes us

to compromise on some other goal

In fact, as you will see throughout this text, there are virtually always tradeoffs involved in government policy making For this reason, we consider government policy tradeoffs

to be one of the basic principles of economics

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The Principle of Policy Tradeoffs

Basic Principle #5: Policy Tradeoffs Government policy is constrained by the

reactions of private decision makers As a result, policy makers face tradeoffs

• Making progress toward one goal often requires some sacrifice of another goal

Economics is famous for making the public aware of policy tradeoffs

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Using Supply and Demand: The Invasion of Kuwait

Why did Iraq’s invasion of Kuwait cause the price of oil to rise? Immediately after the invasion, United States led

a worldwide embargo on oil from both Iraq and Kuwait

A significant decrease in the oil industry’s productive capacity caused a shift in the supply curve to the left• Price of oil increased

56

Figure 13: The Market For Oil

P2

D

E'

P1E

Q2 Q1

S2

S1

Barrels of Oil

Price per Barrel of Oil

57

Using Supply and Demand: The Invasion of Kuwait

Why did the price of natural gas rise as well?Oil is a substitute for natural gasRise in the price of a substitute increases

demand for a goodRise in price of oil caused demand curve

for natural gas to shift to the right• Thus, the price of natural gas rose

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Figure 14: The Market For Natural Gas

Cubic Feet of Natural Gas

Price per Cubic Foot of Natural

Gas

P4

P3

F

Q3 Q4

S

D2

F'

D1