ECON 160Week 4

• The functioning of Markets: The interaction of buyers and sellers. (Chapter 4)

ReviewReview

• Economic competitionEconomic competition: We compete for goods by offering to trade $ dollars.

• Circular flow diagramCircular flow diagram: Shows the interaction of households and firms in two kinds of markets.

Product Markets

FIRMSHOUSEHOLDS

 ResourceMarkets

$'s $'s Revenue

$'s Income $'s

Goods & Services

Goods &Services

Resources Inputs

            

  

 

Circular Flow Diagram of the Exchange Economy

NEW: Study of MarketsNEW: Study of Markets

• MarketsMarkets 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 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

0

10

20

30

40

50

60

70

80

1 2 3 4

Marginal Value

MVx

Qtyx/T

$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1

1 2 3 4 5 6 7 8 9 10

Marginal ValueThe height above each additional unit = the most you are willing to pay

Marginal Value

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)

• DemandDemand: A schedule of the alternative quantities that an individual is willing and able to buy at alternative $ prices.

$Price x

Qtyx/T

$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1

1 2 3 4 5 6 7 8 9 10

MVx = Demand X

Demand Curve

$ P x

$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1

1 2 3 4 5 6 7 8 9 10

Demand x

Demand shows the amounts purchased at alternative prices (horizontal distances at each price)

Qtyx /T

Dx

Dx

Demand for X Demand for X

First Law of Demand 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.

$ P x

$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1

1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T

Dx

Dx

Dx’

Dx’

Increase in Demand

Increase in demand is a rightward shift (greater quantity demanded at each price.)

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.

$Price

$ 4

3

2.50

2.00

1.50

1.00

.50

.25

100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T

Demand

Supply

Surplus at this $ PriceSurplus at this $ Price

The Market

$Price

$ 4

3

2.50

2.00

1.50

1.00

.50

.25

100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T

Demand

Supply

Shortage at this $ Price

The Market

$Price

4

3

2.50

2.00

1.50

PePe 1.00

.50

.25

100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T QeQe

Demand

Supply

Market EquilibriumMarket Equilibrium

DDxx = S = Sxx at P at Pee

$ P x

$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1

1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T

SupplyDemand

DxSx

Market: Demand & Supply

At the equilibrium Price, theDx = Sx

Pe

Qe

$ P x

$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1

1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T

SupplyDo

Do

Sx

Effects of Increase in Demand on Price and Quantity

Increases Price and Quantity

Pe

Qe

D1

D1

$ P x

$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1

1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T

Supply: Response

D1

D1

Sx

Demand Determines Price

Demand pulls forth output

D2

D2

D3

D3

$ P x

$ 10 $ 9 $ 8 $ 7 $ 6 $ 5 $ 4 $ 3 $ 2 $ 1

1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T

Demand

DxS0

Effects of an Increase in Supply on Price and Quantity

Price decreases and Quantity increases

Pe

Qe

S0

S1

S1