lecture 3 markets. today’s agenda announcements markets in reality markets in theory markets...

Lecture 3

MarketsMarkets

Today’s Agenda

Announcements

Markets in Reality

Markets in Theory

Markets in Experiments

Market Institutions

Changes in the Schedule

Announcments Markets in Reality Markets in Theory Markets in Experiments Market Institutions

Date Lecture TutorialMay 9 Introduction NO TUTORIALS

May 16 Experimental Design NO TUTORIALS

May 23 NO CLASSES Experiment #1: Markets

May 30 Markets NO TUTORIALS

June 6 Data Analysis Experiment #2: Market Institutions

June 13 Game Theory I How to use excel, Sample questions

June 20 Game Theory II ASS#1 due

June 27 MIDTERM NO TUTORIALS

July 4 Social Preferences Experiment #3: Public GoodsJuly 11 Behavioural Economics Experiment #4: UltimatumJuly 18 Social ID Sample questions

July 25 Crime ASS #2 due

August 1 NO CLASSES NO TUTORIALS

August 8 Development NO TUTORIALS

Other Updates

No tutorials next week Webpage uploads

o New links!1. Econtalk interview with Smith2. List’s Baseball card paper

o This material will not be on the test, but are meant to encourage the interested and motivated student

Midtermo Questions based solely on class notes, tutorial activities, and

assignmentso Types of questions may include multiple choice, T/F, math-type

problemso Calculators are allowed (and necessary), but no programmable

oneso I take cheating very seriously!


What do Markets really look like?


What do markets really look like?


Questions addressed in this Section

How do economists picture markets?

What are the basic principles of markets?

How do we represent individuals in markets?

How do we measure how well markets perform?


How do economists see markets?

2 sides to every market

o Demand

• Created by _____________________

• Represents their _______ _____________________

o Supply

• Created by _____________________

• Represents their _______ _____________________


How do economists see markets?Linear Non-linear

Step Function


Basic Principles of Markets

relationship between demand and supply underlie the forces behind the ____________________________

in market economy theories, demand and supply theory will allocate resources in the _____________________

the most efficient allocation is one that ______________ _______________________________


Basic Principles of Markets: Law of Demand

The ______________ states that the _______ the price of a good, the _____ people will demand that good.

In other words, the higher the __________, the lower the ________ demanded.

The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the _________________ of buying that good.


Basic Principles of Markets: Law of Demand

The curve is ____________ sloping

A, B and C are points that reflect a direct correlation between quantity demanded (Q) and price (P)

The demand relationship curve illustrates the _________ relationship between price and quantity demanded

The higher the price of a good the lower the quantity demanded (A), and the lower the price, the more the good will be in demand (C)


Basic Principles of Markets: Law of Supply

The ____________ demonstrate that the ________ the price, the _________ the quantity supplied

The curve has an ______ slope.

This means producers supply more at a higher price because selling a higher quantity at a higher price increases _____________.

A, B and C are points that reflect a direct correlation between quantity supplied (Q) and price (P).

At point B, the quantity supplied will be Q2 and the price will be P2, and so on.


Basic Principles of Markets: Equilibrium

When supply and demand are equal (i.e. when the supply function and demand function intersect) the economy is said to be at _________

At this point, the allocation of goods is at its _______ because the amount of goods being supplied is exactly the same as the amount of goods being demanded.

Thus, everyone (individuals, firms, or countries) is satisfied with the current economic condition. At the given price, suppliers are selling all the goods that they have produced and consumers are getting all the goods that they are demanding.



As you can see on the chart, equilibrium occurs at the _________ ___________________ with the price of the goods will be P* and the quantity will be Q*.

In the real market place, equilibrium can only ever be reached in theory, so the prices of goods and services are constantly changing in relation to fluctuations in demand and supply.



Assumptions of Competitive Equilibrium

1. ____________________________

_______________________

2. ___________________________

3. ___________________________

4. ___________________________

5. ___________________________


Basic Principles of Markets: Movement along Demand

__________________________ denotes a change in both price and quantity demanded from one point to another on the curve.

The movement implies that the demand relationship remains consistent. Therefore, a movement along the demand curve will occur when the price of the good changes and the quantity demanded changes in accordance to the original demand relationship.


Basic Principles of Markets: Movement along supply

Like a movement along the demand curve, a movement along the supply curve means that the supply relationship remains consistent.

Therefore, a movement along the supply curve will occur when the price of the good changes and the quantity supplied changes in accordance to the original supply relationship.

In other words, a movement occurs when a change in quantity supplied is caused only by a change in price, and vice versa.


Basic Principles of Markets: Shift in Demand

A shift in a demand or supply curve occurs when a good's quantity demanded or supplied changes _________________ ________________________

For instance, if the price for a bottle of beer was $2 and the quantity of beer demanded increased from Q1 to Q2, then there would be a shift in the demand for beer.

Shifts in the demand curve imply that the original demand relationship has changed, meaning that quantity demand is affected ___________________ ________________________


Basic Principles of Markets: Shift in Demand

A shift in the demand relationship would occur if, for instance, beer suddenly became the only type of alcohol available for consumption.

Other causes of a shift in demand include:

1. ________________________ 2. ________________________ 3.________________________ 4. ________________________ 5. ________________________


Basic Principles of Markets: Shift in Supply

Conversely, if the price for a bottle of beer was $2 and the quantity supplied decreased from Q1 to Q2, then there would be a shift in the supply of beer.

A shift in the supply curve implies that the original supply curve has changed, meaning that the quantity supplied is effected by a factor other than price.


Basic Principles of Markets: Shift in Supply

A shift in the supply curve would occur if, for instance, a natural disaster caused a mass shortage of hops; beer manufacturers would be forced to supply less beer for the same price.

Other factors that can cause supply to shift include:

1. ________________________

2. ________________________

3. ________________________

4. ________________________

5. ________________________


Basic Principles of Markets: Elasticity

The degree to which a demand or supply curve reacts to a change in price is the curve's _______________

Elasticity varies among products because some products may be more essential to the consumer

Products that are _________________ are more insensitive to price changes because consumers would continue buying these products despite price increases

Conversely, a price increase of a good or service that is considered _______________________ will deter more consumers because the opportunity cost of buying the product will become too high.


Basic Principles of Markets: Elasticity A good or service is considered to be highly elastic if a slight change

in price leads to a _________________ in the quantity demanded or supplied.

Usually these kinds of products are _______________ in the market and a person may not necessarily need them in his or her daily life.

On the other hand, an inelastic good or service is one in which changes in price witness only _____________ in the quantity demanded or supplied, if any at all.

These goods tend to be things that are more of a ____________ to the consumer in his or her daily life.


Basic Principles of Markets: Elasticity of Demand

If there is a large decrease in the quantity demanded with a small increase in price, the demand curve looks _________________________

This flatter curve means that the good or service in question is _______

Inelastic demand is represented with a much more _____________ as quantity changes little with a large movement in price.


Basic Principles of Markets: Elasticity of Supply

Elasticity of supply works similarly. If a change in price results in a big change in the amount supplied, the supply curve appears flatter and is considered elastic.

On the other hand, if a big change in price only results in a minor change in the quantity supplied, the supply curve is steeper and its elasticity would be less than one.


How to we get market demand and supply? Remember, a market is composed of a number of

buyers and sellers

Each of these buyers and sellers, in theory, has their own demand and supply schedule for a given good

The question is, how do we go from many individual demand and supply curves to a single market demand and supply curve


How to we get market demand and supply? The individual consumer's demand for a particular good—call it good X—is depicted by a downward-sloping _______________________________.

The _________________________ for good X includes the quantities of good X demanded by all participants in the market for good X.

The market demand curve is found by taking the ______________________ of all individual demand curves.


How to we get market demand and supply?For example, suppose that there were just two consumers in the market for good X, who have different individual demand curves corresponding to their different preferences for good X.

The market demand curve for good X is found by summing together the quantities that both consumers demand at each price.


How to we get market demand and supply?

Example Using Mathematical Equations

Market consists of 2 people, Sarah and Graeme

Sarah’s demand: _____________

Graeme’s demand: ___________

We want to aggregate these two demand schedules to get the market demand P(QM)

Sarah's Demand

P = -0.1Q + 3

0

0.5

1

1.5

2

2.5

3

3.5

0 5 10 15 20 25 30 35

quantity

pri

ce

Graeme's Demand

P = -0.1Q + 5

0

1

2

3

4

5

6

0 10 20 30 40 50 60

quantity

pri

ce




Aggregating demands involves taking the sum of individual demands horizontally

In other words, we want to add the individual quantities demanded at every possible price

Notice that for prices greater than $3, only Graeme demands a positive quantity

We aggregate the two individual demands over their common price range (i.e. from $0-$3)

Sarah and Graeme's Demand

Graeme

Sarah

0

1

2

3

4

5

6

0 10 20 30 40 50 60

quantitiy

pri

ce




Mathematically, what we have to do is:o QS + QG = QM

First, we have to re-arrange the original demand equations:

• _

Market Demand

0

1

2

3

4

5

6

0 10 20 30 40 50 60 70 80 90

quantity

pri

ce




Second, we have to sum them up: Market Demand

0

1

2

3

4

5

6

0 10 20 30 40 50 60 70 80 90

quantity

pri

ce




Third, re-arrange so it is in the form P(QM) as in the individual

demands

o M

Market Demand

0

1

2

3

4

5

6

0 10 20 30 40 50 60 70 80 90

quantity

pri

ce




Finally, write down the entire expression for the market demand over all price ranges.

Remember the above expression is only valid for prices less than $3.

Market Demand

0

1

2

3

4

5

6

0 10 20 30 40 50 60 70 80 90

quantity

pri

ce


How do we measure market efficiency?

A market is 100% efficient when the ______________ is maximized.

Total surplus is maximized in ____________________

Total surplus = ______________ + _______________

Consumer’s surplus = area _______ the demand curve, and _________ the equilibrium price P*

Producer’s surplus = area __________ the supply curve, and __________ P*


How do we measure market efficiency?

Let’s calculate the total surplus for the following market

Remember, the area of a triangle is equal to ½*base*height

Consumer Surplus (CS)

Producer Surplus (PS)

Total Surplus (TS)

o _


How do we measure inefficient markets? Market inefficiencies can show

up through government interventions such as _______ ________________________________________________

Graphically, these inefficiencies are captured in the area called ____________ ______________

Deadweight loss = ________


How do we measure inefficient markets? Deadweight loss gives us an absolute measure of the

_______________ of the inefficiency

If we want a relative measure of inefficiency, such that we can compare across markets, regardless of size, we should use the _________ of total surplus with the inefficiency to total surplus at the efficient level

This measure will tell us how efficient a market is


How do we measure inefficient markets?Example with a $2 Tax TSbefore tax = CSbefore tax + PSbefore tax

TSbefore tax =

TSbefore tax =

TSafter tax = CSafter tax + PSafter tax + tax revenue

TSafter tax =

TSafter tax =

Deadweight loss =

Market efficiency =

Market efficiency =


How do we go from theoretical markets to experimental markets? Just like theoretical markets,

experimental markets consist of buyers and sellers which make up the market demand and supply

Unlike theoretical markets, where buyers and sellers have well defined demand and supply functions over a range of prices and quantities, buyers and sellers in experimental markets _______ ___________________________

Thus an individual demand or supply schedule in an experimental market will be a _________________ at the given valuation or cost for a single unit

Individual Experimental Demands

0

1

2

3

4

5

6

0 0.2 0.4 0.6 0.8 1 1.2

quantity

pri

ce

Graeme

Sarah

Pat

Jelena

Nic


How do we go from theoretical markets to experimental markets?

Example of Aggregating Experiment Demand

Suppose there are 5 buyers with the following valuations: _______

Again, we aggregate by adding up quantities horizontally, making sure to pay attention to each price range

Individual Experimental Demands

0

1

2

3

4

5

6

0 0.2 0.4 0.6 0.8 1 1.2

quantity

pri

ce

Graeme

Sarah

Pat

Jelena

Nic

Aggregate Market Demand

0

1

2

3

4

5

6

0 1 2 3 4 5 6

quantities

pri

ce


How do we determine experimental equilibria? There are 2 types of equilibria

we need to consider in experimental markets

In Experimental Market #1, it is evident that the equilibrium price is $3, but the equilibrium quantity exists in a range from 2 to 3 units

In Experimental Market #2, the equilibrium quantity is 3, but the equilibrium price can exist anywhere between $3 and $4

Experimental Market #1

0

1

2

3

4

5

6

0 1 2 3 4 5 6

quantity

pri

ce


0

1

2

3

4

5

6

7

0 0.5 1 1.5 2 2.5 3 3.5

quantity

pri

ce


How do we calculate surplus in experimental markets? Surplus is calculated in the

same fashion as for theoretical markets

In Experimental Market #1, surplus is straight forward as we have a unique equilibrium price

o CS =

o PS =

o TS=


0

1

2

3

4

5

6

0 1 2 3 4 5 6

quantityp

rice


How do we calculate surplus in experimental markets? In Experimental Market #2,

calculating surplus is not as straight since there is a range of possible prices. For this course, we will ALWAYS assume the equilibrium price is exactly at the halfway point of the range (i.e. $3.50)

o CS =

o PS=

o TS=


0

1

2

3

4

5

6

7

0 0.5 1 1.5 2 2.5 3 3.5

quantity

pri

ce


Market Design Considerations

In designing the rules of trade for a market, there are many choices to be made about the exact nature and timing of subjects` decisions

o ___________________________________________________

o ___________________________________________________

o __________________________________________________

Seemingly small variations in the market institution can have large effects, both on the theoretical predictions, as well as on the observed behaviour of subjects


Types of Market Institutions

1. Decentralized Negociations

2. Posted Prices

3. Uniform Prices

4. One-sided Sequential Auctions

5. Double Auctions


Decentralized Negociations

Simplest symmetric two-sided institution

This is what we did in tutorials last week

Early experiments with this institution often resulted in _____________ transactions taking place

The _______ in which transactions take place is important for there to be too many units sold

In trading periods when too many transactions occur, there is a lot of _______________


Posted Prices

This market institution is most often found in _________________________

Sellers quote prices on a take-it-or-leave-it basis in many ____________________________

Posted prices became common in the last century in large stores in which the owner/managers had to rely on numerous sales clerks

Government regulation in industries such as alcohol sometimes require that prices be posted with the regulatory agency and that discounts not be granted


Posted Prices: Experimental Rules

At the beginning of each trading period, sellers decide on a price offer which they write down and submit on cards

Buyers will then be free to make bids to purchase from sellers

Buyers will be ordered randomly, and allowed to make bids one at a time

Once all buyers have had a chance to make a bid, the trading period is over


Posted Prices: Effect on Market

Consider the simplest possible market with one buyer and one seller of a single unit

Suppose the seller has a cost of $1 and the buyer a valuation of $2

In a market with decentralized negotiations, one would expect traders to reach an agreement somewhere in the middle (i.e. $1.50)

In a posted price market, theory tells us that the seller could sell it for _________


Uniform Prices

The price discrimination that occurs in posted price institutions can cause a sense of regret among buyers

The sale of all units at a uniform price, in contrast, can create an appearance of fairness

In practice, a ____________ is a form of uniform price auction where both buyers and sellers submit bids

The auctioneer then constructs the corresponding demand and supply schedules in order to determine the uniform price (i.e. the equilibrium price)


One-sided Sequential Auction

This institution can be used when we have a single seller of a single good, along with multiple buyers

There are 2 types of such auctions:

1. _________________

o Price starts high and is lowered until a buyer makes a bid

2. _________________

o Price starts low and increases until there is only 1 buyer willing to pay at that price


Double Auction: Experimental Rules

During a trading period, any buyer is free at any time to raise his/her hand and make a bid to buy a unit at a specified price

Any seller is free at any time to raise his/her hand to state an asking price for a unit at a specified price

Any bid or asking price will remain on the blackboard until it is either accepted or improved (i.e. replaced by a higher bid or a lower asking price)

When a bid or ask is accepted, all outstanding bids and asks are cancelled and the market is re-set


Double Auction

Both buyers and sellers can actively post and accept prices

_______________ of all the market institutions

Thousands of experiments have been done investigating this institution and have found that neither complete information (i.e. buyers and sellers knowing each others costs and valuations) nor large numbers of traders is a necessary condition for convergence to competitive equilibrium outcomes


lecture 3 markets. today’s agenda announcements markets in reality markets in theory markets...

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