Simple Models: PPF & Supply/Demand Rebecca Tuttle Baldwin Bellevue Community College

From the perspective of a society n Choices about linking inputs to outputs through production (allocation & distribution of mix of goods) n Three fundamental questions: What will be produced How will it be produced For whom

What is possible? n Doesn’t mean it will be done but could be done n Can represent graphically or numerically n Each possibility gains something but we also face opportunity cost n Can illustrate with Production Possibilities Frontier (outermost curve, PPF)

Shape of PPF tells us something n Linear or “bowed” n Constant or increasing rate of opportunity cost n Which is more “realistic”

David Ricardo n Theory of Comparative Advantage – Not absolute advantage – Explanation for trade n Among nations n Exchange in markets between individuals

Types of Economies n related but not the same as political structure n Differentiated by the way society answers those fundamental questions Command—centralized authority is decision- maker “laissez faire” or market economy has individual economic agents making choices mixed

Focusing first on a market economy n Individual economic units as decision- makers n People in households n Firms in business sector n Interact in markets n Inputs through production functions to outputs (goods/services)

What is a Market? n A market is the collection of buyers and sellers that, through their actual or potential interactions, determine the price of a product or set of products.

Two types of goods n Consumer Goods—who uses? n Capital Goods—also an input! n Time Matters

Market Outcome n Supply and demand interact through the price signal to reach equilibrium (market price and associated quantity where neither a surplus nor shortage exists).

Exhibit 1a: The Demand Schedule for Milk

Exhibit 1b: The Demand Curve for Milk

Law of Demand All other things being equal (ceteris paribus), the lower the price, the higher the quantity buyers will wish to purchase in a given time period.

Consumer Demand: Qd=f(P) n Taste/Preference n Income/Wealth n Price/availability of other goods n Expectations n Number of consumers

Exhibit 2: An Increase in the Market Demand for Milk

Exhibit 3a: The Supply Schedule for Milk

Exhibit 3b: The Supply Curve for Milk

Law of Supply As the price of a good rises, the quantity that firms are willing to supply will increase, c.p.

Firms’ Supply: Qs=f(P) n Technology n Prices of other goods (factor prices) n Expectations n # of sellers

Exhibit 4: An Increase in the Supply of Milk

Equilibrium n Price at which QD=QS n Intersection of Supply & Demand n Market forces bring us to equilibrium when markets function n Point we stay at until “ceteris paribus” condition is violated for supply, demand, or both n no forces acting for change n not perfection

Shortage n QD greater than QS n What has to happen to price to move us out of the shortage? n Laws of Supply & Demand tell us…as price increases, QD falls and QS increases…c.p. n Shortage=Excess Demand n No one coordinates

Surplus n QS greater than QD n Also called Excess Supply n What has to happen to P to bring us to equilibrium? n Price has to fall

Ceteris paribus n Latin phrase, meaning “all other things being equal” n key assumption for some of our micro theories/models

Exhibit 5a: Equilibrium in the Milk Market (Market Schedules)

Exhibit 5b: Equilibrium in the Milk Market (Market Curves)

Price n Only piece of information individual agents on both side observe n Allocation mechanism/ rationing n what must be given in exchange for the good

Do all markets reach equilibrium? n time n regulations (price ceiling/price floor) n what happens then?

Effects of an Increase in Demand

Effects of an Increase in Supply

Indeterminate Effect of an Increase in Both Supply and Demand (Shift in Demand Dominates ) Indeterminate Effect of an Increase in Both Supply and Demand (Shift in Demand Dominates )

Indeterminate Effect of an Increase in Both Supply and Demand (Shift in Supply Dominates) Indeterminate Effect of an Increase in Both Supply and Demand (Shift in Supply Dominates)

Effects of Changes in Both Supply and Demand

Effects of a Price Floor and Price Ceiling (Price Floor for Milk)

Effects of a Price Floor and Price Ceiling (Price Ceiling for Rent)

University lunchroom

Americans’ tastes have shifted from beef to chicken n describe market for beef before & after that change n describe market for chicken n describe market for roadside hamburger stands

For each of the following, decide whether shift or movement on what curve n The housing market: Consumers’ incomes fall n shift in demand, movement along supply n Sudden increase in price of milk, which is used to produce frozen yogurt. n supply shifts left, movement along demand

Classic Example of Market--Competitive n Many buyers n Many sellers n Perfect Information n No barriers to entry or exit n Homogenous good

Most markets are not the competitive ideal So market power exists-- ability to influence price

The End!