1. Foundation of Economic Analysis 3250:600
Instructor: Richard W. Stratton
Meets: Thursday 5:20 – 7:50 pm
CAS 136

2. The University of Akron
Administration
This Week’s Assignments
Farnham Chapter 2 (D & S)
Homework 02
Next Week’s Assignments
Farnham Chapter 3 (Elasticity)
Week four
Test 1
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Decision Tree

3. The University of Akron
Student Questions
Groups
Questions from last week?
Can group members help clarify?
Questions on reading for this week?
Share common unanswered questions
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4. Introduction Demand Supply Market equilibrium
Decision Tree
Introduction
Demand
Supply
Market equilibrium
Complications
Applications

5. The University of Akron
Introduction
What is a market?
Impact of transaction costs
Factors reducing transaction costs
Property rights
Institutions
Rules and enforcement
Money
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6. The University of Akron
What is a market?
Remember our discussion last week?
Individuals who produced an excess in one good trade with those who produced an excess in another good
That exchange is a market
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7. The University of Akron
What is a market?
It need not be a place
Though we often think about the New York Stock Exchange, Chicago Board of Trade, of the local flea market as examples
It is not a person
Markets do NOT get excited, nervous or depressed
Markets do NOT expect, react, or hope
Markets do NOT get tired, sick, or even bullish
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8. The University of Akron
What is a market?
It is not a mechanism
Though we sometime use mechanistic models to explain results
It is a process of exchange
Human beings trading items of value
A process of completing bids and offers
Sometimes we include the rules and regulations by which exchanges are made
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9. The University of Akron
Transaction costs
Transactions costs are incurred when making an exchange (or trade)
Remember our discussion last week?
Individuals who produced an excess in one good trade with those who produced an excess in another good
We ignored any costs incurred in making the trade (transaction costs)
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10. The University of Akron
Transaction costs
For example:
You have the winning bid on eBay of $4000 for a used car and this exceeds the seller’s reservation
What are some transaction costs?
Time spent searching for the car
Cost of entering into a contract with the seller
Cost of enforcing the agreement (PayPal, etc.)
Shipping costs
Cost to transfer the title
Assume Total transaction costs of $500
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11. The University of Akron
Transaction costs
For both parties to benefit from the trade, the opportunity cost of the received item must be greater than
the item sacrificed
plus the transaction cost of the trade
In this example, you must value the car at more than for you to benefit from the trade.
$4500
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12. The University of Akron
Transaction costs
In this example, if the transaction costs are too high the exchange will not occur.
Thus markets work best when transaction costs are low.
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13. Reducing transaction costs
Property rights
Who has the authority to trade items?
Can I do what I want with those items?
Who has property rights to water in Lake Erie?
Who has property rights to clean air?
Who has property rights to space?
Who has property rights to shoreline?
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14. Reducing transaction costs
If property rights are not well-defined, free, mutually beneficial trade is more difficult
Institutions help to define “rules of the game” and enforce them
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15. Reducing transaction costs
Institutions help to define “rules of the game” and enforce them
Social pressure or convention
Government laws
Judicial system
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16. Reducing transaction costs
Remember our discussion last week?
Individuals who produced excess fish trade with those who produced excess rabbit
This is called barter
It tends to have high transaction costs, especially in larger economies
Money can lower these costs
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17. Reducing transaction costs
Why might the use of money reduce transactions costs?
Barter requires coincidence of wants
Intersection of group who wants your excess and
Group whose excess you want
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18. Reducing transaction costs
Why might the use of money reduce transactions costs?
Want what I have
Have what I want
Barter Group
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19. Reducing transaction costs
Money allows you to search everyone who want your excess
Functions of money
Medium of exchange
Unit of account
Store of value
Standard of deferred payment
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20. The University of Akron
Student Questions
Individually
What is the muddiest point about markets?
What is the muddiest point about transaction cost?
In groups compare muddiest points
Are any in common?
Can group members help clarify?
List common unanswered questions
Share common questions
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21. The University of Akron
Introduction
What is a market?
Impact of transaction costs
Factors reducing transaction costs
Property rights
Institutions
Rules and enforcement
Money
2/17/2019
The University of Akron

22. Introduction Demand Supply Market equilibrium
Decision Tree
Introduction
Demand
Supply
Market equilibrium
Complications
Applications

23. The University of Akron
Demand
Definition
Determinants
Demand function (curve)
Movement along demand
Shifting of demand
Individual and market demand
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24. The University of Akron
Definition of Demand
Relationship
Price
Quantity
Per unit of time (it is a flow)
Holding other things constant
Inverse (negative) relationship
Substitution effect
Income effect
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25. The University of Akron
Demand - determinants
Own price (varies)
Price of related commodities (P)
Substitutes
Complements
Consumer income (Y)
Consumer preferences - tastes (T)
Number of consumers (N)
Expectations (E)
PYNTE
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26. The University of Akron
Demand function
Table
Graph
Algebraic function
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27. The University of Akron
Demand function
Table
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28. The University of Akron
Demand function
Graph
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29. Demand - movement along
Table
A change in the price causes a movement along the demand curve
As price declines from $9 to $6 to $2, quantity increases from 2, to 5, to 9
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30. Demand - movement along
Graph
As price declines from $9 to $6 to $2, quantity increases from 2, to 5, to 9
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31. The University of Akron
Demand - shifts
Shift or Change in demand
Refer to changes in the functional relationship between price and quantity
Table – new column
Graph – new line
Algebraic function – change in the parameters
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32. The University of Akron
Demand - shifts
Algebraic function – change in the parameters
Price of a complement
Price of a substitute
Consumer income
Consumer tastes or preferences
Number of consumers
Expectations
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33. The University of Akron
Demand - shifts
Algebraic function – change in the parameters
Thus there is a new relationship between price and quantity
For example: increase the price of a substitute good
Old
New?
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34. The University of Akron
Demand - shifts
Table
An increase in the price of substitute causes a right shift of the demand curve
At each price the quantity demanded increases
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35. The University of Akron
Demand - shifts
Graph
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36. The University of Akron
Demand – shifts (quiz)
Number of consumers (N)
Number of consumers increase =>
Demand shifts to
Consumer preferences - tastes (T)
Consumers’ preference increase =>
Right
Right
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37. The University of Akron
Demand – shifts (quiz)
Price of related commodities (P)
Substitutes
Price of substitute increase =>
Demand shifts to
Price of substitute decrease =>
Complements
Price of complement increase =>
Price of complement decrease =>
Right
Left
Left
Right
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38. The University of Akron
Demand – shifts (quiz)
Consumer income (Y)
Normal goods
Consumer income increase =>
Demand shifts to
Consumer income decrease =>
Inferior goods
Right
Left
Left
Right
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39. The University of Akron
Demand – shifts (quiz)
Expectations (E)
Consumers expect future prices to increase =>
Current demand shifts to
Consumers expect future prices to decrease =>
Right
Left
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40. Demand – individual to market
Assume there are 5 individuals in the market, each with a different individual demand
At any given price, the market demand is the sum of the individual quantities demanded
Horizontal summation
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41. Demand – individual to market
Table
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42. Demand – individual to market
Graph
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43. The University of Akron
Student Questions
Individually
What is the muddiest point about demand?
In groups compare muddiest points
Are any in common?
Can group members help clarify?
List common unanswered questions
Share common questions
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44. The University of Akron
Demand
Definition
Determinants
Demand function (curve)
Movement along demand
Shifting of demand
Individual and market demand
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The University of Akron

45. Introduction Demand Supply Market equilibrium
Decision Tree
Introduction
Demand
Supply
Market equilibrium
Complications
Applications

46. The University of Akron
Supply
Definition
Determinants
Supply function (curve)
Movement along supply
Shifting of supply
Individual and market supply
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47. The University of Akron
Definition of Supply
Relationship
Price
Quantity
Per unit of time (it is a flow)
Holding other things constant
Direct (positive) relationship
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48. The University of Akron
Supply - determinants
Own price (varies)
Technology (TX)
Expectations (E)
Number of suppliers (firms) (N)
Price of related commodities (O)
Substitutes in production
Complements in production (by-products)
Resource prices - inputs (R)
TENOR
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49. The University of Akron
Supply function
Table
Graph
Algebraic function
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50. The University of Akron
Supply function
Table
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51. The University of Akron
Supply function
Graph
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52. Supply - movement along
Table
A change in the price causes a movement along the supply curve
As price increases from $2 to $6 to $9, quantity increases from 0, to 4, to 7
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53. Supply - movement along
Graph
As price increases from $2 to $6 to $9, quantity increases from 0, to 4, to 7
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54. The University of Akron
Supply - shifts
Shift or Change in supply
Refer to changes in the functional relationship between price and quantity
Table – new column
Graph – new line
Algebraic function – change in the parameters
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55. The University of Akron
Supply - shifts
Algebraic function – change in the parameters
Technology
Expectations (suppliers)
Number of suppliers
Price of a complement in production
Price of a substitute in production
Price of resources (inputs)
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The University of Akron

56. The University of Akron
Supply - shifts
Algebraic function – change in the parameters
Thus there is a new relationship between price and quantity
For example: increase the price of a substitute good
Old
New?
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57. The University of Akron
Supply - shifts
Table
An increase in the price of complement in production causes a right shift of the supply curve
At each price the quantity supplied increases
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58. The University of Akron
Supply function
Graph
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59. The University of Akron
Supply – shifts (quiz)
Number of suppliers (Np)
Number of suppliers increase =>
Supply shifts to
Price of recourses (PR)
Price of resources increase =>
Right
Left
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60. The University of Akron
Supply – shifts (quiz)
Technology (TX)
Technology improves =>
More output with the same inputs
Supply shifts to
Right
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61. The University of Akron
Supply – shifts (quiz)
Price of related commodities (Pcs, Pss)
Substitutes in production
Price of substitute increase =>
Supply shifts to
Price of substitute decrease =>
Complements in production
Price of complement increase =>
Price of complement decrease =>
Left
Right
Right
Left
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62. The University of Akron
Supply – shifts (quiz)
Expectations (E)
Suppliers expect future prices to increase =>
Current supply shifts to
Suppliers expect future prices to decrease =>
Left
Right
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63. Supply – individual to market
Assume there are 5 suppliers in the market, each with a different individual supply
At any given price, the market supply is the sum of the individual quantities supplied
Horizontal summation
Note: assumes resource prices constant
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64. Supply – individual to market
Table
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65. Supply – individual to market
Graph
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66. The University of Akron
Student Questions
Individually
What is the muddiest point about supply?
In groups compare muddiest points
Are any in common?
Can group members help clarify?
List common unanswered questions
Share common questions
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67. The University of Akron
Supply
Definition
Determinants
Supply function (curve)
Movement along supply
Shifting of supply
Individual and market supply
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The University of Akron

68. Introduction Demand Supply Market equilibrium
Decision Tree
Introduction
Demand
Supply
Market equilibrium
Complications
Applications

69. The University of Akron
Market equilibrium
Why do prices increase?
Why do prices decrease?
Definition of equilibrium
Shifting Demand and Supply
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70. The University of Akron
Market equilibrium
Why do prices increase?
Consumers can’t buy as much of a commodity as they want
Some consumers value the commodity much higher
And are willing to pay a premium to obtain more
Thus bidding the market price higher
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71. The University of Akron
Market equilibrium
Why do prices decrease?
Sellers can’t sell as much of a commodity as they want
Inventories increase
What can they do to improve their situation?
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72. The University of Akron
Market equilibrium
What can they do to improve their situation?
Store surplus
Reduce production
Have a sale – lower the price
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73. The University of Akron
Market equilibrium
Consumers don’t want higher prices.
So why would they bid the prices higher?
Sellers don’t want lower prices.
So why would they lower the price?
It is better than other alternatives
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74. Definition of Equilibrium
Balance
At rest (an attractor)
No internal tendency to change
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75. Definition of Equilibrium
Price at which the quantity demanded equals the supplied
Consumers are able to buy the quantity they are willing to
Sellers are able to sell all they are willing to
Thus neither consumers nor suppliers have any incentive to bid the price higher or lower
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76. The University of Akron
Market equilibrium
Quantity demanded equals quantity supplied
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77. The University of Akron
Market equilibrium
Px = 6.5
Qx = 4.5
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78. The University of Akron
Market equilibrium
Table
Can you do the table?
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79. Shifting Demand and Supply
Table
Graph
Algebraic function
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80. Shifting Demand and Supply
Quantity demanded equals quantity supplied
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81. Shifting Demand and Supply
Px = 6
Qx = 8
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82. Shifting Demand and Supply
Can you do the table?
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83. The University of Akron
Market surplus
Qd < Qs
Price is above equilibrium
Sellers bid the price lower
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84. The University of Akron
Market shortage
Qd > Qs
Price is below equilibrium
Consumers bid the price higher
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85. The University of Akron
Student Questions
Individually
What is the muddiest point about market equilibrium?
In groups compare muddiest points
Are any in common?
Can group members help clarify?
List common unanswered questions
Share common questions
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86. The University of Akron
Market equilibrium
Why do prices increase?
Why do prices decrease?
Definition of equilibrium
Shifting Demand and Supply
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The University of Akron

87. Introduction Demand Supply Market equilibrium
Decision Tree
Introduction
Demand
Supply
Market equilibrium
Complications
Applications

88. The University of Akron
Complication
Public goods
Externalities
Asymmetric information
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89. The University of Akron
Complication
Private goods
Exclusion
Rival consumption
Public goods
Non-exclusion
Non-rival consumption
Can you provide examples?
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90. The University of Akron
Complication
Externalities
External benefits
External costs
Can you provide examples?
Asymmetric information
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91. The University of Akron
Complication
Public goods
Externalities
Asymmetric information
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92. Introduction Demand Supply Market equilibrium
Decision Tree
Introduction
Demand
Supply
Market equilibrium
Complications
Applications

93. The University of Akron
Applications
Ceilings and floors
Income distribution
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94. The University of Akron
Ceilings and floors
Ceiling
$8.00
Qd = 3
Qs = 6
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95. The University of Akron
Ceilings and floors
Floor
$4.00
Qd = 7
Qs = 6
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96. Introduction Demand Supply Market equilibrium
Decision Tree
Introduction
Demand
Supply
Market equilibrium
Complications
Applications