2. Markets Are a mechanism that brings buyers and sellers together to exchange goods, services, and resources. It is a device for allocating or rationing goods, services, and resources. A competitive market: –Many buyers and sellers; Same good or service Product market: where consumer goods are bought and sold. Business firms are the seller, consumers are the buyers Resource market: where the resource services are bought and sold. Resource owners(consumers) are the sellers and business firms are the buyers Five key elements: –Demand curve, Supply curve –Demand and supply curve shifts –Market equilibrium –Changes in the market equilibrium

3. Definition: relationship between the price and the quantity demanded of a good. Quantity demanded: amount of an item that buyers are willing and able to purchase over a certain time period, at a specific price, ceteris paribus.

4. 1. Price 2. Income Normal good: Buy more of a good when income increases Inferior good : Buy less of that good when income increases 3. Tastes and Preferences 4. Prices of related goods Substitutes:Two goods that perform the same function (interchangeable) Complements: Two goods that are used together to enhance one another 5. Expectations (of future price, expected income, etc.) 6. Number of consumers

5. 1. Price The variables below this line will be held constant (ceteris Paribus) 2. Income Normal good: Wish to buy more of a good when income increases Inferior good : Wish to buy less of that good when income increases 3. Tastes and Preferences 4. Prices of related goods Substitutes:Two goods that perform the same function (interchangeable) Complements: Two goods that are used together to enhance one another 5. Expectations (of future price, expected income, etc.) 6. Number of consumers

6. By holding all other variables constant we get our first prediction (hypothesis). Law of Demand: The price and quantity demanded of a good are inversely related, ceteris paribus. possible prices quantity demandedDemand schedule: A list of possible prices with the corresponding quantity demanded at that price. It is a representation of the law of demand. What if the price was..., then what would be quantity demanded at that price. Think of it like answering a survey… …no other variable changes except the one you ask about 1. Price

7. Example: A demand schedule For Coffee Price (per pound) Quantity Demanded (pounds per week) $7.00 1,000 $6.50 2,000 $6.00 3,000 $5.50 4,000 $5.00 5,000 $4.50 6,000 $4.00 7,000 $3.50 8,000 $3.00 9,000

8. Demand curve - a curve representing the law of demand. Price Quantity Demanded $7.00 1,000 $6.50 2,000 $6.00 3,000 $5.50 4,000 $5.00 5,000 $4.50 6,000 $4.00 7,000 $3.50 8,000 $3.00 9,000 Price Quantity Demanded (QD) (In thousands) 0 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 12345678910 Connect the dots and we get... A Demand Curve! price decreases As the price of a good decreases, buyers are willing and able purchase more to purchase more of this good, all other variables constant Plot the demand schedule on the graph.... This is called an increase in quantity demanded.

9. Pay More, Pump Less…  Because of high taxes, gasoline and diesel fuel are more than twice as expensive in most European countries as in the United States.  According to the law of demand, Europeans should buy less gasoline than Americans, and they do: Europeans consume less than half as much fuel as Americans, mainly because they drive smaller cars with better mileage. 1.01.40.60.2 $8 7 6 5 4 3 Price of gasoline (per gallon) 0 Italy France Canada United States Japan Germany Spain United Kingdom Consumption of gasoline (gallons per day per capita)

10. What about the other variables? To construct a single demand curve a number of variables are held constant... (Income, Expectations, prices of related goods, etc) What would happen to the demand curve if one of these variables were to change? Example: Suppose consumers income increases and coffee is a normal good. People will want to buy more coffee......not just at one specific price but at all prices!

11. Price Quantity Demanded (QD) (In thousands) 0 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 12345678910 Demand Curve Price Quantity QD Demand (new) $7.00 1,000 2,000 $6.50 2,000 3,000 $6.00 3,000 4,000 $5.50 4,000 5,000 $5.00 5,000 6,000 $4.50 6,000 7,000 $4.00 7,000 8,000 $3.50 8,000 9,000 $3.00 9,000 10,000 If the price were $5.00, coffee drinkers would by 6,000 pounds instead of 5,000… If one point can be shifted off a demand curve then all of them can be Increase in Demand Demand Curve ( after income increase) When this occurs we call it a shift in the demand curve. In this case it shifts to the right which is an increase since more coffee is desired at any price

12. Price Quantity Demanded Changes in quantity demanded (caused by the price of the good) Original Demand curve Changes in Demand (caused by a “ceteris paribus” variable changing). Will shift the position of the demand curve. Changes in demand vs. Changes in quantity demanded

13. Price Quantity Demanded (QD) (In thousands) 0 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 12345678910 Demand Curve New Demand Curve Don’t confuse changes in quantity demanded with changes in demand Both a reduction in price and an increase in demand will cause sales to increase, but the reason they do so is different. This difference is important and will become clearer after Supply is introduced

14. How do the other “ceteris paribus” variables affect the demand curve? 1. Prices of related goods Substitutes increasesIf the price of tea increases, then consumers will wish to buy more coffee...since coffee is now relatively cheaper compared to tea. price of a substitute good increasesincreases. In general, as the price of a substitute good increases, the demand for the other good increases. Therefore, there is a direct relationship between the demand for a good and the price of a substitute good. Other examples: Foreign cars - American cars, chicken - beef, Coke - Pepsi, etc. Consumers always purchase more of the good that is now cheaper relative to the other good.

15. “Ceteris paribus” Variables 1. Prices of related goods Complements increaseIf the price of sugar and cream were to increase, then consumers will desire to buy less coffee because the two joined products (Coffee-(sugar-cream)) now are more expensive. price of a complementary good increases decreases As the price of a complementary good increases, the demand for the other good decreases. Therefore, there is an inverse relationship between the demand for a good and the price of a complementary good. Other examples: Cars - gasoline, Computers - software, Compact discs - Compact disc players, hot dogs - mustard

16. “Ceteris paribus” Variables 2. Tastes & Preferences If consumers prefer a good there is an increase in demand. If a good falls out of favor there is a decrease in demand Advertising could have an effect on tastes & preferences 3. Expectations Of future prices, availability of goods, income. If you believe that prices will increase in the future, you will want to buy more today before the price increase (increase in demand) Important for prices of commodities, stocks, and bonds 4. # of consumers: more consumers, increase in demand

17. Definition: relationship between the price of a good and the quantity supplied of a good. Quantity supplied: amount of an item that sellers are willing and able to make available to market over a certain period, at a specific price, ceteris paribus.

18. 1. Price of the good 2. Price of inputs (resources) 3. Technology 4. Prices of other goods that can be produced by the firm 5. Expectations of future price 6. Number of Firms 7. Taxes and Subsidies

19. 1. Price of the good The variables below this line will be held constant (ceteris paribus) 2. Price of inputs (resources) 3. Technology 4. Prices of other goods that can be produced by the firm 5. Expectations of future price 6. Number of Firms 7. Taxes and Subsidies

20. By holding all other variables constant we get our second prediction (hypothesis). Law of Supply: The price and quantity supplied of a good are directly related, ceteris paribus. possible prices quantity suppliedSupply schedule: A list of possible prices with the corresponding quantity supplied at that price. It is a representation of the law of supply. What if the price was... then what would be quantity supplied at that price. 1. Price

21. Example: A supply schedule For Coffee Price (per pound) Quantity Supplied (pounds per week) $7.00 9,000 $6.50 8,000 $6.00 7,000 $5.50 6,000 $5.00 5,000 $4.50 4,000 $4.00 3,000 $3.50 2,000 $3.00 1,000

22. Supply curve...a curve representing the law of supply Price Quantity Supplied (QS) (In thousands) 0 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 12345678910 Connect the dots and we get… A Supply Curve price increases make more of the good available for sale As the price of a good increases, business firms are willing to make more of the good available for sale, ceteris paribus Price Quantity Supplied $7.00 9,000 $6.50 8,000 $6.00 7,000 $5.50 6,000 $5.00 5,000 $4.50 4,000 $4.00 3,000 $3.50 2,000 $3.00 1,000 Plot the supply schedule on the graph... This is called an increase in quantity supplied.

23. Price Quantity Supplied Changes in quantity Supplied (caused by the price of the good) Changes in Supply (caused by a “ceteris paribus” variable) Will shift the position of the Supply curve. Changes in quantity supply vs. Changes in supply Increase in Supply Decrease in Supply Original Supply curve

24. How do the “ceteris paribus” variables affect the Supply curve? Price of inputs (resources) If the price of an input increases (labor, materials,etc) this makes a good more expensive to produce (raises costs). This lowers the potential profit of the firm so they will wish to decrease the supply of the good Opposite example: The decline in the price of computer processors and chips makes costs decline for computer manufacturers and they increase supply Summary: A decline in input prices increases supply. A rise in input prices decreases supply.

25. “Ceteris paribus” variables (Supply) Technology...allows a firm to produce the same amount of a good with less resources, which results in lower costs and an increase in supply Price of other goods the firm can produce... Example: If a farmer who grows coffee beans finds that another crop will pay them more… … they devote less land to coffee(a decrease in supply of coffee ) and more land to the other crop Expectations... of future prices If firms expect higher prices in the future they will make less available today ( decrease in supply ). Why? So they will have more to sell in the future (at the higher prices

26. “Ceteris paribus” variables (supply) Number of firms The more firms that produce the good the greater is the supply of the good (more it shifts to the right) Taxes and Subsidies Excise taxes...a tax on a good (gas, cigarette,etc) An increase in excise taxes will raise the cost of the good, lower potential profits, cause a decrease in supply A subsidy gives money (directly or indirectly) to firms, lowers the cost of the good and will increase supply. Examples: Public colleges and universities receive money from state governments. Immunizations are also subsidized by the government

27. Market Equilibrium Equilibrium: Definition - At rest, no tendency to change, forces in balance. Market equilibrium. − the price, once reached, when there will be no tendency to change. − Also the price the market comes to rest at and where there are forces in balance. This can only occur when Quantity demand (QD) = Quantity supplied (QS) Price is a rationing device… …based on willingness and ability to pay

28. Price QD QS $7.00 1,000 9,000 $6.50 2,000 8,000 $6.00 3,000 7,000 $5.50 4,000 6,000 $5.00 5,000 5,000 $4.50 6,000 4,000 $4.00 7,000 3,000 $3.50 8,000 2,000 $3.00 9,000 1,000 Price Quantity Demanded & Supply of Coffee(in thousands) 0 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 12345678910 Demand Curve Quantity demanded = Quantity supplied occurs where the demand curve intersects the supply curve. This will determine the equilibrium price and quantity. Equilibrium price = $5.00 and 5,000 pounds of coffee are bought and sold at that price Supply curve

29. Price QD QS $7.00 1,000 9,000 $6.50 2,000 8,000 $6.00 3,000 7,000 $5.50 4,000 6,000 $5.00 5,000 5,000 $4.50 6,000 4,000 $4.00 7,000 3,000 $3.50 8,000 2,000 $3.00 9,000 1,000 Price Quantity Demanded & Supply of Coffee(in thousands) 0 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 123 45678910 Demand Curve Supply curve Economically (not graphically), how would equilibrium be reached? Suppose that the price for coffee were $3.50 instead......At the price of $3.50 QS = 2,000 and QD = 8,000 ( QD > QS) Consumers wish to buy more coffee than firms are willing to make available at $3.50. This means we have a... Shortage (Excess Demand)

30. Price QD QS $7.00 1,000 9,000 $6.50 2,000 8,000 $6.00 3,000 7,000 $5.50 4,000 6,000 $5.00 5,000 5,000 $4.50 6,000 4,000 $4.00 7,000 3,000 $3.50 8,000 2,000 $3.00 9,000 1,000 Price Quantity Demanded & Supply of Coffee(in thousands) 0 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 1234 5678910 Demand Curve Supply curve Some of these consumers are willing to pay more for coffee than go without Shortage (Excess Demand) Some consumers are going without coffee when the price is $3.50… As the price is bid up some consumers drop out of the bidding. QD decreases and coffee growers put more of their product on the market (QS increases) Like an auction, these consumers will bid up the price in order to get coffee... Only when QD = QS can this occur. Which is at the equilibrium price! This will continue consumers are able to buy all they wish to.

31. The Price of Admission: Compare the box office price for a recent Justin Timberlake concert in Miami, Florida, to the StubHub.com price for seats in the same location: $88.50 versus $155. Why is there such a big difference in prices? For major events, buying tickets from the box office means waiting in very long lines. Ticket buyers who use Internet resellers have decided that the opportunity cost of their time is too high to spend waiting in line. For those major events with online box offices selling tickets at face value, tickets often sell out within minutes. In this case, some people who want to go to the concert badly but have missed out on the opportunity to buy cheaper tickets from the online box office are willing to pay the higher Internet reseller price. Economics in Action

32. Price QD QS $7.00 1,000 9,000 $6.50 2,000 8,000 $6.00 3,000 7,000 $5.50 4,000 6,000 $5.00 5,000 5,000 $4.50 6,000 4,000 $4.00 7,000 3,000 $3.50 8,000 2,000 $3.00 9,000 1,000 Price Quantity Demanded & Supply of Coffee(in thousands) 0 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 12345678910 Demand Curve Supply curve Suppose that the price for coffee were $6.00 instead... At the price of $6.00 QS = 7,000 and QD = 3,000 (QD < QS) Coffee growers would like to sell more coffee than consumers wish to buy at $6.00. This means we have a… Surplus (Excess Supply) At the price of $6.00 some coffee growers are not able to sell all they wish to… cut prices! Some growers will want to sell more and to do so will cut prices!

33. Price QD QS $7.00 1,000 9,000 $6.50 2,000 8,000 $6.00 3,000 7,000 $5.50 4,000 6,000 $5.00 5,000 5,000 $4.50 6,000 4,000 $4.00 7,000 3,000 $3.50 8,000 2,000 $3.00 9,000 1,000 Price Quantity Demanded & Supply of Coffee(in thousands) 0 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 12345678910 Demand Curve Supply curve As prices are decreased, consumers will wish to buy more (QD increases), and some coffee growers will take their product off the market (QS decreases) This will continue until all growers are able to sell all they wish to. Only when QS = QD can this occur. It is at the Equilibrium price! Surplus (Excess Supply)

35. Price Quantity of Coffee (In thousands) $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 Demand Curve Supply curve Think of the graph as a “snapshot” of the Market. If something changes(the Supply or Demand curve shifts) in the Market the “snapshot” will change... Example: If the price of tea(a substitute good) increases, consumers will want more coffee (increase in demand) New Demand Curve New Equilibrium If the price of a substitute good increases, there is an increase equilibrium price and quantity. increase in Demand The increase in Demand causes both equilibrium price and quantity to go up: Increase in Income (Normal good), Decrease in price of a complementary good, Expected higher prices in the future, more consumers, Increase in preferences for the good. 0 12345678910

36. Price $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 Demand Curve Supply curve 1 Suppose the price of land(for growing coffee) decreases......the decline in the price of an input will increase the profitability of coffee growers who will want to produce more (increase in supply)… Let’s return to our original equilibrium. Supply curve 2 New Equilibrium The decline in the price of an input increases the equilibrium quantity and decreases the equilibrium price increase in supply The increase in supply causes an increase in equilibrium quantity and a decrease in equilibrium price: An increase in technology, a fall in the price of other goods that can be produced, expected fall in future price, more firms producing the good, a fall in taxes or an increase in subsidies Quantity of Coffee (In thousands) 0 $1.00 12345678910

37. Price Quantity of Coffee (In thousands) 0 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 12345678910 Demand Curve Supply curve 1 …would expect that supply of coffee would have to be reduced......which will shift the supply curve to the left... On the other hand, suppose a hurricane destroys a fair amount of the coffee crop in Central America......This results in a decrease in equilibrium quantity and an increase in equilibrium price. Supply curve 2

38. The Great Tortilla Crises: A sharp rise in the price of tortillas, a staple food of Mexico’s poor, which had gone from 25 cents a pound to between 35 and 45 cents a pound in just a few months in early 2007. Why were tortilla prices soaring? It was a classic example of what happens to equilibrium prices when supply decreases. Tortillas are made from corn; much of Mexico’s corn is imported from the United States, with the price of corn in both countries basically set in the U.S. corn market. U.S. corn prices were rising rapidly thanks to surging demand in a new market: the market for ethanol. This increase in the price of an input caused the supply of tortillas to decrease and equilibrium price to increase.

39. Other Examples Making predictions about price and quantity

40. increase Question: How would an increase in the price of oil affect the price and quantity of cars? Price Quantity of Gasoline D1D1 S1S1 $2.00 Q1Q1 Suppose the price of oil were to increase... 7...since oil is an important input in the production of gas......the increase in it’s price will raise the cost of producing gas......this lowers potential profit and firms reduce production.....the supply curve shifts to the left......the price of gasoline will increase How are gasoline and cars related? They are complements! If the price of a complement increases this will cause a decrease in demand for the other good... S2S2 $3.00 Q2Q2

41. increase Question: How would an increase in the price of oil affect the price and quantity of cars? Price of Cars Quantity of Cars D1D1 S1S1 P1 Q1Q1 If the price of a complement increases this will cause a decrease in demand for the other good... …a decrease in the demand for cars! The result is a decline in the price of cars as well as a decline in the amount of cars bought and sold. This example is to show you how markets are related to one another. Other examples for you to think about: If the price of Coke increases, what happens to the price of Pepsi? If the price of computers decrease, what happens to the price of computer software? D2D2 P2 Q2Q2

42. Example: Both Demand and Supply curves shifting at the same time

43. Price Quantity of Cellular phones D 1988 S 1988 $800 Q1Q1 Today, many people besides the wealthy have a cellular phone....in other words there has been a large increase in demand the last 20 years Around 1988, the cellular phone was just beginning to be used....it’s price was very high, and only wealthy individuals used them.. D 2008 S 2008 According to this graph the price of cellular phones should be over $1,000. Yet good ones today are around $50. Yet we know that demand has increased...How to explain this? There has also been a large increase in Supply as well the last 20 years! $40 Q2Q2

44. Price Quantity of Cellular phones D 1988 S 1988 $800 Q1Q1 D 2008 S 2008 The increase in supply causes prices to decrease 1. Decrease in price of inputs 2. Increase in technology 3. Increase in number of firms making cellular phones The increase in supply is greater than the increase in demand. Increase in Demand: Increase Price, Increase Quantity Increase in Supply: Decrease Price, Increase Quantity quantity increases Add together: We observe the quantity increases, both supply and demand cause quantity to go up (re-enforce one another) Since we know price goes down it must be that the force pushing price down( supply) > force pushing the price up(demand). Q2Q2 $40

45. Simultaneous Shifts of Supply and Demand We can make the following predictions about the outcome when the supply and demand curves shift simultaneously: Simultaneous Shifts of Supply and Demand Supply IncreasesSupply Decreases Demand Increases Price: ambiguous Quantity: up Price: up Quantity: ambiguous Demand Decreases Price: down Quantity: ambiguous Price: ambiguous Quantity: down

46. A recent drought in Australia reduced the amount of grass on which Australian dairy cows could feed, thus limiting the amount of milk these cows produced for export. At the same time, a new tax levied by the government of Argentina raised the price of the milk the country exported, thereby decreasing Argentine milk sales worldwide. These two developments produced a supply shortage in the world market, which dairy farmers in Europe couldn’t fill because of strict production quotas set by the European Union. In China, meanwhile, demand for milk and milk products increased, as rising income levels drove higher per-capita consumption. All these occurrences resulted in a strong upward pressure on the price of milk everywhere in 2007. Demand and Supply Shifts at Work in the Global Economy

47. 1.The supply and demand model illustrates how a competitive market works. 2.The demand schedule shows the quantity demanded at each price and is represented graphically by a demand curve. The law of demand says that demand curves slope downward. 3.A movement along the demand curve occurs when a price change leads to a change in the quantity demanded. When economists talk of increasing or decreasing demand, they mean shifts of the demand curve—a change in the quantity demanded at any given price. Summary

48. 4.There are five main factors that shift the demand curve: A change in the prices of related goods or services A change in income A change in tastes A change in expectations A change in the number of consumers 5.The market demand curve for a good or service is the horizontal sum of the individual demand curves of all consumers in the market. 6.The supply schedule shows the quantity supplied at each price and is represented graphically by a supply curve. Supply curves usually slope upward. Summary

49. 7.A movement along the supply curve occurs when a price change leads to a change in the quantity supplied. When economists talk of increasing or decreasing supply, they mean shifts of the supply curve—a change in the quantity supplied at any given price. 8.There are five main factors that shift the supply curve: A change in input prices A change in the prices of related goods and services A change in technology A change in expectations A change in the number of producers 9.The market supply curve for a good or service is the horizontal sum of the individual supply curves of all producers in the market. Summary

50. 10.The supply and demand model is based on the principle that the price in a market moves to its equilibrium price, or market-clearing price, the price at which the quantity demanded is equal to the quantity supplied. This quantity is the equilibrium quantity. When the price is above its market-clearing level, there is a surplus that pushes the price down. When the price is below its market-clearing level, there is a shortage that pushes the price up. 11.An increase in demand increases both the equilibrium price and the equilibrium quantity; a decrease in demand has the opposite effect. An increase in supply reduces the equilibrium price and increases the equilibrium quantity; a decrease in supply has the opposite effect. 12.Shifts of the demand curve and the supply curve can happen simultaneously. Summary