1. The Economic Way of Thinking 10e ©Prentice Hall 2003 1 “The Economic Way of Thinking” 10 th Edition by Paul Heyne, Peter Boettke, and David Prychitko “Supply and Demand: A Process of Cooperation” PowerPoint Slides prepared by Assistant Professor Paul Harris Camden County College

2. The Economic Way of Thinking 10e ©Prentice Hall 2003 2 Chapter Outline I.Introduction II.The Market is a Process of Competing Bids and Offers III.Transaction Cost IV.Property Rights and Institutions V.The Coordinating Role of Money Prices VI.The Basic Process

3. The Economic Way of Thinking 10e ©Prentice Hall 2003 3 VII.Competition, Cooperation, and Market Clearing. VIII. Changing Market Conditions IX.The Urge to Fix Prices X.Competition When Prices are Fixed XI.Appropriate and Inappropriate Signals XII.Competition Results From Scarcity XIII. Once Over Lightly Chapter Outline

4. The Economic Way of Thinking 10e ©Prentice Hall 2003 4 Introduction Specialization is what distinguishes every wealthy society the world has ever known.Specialization is what distinguishes every wealthy society the world has ever known. Adam Smith observed…….. “It is the great multiplication of the productions of all the different arts, “in consequence of the division of labour” which occasions, in well governed society, that universal opulence which extends itself to the lowest ranks of the people.

5. The Economic Way of Thinking 10e ©Prentice Hall 2003 5 How do wealthy highly specialized commercial societies know to take the actions necessary wind up producing the myriad of goods and services they enjoy? Answer… Massive ignorance, since specialist by their very nature don’t know how to do everything. The miracle of the market is that millions of people globally, manage to cooperate together to produce the goods and services that we enjoy. Introduction

6. The Economic Way of Thinking 10e ©Prentice Hall 2003 6 The role of government in these societies is to … Introduction Monitorpropertyrights. Enforcepropertyrights. Enforcecontracts

7. The Economic Way of Thinking 10e ©Prentice Hall 2003 7 The Market – Competing Bids and Offers Markets are not necessarily physical places. They are mechanisms which brings together buyers and sellers, demanders and suppliers. A market can be formal, but many markets are informal. A market is not a person place or thing. It is a process of competing bids and offers.

8. The Economic Way of Thinking 10e ©Prentice Hall 2003 8 Transaction Cost Transaction costs are the costs of arranging contracts or transaction agreements between demanders and suppliers. It isn’t enough that demanders are willing to what suppliers would require. Someone needs to arrange the the actual transaction.

9. The Economic Way of Thinking 10e ©Prentice Hall 2003 9 Questions…… Why does broken glass stay on a bicycle trail even if each bicyclist would pay someone to clean it up? Why don’t commuters in no hurry clear the way for those who are? Why does even the most environmentally aware person contribute to its degradation? Why did food rot in the fields in the U.S.S.R. when people were starving? Transaction Cost

10. The Economic Way of Thinking 10e ©Prentice Hall 2003 10 Questions…… Why does broken glass stay on a bicycle trail even if each bicyclist would pay someone to clean it up?Why does broken glass stay on a bicycle trail even if each bicyclist would pay someone to clean it up? Why don’t commuters in no hurry clear the way for those who are?Why don’t commuters in no hurry clear the way for those who are? Why does even the most environmentally aware person contribute to its degradation?Why does even the most environmentally aware person contribute to its degradation? Why did food rot in the fields in the U.S.S.R. when people were starving?Why did food rot in the fields in the U.S.S.R. when people were starving? Answer: When transaction costs are too high, the result will be a failure of cooperation. All of these questions illustrate a failure of cooperation because the cost of arranging the transaction are too high. Transaction Cost

11. The Economic Way of Thinking 10e ©Prentice Hall 2003 11 Property Rights and Institutions Private Ownership People have the incentive to take control of resources. Resources will quickly and cheaply come together. Low Transaction Costs Allow negotiations necessary to produce goods and services to succeed

12. The Economic Way of Thinking 10e ©Prentice Hall 2003 12 Questions… Why are the countries that are attempting to move to a market system facing high transaction costs? Can they design an efficient system? Can they do it quickly? Property Rights and Institutions

13. The Economic Way of Thinking 10e ©Prentice Hall 2003 13 Questions… Why are the countries that are attempting to move to a market system facing high transaction costs? Can they design an efficient system? Can they do it quickly? Property Rights and Institutions

14. The Economic Way of Thinking 10e ©Prentice Hall 2003 14 Questions… Why are the countries that are attempting to move to a market system facing high transaction costs? Can they design an efficient system? Can they do it quickly? Property Rights and Institutions Answer….. The success of market reform projects in many nations depends on overcoming the problem of high transaction cost rapidly.

15. The Economic Way of Thinking 10e ©Prentice Hall 2003 15 The Coordinating Role of Money Prices Question……….Question………. –Why is money used in exchanges instead of barter? Answer………Answer……… –Money is a general medium of exchange. Question……….Question………. –Why is money used in exchanges instead of barter? Answer………Answer……… –Money is a general medium of exchange.

16. The Economic Way of Thinking 10e ©Prentice Hall 2003 16  Money’s Advantages  Lowers transaction costs  Acceptability  Provides signals quickly The Coordinating Role of Money Prices

17. The Economic Way of Thinking 10e ©Prentice Hall 2003 17 The Basic Process D S 1000 500 $500 1,200 $700 800 $300 Supply and Demand in the Acoustic Guitar Market Quantity of Acoustic Guitars Price

18. The Economic Way of Thinking 10e ©Prentice Hall 2003 18 The Basic Process D S 1000 500 $500 1,200 $700 800 $300 Supply and Demand in the Acoustic Guitar Market Quantity of Acoustic Guitars Price The Market clears at $500

19. The Economic Way of Thinking 10e ©Prentice Hall 2003 19 The Basic Process D S 1000 500 $500 1,200 $700 800 $300 Supply and Demand in the Acoustic Guitar Market Quantity of Acoustic Guitars Price A shortage of 400 guitars At $300

20. The Economic Way of Thinking 10e ©Prentice Hall 2003 20 The Basic Process D S 1000 500 $500 1,200 $700 800 $300 Supply and Demand in the Acoustic Guitar Market Quantity of Acoustic Guitars Price A surplus of 400 guitars at $700

21. The Economic Way of Thinking 10e ©Prentice Hall 2003 21 Competition, Cooperation, and Market Clearing Competition, like cooperation, is rampant throughout the market process.Competition, like cooperation, is rampant throughout the market process. Rather than competition between buyer and seller;Rather than competition between buyer and seller; –Buyers tend to compete with other buyers. –Sellers tend to compete with other sellers. Competition, like cooperation, is rampant throughout the market process.Competition, like cooperation, is rampant throughout the market process. Rather than competition between buyer and seller;Rather than competition between buyer and seller; –Buyers tend to compete with other buyers. –Sellers tend to compete with other sellers.

22. The Economic Way of Thinking 10e ©Prentice Hall 2003 22 In the case of a shortage, buyers compete with one another by offering higher prices, and the bidding process eliminates the shortage. In the case of a surplus sellers compete amongst themselves by trying to attract customers and move excess inventories. Each seller would compete with lower prices until the surplus disappears. Competition, Cooperation, and Market Clearing

23. The Economic Way of Thinking 10e ©Prentice Hall 2003 23 In the case of a shortage, buyers compete with one another by offering higher prices, and the bidding process eliminates the shortage.In the case of a shortage, buyers compete with one another by offering higher prices, and the bidding process eliminates the shortage. In the case of a surplus sellers compete amongst themselves by trying to attract customers and move excess inventories.In the case of a surplus sellers compete amongst themselves by trying to attract customers and move excess inventories. –Each seller would compete with lower prices until the surplus disappears. Competition, Cooperation, and Market Clearing With individual buyers bidding up prices when there are shortages, and sellers reducing prices when there are surpluses, the market system, through the forces of supply and demand settles on a market clearing price. The clearing price is the equilibrium quantity, and price

24. The Economic Way of Thinking 10e ©Prentice Hall 2003 24 Competition When Prices Are Fixed Question…Question… –What happens if the price of a good is not allowed to rise when it becomes more scarce? Answer….Answer…. –Government imposed price ceilings cause shortages, and make it necessary for the government to ration the product.

25. The Economic Way of Thinking 10e ©Prentice Hall 2003 25 Competition When Prices Are Fixed P Q DS Legal ceiling price shortage Money costs Non- monetary costs

26. The Economic Way of Thinking 10e ©Prentice Hall 2003 26 Competition When Prices Are Fixed Question……Question…… –What are the non-monetary costs? Answer…….Answer……. –Waiting lines –Restraining activity –Striking deals Question……Question…… –What are the non-monetary costs? Answer…….Answer……. –Waiting lines –Restraining activity –Striking deals

27. The Economic Way of Thinking 10e ©Prentice Hall 2003 27 Appropriate and Inappropriate Signals Question…. What will suppliers do if a law prevents them from raising their prices when a shortage exists? Answer… Prices provide signals. Price Ceilings Suppliers and demanders receive incorrect signals Effective accommodation does not occur

28. The Economic Way of Thinking 10e ©Prentice Hall 2003 28 Competition Results from Scarcity Scarce Goods When people cannot obtain as much of a good as they would like without being required to sacrifice something else of value. Rationing Prices ration scarce goods Competition A result of scarcity Occurs when people strive to meet the criteria that is being used to ration scarce goods

29. The Economic Way of Thinking 10e ©Prentice Hall 2003 29 From Scarcity to Competition P Q D S Scarce good

30. The Economic Way of Thinking 10e ©Prentice Hall 2003 30 From Scarcity to Competition P Q D S A nonscarce good

31. The Economic Way of Thinking 10e ©Prentice Hall 2003 31 Surpluses and Scarcity Surplus Occurs when quantity supplied exceeds quantity demanded Surplus of Teachers Decreasing wages motivates people to look at different careers. Question How would school systems respond if they were not allowed to reduce wages?

32. The Economic Way of Thinking 10e ©Prentice Hall 2003 32 Surpluses and Scarcity Surplus of DoctorsSurplus of Doctors –Number “needed” is quantity demanded at the current price. QuestionQuestion –What would this surplus do to wages and prices?

33. The Economic Way of Thinking 10e ©Prentice Hall 2003 33 Market Processes Versus Central Planning A socialist economy would be run like one huge non-profit organization. They utilize a system of central planners, to perform the functions that we take for granted, and which occur automatically in a market system. There is no efficient way to effectively and efficiently produce and distribute the massive array of goods and services desired by millions of citizens.

34. The Economic Way of Thinking 10e ©Prentice Hall 2003 34 Once Over Lightly Society is characterized by extensive division of labor. The market is a process of competing bids and offers. Intermediaries facilitate exchange and reduce transaction cost. Transaction cost is the cost of arranging contracts or or transaction agreements between suppliers and demanders. Money is used as a medium to facilitate exchange.

35. The Economic Way of Thinking 10e ©Prentice Hall 2003 35 Once Over Lightly The market clears when quantity demanded equals quantity supplied. Exchange is a cooperative activity. Scarce goods must be rationed in some fashion. Surpluses and shortages arise when the market price is above or below the equilibrium price.

36. End of Chapter 5 Next Chapter 6 Supply and Demand: Issues and Applications