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Demand, supply and market equilibrium Basic decision-making units in market (the circular flow)
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Household demand in product market Household’s decision about quantity demanded (number of units per period of time) depends on: - Price of product (p) - Income of household (normal vs. inferior goods) (y) - Household’s wealth (w) - Prices of other products (substitutes vs. complementary goods) (op) - Household’s tastes and preferences (pref) - Expectations about future income, wealth, and prices (exp)
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Household demand curve issues Household demand curve: A graph illustrating how much of a product a household would be willing to buy at different prices. q p 0 D (y 0, w 0, op 0, pref 0, exp 0 ) Discussion: -Ceteris paribus or all else equal - Law of demand - Dem curve intersects q axis (time limitations and diminishing marginal utility) - Dem curve intersects p axis (limited income and wealth) - Change in income
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From household demand to market demand Market demand: The sum of the quantities of a good demanded per period by all the households buying in that market.
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Firm supply in product markets Firms engage in production to maximize profits. Therefore, firm’s decision about the quantity supplied (number of units per period of time) depends on: - Price of product (p) - Cost of producing the product: price of inputs (e.g. wage (w) and interest rate (r)), technology used (tech), short run limitations - Prices of other products (op)
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Firm supply curve issues Firm supply curve: A graph illustrating how much of a product a firm would be willing to sell at different prices. q p 0 Discussion: - Law of supply - Change in wages - Short run vs. long run supply curve S (w 0, r 0, tech 0, op 0 )
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From firm supply to market supply Market supply: The sum of what is supplied each period by all producers of a single product.
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Market equilibrium Market equilibrium: The condition that exist when quantity supplied and quantity demanded are equal. At equilibrium there is no tendency for price to change. q p 0 S D q eq p eq Example: S: q s = -10 + p D: q d = 20 – p p eq =15, q eq =5 equilibrium point
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Stability of market equilibrium Economists like equilibriums, but we love those that are stable!!! Stable equilibrium: The system always returns to it after small disturbances. Unstable equilibrium: The system moves away from the equilibrium after small disturbances
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Stability of market equilibrium q p 0 S D equilibrium point excess demand excess supply p0p0 p1p1 The inherent forces of the market move the system to its equilibrium!!!
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Changes in Equilibrium q p 0 S D 0 eq. point 0 Example: Increase in income D 1 eq. point 1
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