1. 8-1 Economics: Theory Through Applications

2. 8-2 This work is licensed under the Creative Commons Attribution-Noncommercial-Share Alike 3.0 Unported License. To view a copy of this license, visit http://creativecommons.org/licenses/by-nc-sa/3.0/or send a letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA

3. 8-3 Chapter 8 Why Do Prices Change?

4. 8-4 Learning Objectives How is the market demand curve derived? What is the slope of the market demand curve? How is the market supply curve derived? What is the slope of the market supply curve? What is the equilibrium of a perfectly competitive market? Why do market prices increase and decrease?

5. Learning Objectives How can I predict what is going to happen to prices? Are price changes good for the economy? How is information conveyed among households and firms in an economy? How do the tools of comparative statics extend to other markets, such as the market for credit or labor? How do markets interact with one another? How can I predict what will happen to prices when markets are not competitive? 8-5

6. Market Demand 8-6

7. Figure 8.1 - The Demand Curve of an Individual Household 8-7

8. Table 8.1 - Individual and Market Demand 8-8

9. Figure 8.2 - Market Demand 8-9

10. Market Supply 8-10

11. Figure 8.3 - The Supply Curve of an Individual Firm 8-11

12. Figure 8.4 - Market Supply 8-12

13. Figure 8.5 - Market Equilibrium 8-13

14. Table 8.2 - Market Equilibrium: An Example 8-14

15. Market Equilibrium 8-15

16. Figure 8.6 - A Shift in the Supply Curve of an Individual Firm 8-16

17. Using the Supply-and-Demand Framework 8-17

18. Figure 8.7 - A Shift in Market Supply 8-18

19. Figure 8.8 - The New Equilibrium from the Perspective of an Individual Firm 8-19

20. Figure 8.9 - Shifts in Household Demand 8-20

21. Figure 8.10 - Shifts in Market Demand 8-21

22. Figure 8.11 - Finding the Elasticities of the Supply and Demand Curves 8-22

23. Buyer’s Surplus 8-23

24. Table 8.3 - Calculating Buyer’s Surplus for an Individual Household 8-24

25. Figure 8.12 - Buyer Surplus for an Individual Household 8-25

26. Seller Surplus 8-26

27. Table 8.4 - Calculating Seller Surplus for an Individual Firm 8-27

28. Figure 8.13 - Seller Surplus for an Individual Firm 8-28

29. Figure 8.14 - Surplus in the Market Equilibrium 8-29

30. Figure 8.15 - Surplus Away from the Market Equilibrium 8-30

31. Figure 8.16 - Credit Market Equilibrium 8-31

32. Figure 8.17 - Foreign Exchange Market Equilibrium 8-32

33. Figure 8.18 - Labor Market Equilibrium 8-33

34. Figure 8.19 - The Sugar Market in Thailand and the Butter Market in Australia 8-34

35. Figure 8.20 - Finding the Profit-Maximizing Price and Quantity when a Firm Has Market Power 8-35

36. Figure 8.21 - An Increase in Marginal Cost 8-36

37. Figure 8.22 - Shifts in Demand and Marginal Revenue 8-37

38. Key Terms Competitive market: A market that satisfies two conditions: – There are many buyers and sellers, and – The goods the sellers produce are perfect substitutes Marginal cost: The extra cost of producing an additional unit of output, which is equal to the change in cost divided by the change in quantity Exogenous: Something that comes from outside a model and is not explained in our analysis Endogenous: Something that is explained within our analysis 8-38

39. Key Terms Comparative statics: A technique that allows us to describe how market equilibrium prices and quantities depend on exogenous events Price elasticity of supply: The percentage change in the quantity supplied to the market divided by the percentage change in price Price elasticity of demand: The percentage change in the quantity demanded in the market divided by the percentage change in price Natural experiment: An exogenous change that can be associated with a shift in either the demand curve only or the supply curve only 8-39

40. Key Terms Total surplus: A measure of the gains from trade that is equal to the buyer’s valuation minus the seller’s valuation Loan market (or credit market): Where suppliers and demanders of credit meet and trade Foreign exchange market: The place where suppliers and demanders of currencies meet and trade Exchange rate: The price in the foreign exchange market – It measures the price of one currency in terms of another 8-40

41. Key Takeaways The market demand curve is obtained by adding together the demand curves of the individual households in an economy As the price increases, household demand decreases, so market demand is downward sloping The market supply curve is obtained by adding together the individual supply curves of all firms in an economy As the price increases, the quantity supplied by every firm increases, so market supply is upward sloping 8-41

42. Key Takeaways A perfectly competitive market is in equilibrium at the price where demand equals supply Changes in prices come from shifts in market supply, market demand, or both Economists use comparative statics to predict changes in prices This technique explains how changes in exogenous variables cause shifts in supply and/or demand curves, which lead to changes in prices 8-42

43. Key Takeaways The response of prices and quantities to exogenous events is key for the efficient allocation of resources in the economy Information about the tastes of households and the costs of production for a firm is conveyed through the price system Through price adjustments in competitive markets, all potential gains from trade are realized The supply-and-demand framework can be used to understand the markets for labor, credit, and foreign currency 8-43

44. Key Takeaways Comparative statics can be used to study price and quantity changes in these markets As markets interact with one another, sometimes comparative statics requires us to look at effects across markets Even if markets are not competitive, the qualitative predictions from comparative statics in a competitive market remain The prediction of the supply-and-demand framework could be misleading if a shift of the demand curve does not lead the marginal revenue curve to shift in the same direction 8-44