Transcript ECO1000 Economics - University of Southern Queensland

ECO1000
Economics
Semester One, 2004
Lecture Three
Brief Recap of Last Week
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PPF’s are used to display production
choices and the opportunity costs of those
choices.
From a table of figures we plot the PPFs,
calculate opp. costs, work out comparative
advantages and decide who specialises in
what.
This is a simple but useful tool.
Good Question: Does (Complete)
Specialisation And Trade Always Lead to
Increased Consumption Possibilities?
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The answer is yes. The proof can be
displayed geometrically:
*
Another Good Question: Is the
Opportunity Cost the Slope?
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The Answer is yes (and no). Importantly, a slope can be
negative but opportunity cost is not.
For those with a bit of maths experience:
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Opportunity cost can be thought of as the absolute value of the
slope.
Δy/Δx = -2/3 = -0.66 Δy equals -2 because we give up 2 food to
gain 3 cloth (PPF slopes downwards)
Opportunity cost = |-0.66| = 0.66
Δx/Δy = 3/2 = 1.5 (or 1/0.66)
From applying these ideas we can see that once we calculate
the opportunity cost of one good (absolute value of the slope),
the opportunity cost of the other is simply its inverse.
(numbers from last week’s lecture)
Outline or Plan of Today’s Lecture
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Material Covered: Module
Two, Part One
Reading: Text Chapter
Four plus Chapter Four of
Hakes and Parry.
Topics Considered:
Markets and Supply and
Demand.
Purpose or Objectives of Today’s
Lecture
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You will learn about:
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What a market is
The determinants of demand
The determinants of supply
The allocation role of prices in a market
economy.
Relevant Economic Principles
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3. Rational People Think at the Margin
4. People Respond to Incentives
6. Markets Are Usually a Good Way to
Organise Activity
Reasons for learning about markets
 There
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are three reasons:
It is fundamental to economics
It is crucial to business
It helps you understand your own
behaviour as a consumer and
social person
What is a Market?
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A market is not a thing
or a place. It is a
process.
The interaction of
buyers and sellers
determines demand
and supply.
Demand
Or, How Consumers Behave
What Determines an Individual’s
Demand for a Product or Service?
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Price (law of demand)
Income
Prices of Related Goods
Tastes
Expectations
A Note on Normal Versus Inferior
Goods
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As income increases, demand increases
for a NORMAL good.
As income increases, demand decreases
for an INFERIOR good.
Example:
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If your income rises you are likely to buy less of
the generic branded goods (inferior) and more
brand-name products (normal)
Caspar’s Demand For Chocolate
Bars
Price
($/bar)
Quantity
(bars/wk)
12
10
8
6
4
2
1
4
7
10
13
16
Estimating Caspar’s Ceteris
Paribus Demand Curve
Price ($/bar)
12
*
10
*
8
*
6
*
*
4
*
2
0
1
4
7
10
13
16
D
Quantity (bars/wk)
What Does Ceteris Paribus Mean?
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Latin phrase meaning “other things equal”.
We use it in economics when we want to
indicate that the change (in a curve or
number) occurs in isolation.
Example: when income rises, we say
demand rises (for a normal good), Ceteris
Paribus. That is, nothing else is happening
to offset the change we are talking about.
Market Demand (sum of individual
demands)
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Each consumer has a different utility and
therefore a different demand curve
Utility is a subjective thing
The market demand for a good or service
can be calculated by adding up all of the
individual demand curves.
A Two-Buyer Market For
Chocolate Bars
Price ($/bar)
12
10
Caspar
*
Louise
*
8
*
6
*
*
4
*
2
0
10 11.5
13
14.5
16
17.5
Q (bars/wk)
Total Demand for Chocolate
Quantity
demanded by
Caspar
Quantity
demanded by
Louise
Plus all other
consumers
Total quantity
demanded
12
1
10
???
550
10
4
11.5
???
600
8
7
13
???
650
6
10
14.5
???
700
4
13
16
???
750
2
16
17.5
???
800
Price
Market Demand for Chocolate Bars
Price ($/bar)
12
10
8
6
4
2
0
*
*
*
*
*
*
550 600 650 700 750 800
Q (bars/wk)
A Change in Quantity Demanded
An increase or decrease in
price is represented by a
movement ALONG the
demand curve. This is called
a change in quantity
demanded. The curve does
NOT shift.
Price
P0
P0
D
Q0
Q1
Quantity
A Change in Demand
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As opposed to a change in quantity
demanded, a change in demand is:
a change in the quantity demanded at all
prices.
Change in Demand
A change in
demand is
represented by a
movement of
the demand
curve.
Price
P
D2
D0
D1
Q1
Q0
Q2
Quantity
A Change in Demand Occurs
When There is:
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A change in income
a change in population
a change in taste
a change in the price of a substitute
a change in the price of a complement
Expectations about future income
Expectations about future prices
Increase in demand
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Change of tastes (+)
Increased income if
normal or luxury
good
Increase in price of
substitute
Decrease in price of
complement
Increase in
population
Decrease in demand
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Change of tastes (-)
Increased income if
inferior good
Decrease in price of
substitute
Increase in price of
complement
Decrease in
population
Substitutes
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Similar goods that
consumers will accept
as a substitute for each
other
Eg two brands of cola
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If price of A increases,
demand for B
increases
If price of A decreases,
demand for B
decreases
Complements
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Goods that are used
together in
consumption activities
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video recorders and
videos
Cars and petrol
If price of A increases,
demand for B
decreases & vice
versa
Increase in the Price of a
Complement
Price
P
D0
D1
Q1
Q0
Quantity
Increase in the Price of a
Substitute
Price
P
D0
Q0
Q1
D1
Quantity
Negative Change in Taste
Price
P
D0
D1
Q1
Q0
Quantity
An example: Demand for VHS tapes
before and after a decrease in the price of
DVDs (a substitute)
Price
5
Qty0
21 18
Qty1
19 16
(‘000/wk)
(‘000/wk)
7
9
11
13
15
17
15 12
9
6
3
13 10
7
4
1
Change in Demand For VHS
Tapes
Price
18
16
14
12
10
D1
8
6
D0
4
2
0
2
4
6
8
10
12
14
16
18
20
Q
Supply
Or, how producers behave
What Determines an Individual
Producer’s Supply of a Good or
Service?
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Price (law of supply)
Input Prices
Technology
Expectations
The ‘Law’ of Supply
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As the price increases, firms are inclined to
increase production
As the price decreases, firms are inclined to
decrease production
Or, in real world terms, if you are offered
more money you might be inclined to produce
more
Therefore, a supply curve slopes upward and
to the right
A Change in Quantity Supplied
Price
S
P1
P0
Q0
Q1
Quantity
Points to Note
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The producers are prepared to sell more at
a higher price and less at a lower price
A change in the quantity supplied is only
related to changes in price
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a change along the curve
A change in supply leads to a shift in the
curve
Increase in Supply
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Decrease in cost of
factors of
production
New technology
Decreased price of
substitutes in
production
Decrease in Supply
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Increase in cost of
factors of production
Increased price of
substitutes in
production
Expecting higher prices
in the future (storage)
A Change in Quantity Supplied
Price
S1
S0
S2
P
Q1
Q0
Q2
Quantity
An example: Supply of novels before and
after a decrease in the cost of paper (an
input)
Price
5
7
9
11
13
15
17
Qty0
2
4
6
8
10
12
14
Qty1
6
8
10
12
14
16
18
(‘000/wk)
(‘000/wk)
A Change in Supply
Price
S0
18
S1
16
14
12
10
8
6
4
2
0
2
4
6
8
10
12
14
16
18
20
Q
Equilibrium
The Intersection of Supply and
Demand
Price Searching
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In a market, consumers are ‘shopping
around’ looking for lower prices
Firms are adjusting prices in an effort to sell
all their product, but get as high a price as
possible
There is tendency towards equilibrium
Let’s Think About Equilibrium…
Equilibrium
Price
All that is produced is consumed
S
P0
D
Q0
Quantity
What Assumptions Are We Making?
At equilibrium there is market clearance
 There is a competitive market with
many buyers and many sellers
 There is no collusion on prices
 Each brand of the particular good is
much like another (homogenous)
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Changes in the Market
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When supply or demand change, the
equilibrium price and/or quantity changes
This is happening all the time
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consumers are ‘price searching’
producers are responding to price searching
In reality markets are never stationary
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there is a tendency towards an equilibrium
price and quantity
A Change in Demand
Price
A new equilibrium price and quantity
S
P1
P0
D1
D0
Q0
Q1
Quantity
A Negative Change in Supply
A new equilibrium price and quantity
Price
S1
S0
P1
What could cause this?
P0
D1
Q1
Q0
Quantity
A Positive Change in Supply
Price
S0
18
S1
16
14
New
Equilibrium
12
10
8
6
D
4
2
0
2
4
6
8
10
12
14
16
18
20
Q
A Negative Change in Supply & A
Positive Change in Demand
Price
NB In this situation price will increase but changes
in quantity cannot be predicted without actual figures
S1
S0
P1
P0
D1
D0
Q1 Q0
Quantity
How Markets
Allocate Resources
A Preliminary Assessment
Markets Allocate Resources By…
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Markets determine who gets the scarce
resources.
Markets also determine who will produce scarce
resources.
Competitive behaviour eventually balances supply
and demand until something disturbs equilibrium.
Remember, no one is determining how much food
to produce. It is all worked out by individuals
acting in their own interests using market prices
as signals.
Let’s Think About the Market for
Hamburgers…
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What Would Happen if:
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The cost of meat increases
There is increased inward migration
There is an outbreak of botulism in hamburger
cafes
The price of chicken burgers decreases
A new chain of hamburger stores opens up
Conclusions
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A market is a process
Markets and market prices play a key role
in allocating resources
There are several determinants of demand
There are several determinants of supply
The intersection of the two curves
represents equilibrium
Equilibrium is really a thing of beauty.
Next Week
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Next week’s lecture:
 Material Covered: Module Two, Part
Two
 Reading: Text Chapter Five, Hakes and
Parry Chapter Five
 Topics: Elasticity
THE END