Transcript Lecture Week 03 - University of Alberta

Why are markets
important?
In order to reap the benefits from
specialization, trade must be
organized and easy to conduct.
 Markets which are part of a
“market system” facilitate trade.

1
Market System: Characteristics
1.) Markets


Market: any arrangement that enables
buyers and sellers to get information and
do business (trade) with each other.
Markets pool information about buyers’
and sellers’ plans and then summarize this
information in one number:
the price
2
1.) Markets
 Prices:
– Move in response to decisions of buyers
and sellers.
– Send signals to buyers & sellers i.e.,
provide information and incentives to
buyers and sellers.

Function as the rationing device
– Money serves as a medium of exchange,
eliminating the need for barter
3
1.) Markets

Invisible Hand
– In markets, buyers & sellers act in their
own self interest responding to the
incentives provided by changing prices.
– Self interested behaviour becomes
cooperative action resulting in good
solutions for individuals & for society as a
whole to the what, how, for whom
questions
4
Market System: Circular Flow

Decision Makers:
– Buyers & Sellers/Households & Firms
 key
players in the market system.
– Govt. is also an important decision makerto be added later

Markets:
– Two kinds of markets make up the
“market system”:
–Goods Markets &
–Resource Markets
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Revenue
Spending
Goods Market
Firms Sell
Goods &
HH Buy Goods &
services
services
sold
bought
Firms
Households
make & sell
buy & consume
goods & services
goods & services
hire factors of
sell factors of
production
production
Land, Labour
Production
and Capital
Inputs
Factor Market
HH Sell
Firms Buy
Wages, Profits,
Income
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and rent
Market System: Decision Makers:
 1.)
Households
– Buyers – consumers/demanders of final goods &
services
– Sellers – owners/suppliers of scarce resources
(factors of production)
 Rational
decision makers in
–1. spending income (buying) &
–2. allocating/supplying their resources
(selling)
7
Market System: Decision Makers:
 2.)
Firms/Producers
– Sellers/suppliers of goods and services
– Buyers/demanders of resources
 Rational
decision makers in
–1. Production/selling decisions
–2. Hiring/buying resources
8
Market System: Markets

The 2 kinds of markets in which households &
firms meet are:
– 1. Markets for Goods & Services


households demand/buy
firms supply/sell
– 2. Markets for Factors of Production
(resources/inputs)
households supply/sell
 firms demand/buy

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Three Basic Economic Questions
1)
WHAT and how much will be
produced?
2)
HOW will it be produced?
3)
For WHOM will it be produced?
Pure Command Economy
An economic system characterized by
public ownership of all property
resources
3 economic questions answered by a
central government
Pure Capitalist Economy
An economic system characterized by
private ownership of all property
resources
3 economic questions answered by
household and firm interaction
Canada – A Mixed Economy
Property resources are owned privately
and publicly
Decisions are made by the private
sector and the government
Ie) Cost of a pizza – private decision
Ie) Taxes and social assistance –
government decision
Ie) Tuition – mixed decision
Demand & Supply

Markets for Goods & Services
– All the important factors affecting
market exchange & therefore
market price, can be divided into 2
categories:
 those affecting demand and
 those affecting supply.
14
Demand: Definition

A schedule showing amounts of a
product that consumers are willing
and able to purchase at each
specific price during some
specified time period: everything
else held constant.
15
The Law of Demand

There is an inverse relationship
between the quantity of anything
that people will want to purchase
and the price they must pay to
obtain it:
ceteris



paribus
This causes demand curves to be
downward sloping
When prices increase, people buy less
When prices decrease, people buy more
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The Individual’s Demand Schedule
A
B
C
D
E
5.00
4.00
3.00
2.00
1.00
5
Qn/yr
20
30
40
60
50
Price of CD-R ($)
Price/Unit
$
A
B
4
C
3
2 Change in Price
Movement along
1 the Demand
0
10
20
30
D
E
40
Number of CD-R’s per Year
50
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Movement Along Demand/
Changes in Quantity Demanded

A change in a good’s own price
change in quantity
demanded
– the same thing as a movement along
– results in a
the same demand curve.
18
A Shift in the Demand
Suppose universities
Curve
outlaw the
use of
personal computers
Decrease
in Demand
Price of CD-R’s ($)
5
Suppose the federal
government gives
every student a personal
computer.
4
3
Increase
in Demand
2
1
0
D3
20
40
60
D1
D2
80 100 120 140
Quantity of CD-R’s Demanded
(millions of constant-quality units per year)
19
Shifts/Changes in
Demand*
 A change in one or more of the nonprice determinants of demand
(income, tastes, etc)
change in demand *
– also called a shift in demand*
– results in a
*The whole demand schedule
20
“Everything Else” :
The “Determinants”/ “Shifters”
of “Demand”

Factors other than Price
which affect “Demand” :
1) Income, wealth
 2) Tastes and
preferences
 3) The price of related
goods
– Complements
– Substitutes

4) Expectations
– Future prices
– Income
– Product availability
 5) Population (market size)

What movement would these factors
cause?
21
Compliments and Substitutes
 Compliment:
a good that is consumed
WITH another good
– Ie: Ketchup and hot dogs
– Demand for good A DECREASES when the
price of a compliment increases
 Substitute:
a good that is consumed IN
PLACE OF another good
– Ie: Hamburgers and hot dogs
– Demand for good A INCREASES when the
price of a substitute increases
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Review of Demand Terminology
 Demand:
a schedule of quantities that
will be bought/unit of time, at various
prices, ceteris paribus.
 Quantity
Demanded: a specific amount
that will be demanded /unit of time at a
specific price, ceteris paribus.

Distinguish between a change in the
Quantity Demanded and a shift in
Demand.
23
A policy to discourage
smoking (no smoking in
public buildings) shifts
the demand curve left
Price of Cigarettes, per pack
Price of Cigarettes, per pack
Shift vrs. Movement
$2
D’
10
A tax raises the price of
cigarettes, resulting in a
movement along the
demand curve
$4
$2
D
D
20
Number of Cigarettes
smoked per day
10
20
Number of Cigarettes
smoked per day
24
Normal vrs. Inferior Goods
For inferior goods,
Demand increases
When income decrease
Price of Kraft Dinner
Price of Chicken
For normal goods,
Demand decreases
With income
$2
D’
10
$2
D’
D
20
Chicken eaten in a month
D
10
20
30
Kraft Dinner eaten
in a month
25
Supply: Profit

The Cost side of the profit equation
depends on the Costs of Production
which depend on
 the kinds of inputs used
 the amount of each input used
 prices of inputs used
 technology
26
Supply: Definition

A schedule that shows how
much of a product a firm will
supply at alternative prices for a
given time period “ceteris
paribus”.
27
The Law of Supply
• The price of a product or service and
the quantity supplied are directly
related: “ceteris paribus”
• Causes an upward sloping supply curve
• The higher the price of a good, the more
sellers will make available
• The lower the price of a good, the fewer
sellers will make available
• All else being equal
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The Individual Producer’s Supply
Schedule
Qnty of
F
$5
550
G
4
400
H
3
350
I
2
250
J
1
200
5
Price of CD-R ($)
Price /
CD-R
CD-R
Supplied
(thousands /
year)
F
G
4
H
3
I
2
1
J
Change in Price
Movement along
The Supply
0 100 200 300400500 600
Quantity of CD-R Supplied
(thousands of constant-quality units
per year)
29
Movement Along Supply/
Changes in Quantity Supplied
– A change in a good’s own price
change in quantity supplied.
 that is, a movement along the supply curve.

leads to a
30
A Shift in the Supply Curve
When supply decreases
the quantity supplied
will be less at each price: eg, employees form a
union and successfully negotiate higher wages.
Price of CD-R ($)
5
S2
a
b
4
3
b
c
d
S2
S1
d
2
1
0
20
40
60
When supply increases
the quantity supplied
will be greater at each
price: eg, producer
finds that she can use
some cheaper materials
due to a technology
change.
80 100 120 140
Quantity of CD-R Supplied
(millions of constant-quality units per year)
31
Shifts/Changes in
Supply

A change in one or more of the
non-price determinants of supply
leads to a
– change in supply which is the
same thing as a
– shift of the supply curve.
32
“Everything Else” : The
“Determinants”/“Shifters” of Supply
 Factors
Supply
other than Price that affect
– 1) Cost of inputs (price in factor markets)
– 2) Technology and Productivity
– 3) Taxes and Subsidies
– 4) Price Expectations (in the product market)
– 5) Number of firms in the industry
How will these shift
supply?
33
Market Equilibrium Price & Quantity
 Market:
where prices tend toward
equality through the continuous
interaction of buyers and sellers: the
market forces of demand and supply
34
Market Equilibrium Price & Quantity
Perfectly Competitive Market



Buyers & sellers numerous enough that no
single buyer/seller can influence the price
Buyers & sellers are free to enter or exit the
market at any time
Each party to the market exchange has full
information
Single Equilibrium Price
35
Putting Demand and Supply Together:
Finding Market Equilibrium
(1)
(2)
(3)
Price per
Constant-Quality
CD-R
Quantity Supplied
(CD-R
per year)
Quantity Demanded
(CD-R
per year)
(4)
Difference
(2) - (3)
(CD-R
per year)
(5)
Condition
$5
100 million
20 million
80 million
Excess quantity
supplied (surplus)
4
80 million
40 million
40 million
Excess quantity
supplied (surplus)
3
60 million
60 million
0
2
40 million
80 million
-40 million
Excess quantity
demanded (shortage)
1
20 million
100 million
-80 million
Excess quantity
demanded (shortage)
36
Market Equilibrium: Definition
The condition in a
S
market when
quantity supplied
equals quantity
demanded at a
QD= QS
particular price; a
point from where
there tends to be
B
no movement
Excess quantity supplied at price $5
Price per CD-R ($)
5
4
Market clearing, or
equilibrium, price
3
E
2
A
1
Excess quantity demanded at price $1
0
20
40
60
80
D
100
Quantity of CD-R
(millions of constant-quality units per year)
37
The Law of Supply &
Demand

The expression used to describe the fact
that the price of any good will adjust until
the price is such that the quantity
demanded is equal to the quantity
supplied, and
 the
market clears resulting in a single
market clearing or equilibrium price.
38
Adjustment Example: Gas
Prices
Summer: Gas prices at equilibrium at
$1.07 per liter
 Winter arrives and certain drivers limit or
end their driving for the season (shift in
demand)

 The
liter
new market equilibrium is $0.70 per
39
The Price System/Market System
 The equilibrium price rations the limited
amount of a good produced by the most
willing and able suppliers, or sellers, to
the most willing and able demanders or
buyers.
– Prices signal what is relatively scarce and
relatively abundant
– Prices provide information and incentives
–Prices ration
40
Changes in Market Equilibrium: Shifts
in Demand &/or Supply
•Suppose something in the demand &/or
the supply ceteris paribus envelope(s)
changes.
•How is the MARKET affected?
– 1.) Decide whether Demand &/or Supply is
affected.
– 2.) Decide in which direction the affected
Demand &/or Supply will move.
– 3.) Use a Demand and Supply diagram to
determine the new equilibrium.
41