Transcript Review of Basics

Extra Slides for Review
(Slides 1-30)
1. Demand
1
Tony’s Demand Schedule & Curve
Price
of
coffee
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
Price of
Coffee
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
5
10
Quantity
of coffee
demanded
16
14
12
10
8
6
4
Quantity
15 of Coffee
2
Market Demand versus Individual Demand
• The quantity demanded in the market is the sum of the
quantities demanded by all buyers at each price.
• Suppose Tony and Dani are the only two buyers in the coffee
market. (Qd = quantity demanded)
Price
Tony’s Qd
Dani’s Qd
$0.00
16
+
8
=
24
1.00
14
+
7
=
21
2.00
12
+
6
=
18
3.00
10
+
5
=
15
4.00
8
+
4
=
12
5.00
6
+
3
=
9
6.00
4
+
2
=
6
Market Qd
3
The Market Demand Curve for Coffee
P
Qd
(Market)
$0.00
24
$5.00
1.00
21
$4.00
2.00
18
3.00
15
4.00
12
5.00
9
6.00
6
P
$6.00
$3.00
$2.00
$1.00
$0.00
Q
0
5
10
15
20
25
4
Willingness to Pay (WTP)
A buyer’s willingness to pay for a good is the maximum
amount the buyer will pay for that good.
WTP measures how much the buyer values the good.
name
Flea
WTP
Example:
4 buyers’ WTP for an iPod
$300
Anthony
250
Chad
175
John
125
5
WTP and the Demand Curve
Q: If price of iPod is $200, who will buy an iPod, and
what is quantity demanded?
A: Flea & Anthony will buy an iPod,
Chad & John will not.
name
Flea
WTP
$300
Anthony
250
Chad
175
John
125
Hence, Qd = __
when P = $200.
6
WTP and the Demand Curve
Derive the
demand
schedule:
name
Flea
who buys
Qd
$301 & up nobody
0
WTP
251 – 300 Flea
1
$300
176 – 250 Anthony, Flea
2
Chad, Anthony,
126 – 175
Flea
3
John, Chad,
0 – 125
Anthony, Flea
4
Anthony
250
Chad
175
John
P (price
of iPod)
125
7
WTP and the Demand Curve
P
$350
$300
Qd=0
P
Qd
$301 & up
0
251 – 300
1
176 – 250
2
126 – 175
3
0 – 125
4
Qd=1
$250
$200
Qd=2
$175
Qd=3
$150
$125
$100
$50
Qd=4
$0
Q
0
1
2
3
4
8
About the Staircase Shape…
P
This D curve looks like a staircase
with 4 steps.
$350
$300
If there were a huge # of buyers,
as in a competitive market,
$250
$200
there would be a huge #
of very tiny steps,
$150
and it would look
more like a smooth
curve.
$100
$50
$0
Q
0
1
2
3
4
9
Shifts of D Curve
• Economic variables held constant when
specifying demand include income, wealth,
prices of related goods, preferences, price
expectations, the number of buyers…
• If one of the above variables change, the
demand curve will shift.
10
Suppose the number
of buyers increases.
Then, at each price,
quantity demanded
will increase
(by 5 in this example).
D curve shifts to the
right.
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
Q
$0.00
0
5
10
15
20
25
30
11
2. Supply
12
Starbucks’ Supply Schedule & Curve
Price
of
coffee
$0.00
1.00
2.00
3.00
4.00
5.00
6.00
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Quantity
of coffee
supplied
0
3
6
9
12
15
18
Q
0
5
10
15
13
Market Supply versus Individual Supply
• The quantity supplied in the market is the sum of the
quantities supplied by all sellers at each price.
• Suppose Starbucks and Jitters are the only two sellers
in this market. (Qs = quantity supplied)
Market Qs
Price
Starbucks
Jitters
$0.00
0
+
0
=
0
1.00
3
+
2
=
5
2.00
6
+
4
=
10
3.00
9
+
6
=
15
4.00
12
+
8
=
20
5.00
15
+
10
=
25
6.00
18
+
12
=
30
14
The Market Supply Curve
P
QS
(Market)
$0.00
0
1.00
5
2.00
10
$4.00
3.00
15
$3.00
4.00
20
$2.00
5.00
25
6.00
30
P
$6.00
$5.00
$1.00
Q
$0.00
0
5
10 15
20 25 30
35
15
Cost and the Supply Curve
• Cost is the value of everything a seller must give up to
produce a good (i.e., opportunity cost).
• Includes cost of all resources used to produce good,
including value of the seller’s time.
• Example: Costs of 3 sellers in the lawn-cutting
business.
A
seller
will
only
produce
and
name cost
sell the good if the price
Angelo
$10
exceeds his/her cost.
Hunter
20
Hence, cost is a measure of
Kitty
35
willingness to sell.
16
Cost and the Supply Curve
Derive the supply schedule
from the cost data:
name
P
Qs
$0 – 9
0
10 – 19
1
20 – 34
2
35 & up
3
cost
Angelo
$10
Hunter
20
Kitty
35
17
Cost and the Supply Curve
P
$40
$35
$30
$20
$10
$0
P
Qs
$0 – 9
0
10 – 19
1
20 – 34
2
35 & up
3
Q
0
1
2
3
18
Shifts of S Curve
• Economic variables held constant when
deriving a supply curve include production
technology, input prices, taxes and subsidies,
and price expectations
19
Example: input prices
• Examples of inputs:
for coffee: milk, sugar, coffee machines,
buildings…
• A fall in input prices makes production
more profitable at each output price,
so firms supply a larger quantity at each price,
and the S curve shifts to the right.
20
Example: input prices
Suppose the
price of milk falls.
At each price,
the quantity of
coffee supplied
will increase
(by 5 in this
example).
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
Q
$0.00
0
5
10 15
20 25 30
35
21
3. Welfare Measures
22
(1) Consumer Surplus (CS)
Consumer surplus is the amount a buyer is willing to
pay minus the buyer actually pays.
name
Flea
WTP
Suppose P = $260.
$300
Flea’s CS = $300 – 260 = $__.
Anthony
250
Chad
175
The others get no CS because they
do not buy an iPod at this price.
John
125
Total CS = $___.
23
CS and the Demand Curve
P
P = $260
Flea’s WTP
$350
$300
Flea’s CS =
$300 – 260 = ___
$250
$200
Total CS = ___
$150
$100
$50
$0
Q
0
1
2
3
4
24
CS and the Demand Curve
P
Flea’s WTP
$350
$300
Anthony’s WTP
Instead, suppose
P = $220
Flea’s CS =
$250
$200
$300 – 220 = ___
$150
$250 – 220 = ___
$100
$50
Total CS = ____
Anthony’s CS =
$0
Q
0
1
2
3
4
25
CS and the Demand Curve
P
The lesson:
Total CS equals
the area below
the demand curve
& above the price.
$350
$300
$250
$200
$150
$100
$50
$0
Q
0
1
2
3
4
26
CS with Lots of Buyers & a Smooth D Curve
Price per pair
Q: P = $30, CS=?
P
The Demand for Shoes
$ 60
50
A: CS is the area
h
below the D curve
40
and above the P.
30
Recall: area of
20
a triangle equals
10
½ x base x height
0
So, CS=½ x 15 x $30
= _____
1000s of pairs
of shoes
D
Q
0
5 10 15 20 25 30
27
(2) Producer Surplus
P
$40
Producer surplus (PS):
the amount a seller
is paid for a good
minus the seller’s cost.
$30
$20
$10
$0
Q
0
1
2
3
28
Producer Surplus and the S Curve
P
Suppose P = $25
$40
Kitty’s
cost
$30
$25
$20
Hunter’s
cost
$10
Angelo’s cost
$0
Q
0
1
2
3
Angelo’s PS = ___
Hunter’s PS = ___
Total PS = ____
Total PS equals the area
below the price and
above the supply curve.
29
PS with Lots of Sellers & a Smooth S Curve
Price per pair
Q: P=$40, PS=?
A: PS is the area below
the P and above the S
curve.
The height of this
triangle is
$40 – 15 = $25.
P
The supply of shoes
60
S
50
40
30
h
20
So,PS= _____________
= $312.5
$15
1000s of pairs
of shoes
10
Q
0
0
5 10 15 20 25 30
30
Chapter 2
Modeling the Market Process:
A Review of the Basics
31
1. Market Models: Fundamentals
• Defining the Relevant Market
– A market: the interaction between _________ &
___________ to exchange a well-defined
commodity
– Defining the market context is one of critical steps
in economic analysis
• Specifying the Market Model
– Qualitative and quantitative relationship
32
2. Supply and Demand: An Overview
• Primary objective of the supply and demand
model is to facilitate an analysis of market
conditions and any observed change in price
• Sellers’ decisions are modeled through a
_______ function and buyers’ decisions are
modeled through a _______ function
33
Competitive Market for Private Goods
• Private goods are commodities that have two
characteristics: excludable and rival in
consumption
• A competitive market is characterized by:
– A large number of buyers and sellers with no control
over price
– The product is homogenous or standardized
– The absence of entry barriers
– Perfect information
34
Important Characteristics of Goods
• A good is excludable if a person can be prevented from
using it if he does not pay for it.
– excludable: fish tacos
– not excludable: national defense
• A good is rival in consumption if one person’s
use/consumption of it diminishes others’ use/consumption.
– rival: fish tacos
– not rival: national defense
35
Classic division of
goods in economy
Excludable
(have to pay)
Not excludable
Rival in consumption
(consumption
diminishes its value)
Not rival
private goods:
food
clothing
natural monopolies
(club goods):
cable TV
common resources:
fish in the sea
public goods:
national defense
tornado siren
36
3. Demand
• Demand refers to the quantities of a good the
consumer is willing and able to buy at a set of prices
during some time period, ceteris paribus (c.p.)
– The willingness to pay (WTP), or demand price,
measures the marginal benefit (MB) from consuming
another unit of the good
• Law of Demand says there is an _________ relationship
between price (P) and quantity demanded of a good
(qd), c.p.
37
• Market demand captures the decisions of all
consumers willing and able to purchase a
good
– For a private good, market demand is found by
horizontally summing individual demands
38
Market Demand
Bottled Water
Price
(P)
$11.50
P = –0.01QD + 11.5
D
1,150
Quantity
(QD)
39
4. Supply
• Supply refers to the quantities of a good the
producer is willing and able to bring to market
at a given set of prices during some time
period, c.p.
• Law of Supply – there is a direct relationship
between price (P) and quantity supplied (qs) of
a good, c.p.
– Rising marginal cost (MC) supports this positive
relationship (willingness to sell should cover MC)
40
• Market Supply captures the combined decisions
of all producers in a given industry
– Derived by horizontally summing the individual
supply functions
41
Market Supply
Bottled Water
Price
(P)
S
P = 0.0025QS + 0.25
0.25
Quantity
(QS)
42
5. Market Equilibrium
• Supply and demand together determine a unique
equilibrium price (PE) and equilibrium quantity (QE),
at which point there is no tendency for change
– PE occurs where ____________
• Model for bottled water
– D:
P = –0.01QD + 11.5
– S:
P = 0.0025QS + 0.25
– Equilibrium found where
–0.01QD + 11.5 = 0.0025QS + 0.25, or
where QE = 900 and PE = _________
43
Market Equilibrium
Bottled Water
Price
11.50
PE
S
2.50
0.25
D
900
QE
Quantity
44
Market Adjustment to Equilibrium
FYI
• Disequilibrium occurs if the prevailing market price is at
some level other than the equilibrium level
– If actual price is below its equilibrium level, there
will be a shortage
• Shortage = excess demand = QD – QS
– If actual price is above its equilibrium level, there
will be a surplus
• Surplus = excess supply = QS – QD
• Price movements serve as a signal that a shortage or
surplus exists, whereas price stability suggests
equilibrium
45
6. Efficiency Criteria
(1) Allocative Efficiency
• At the market level, allocative efficiency requires that
resources be appropriated such that additional
benefits to society are equal to additional costs
incurred, i.e., _____________
– The value society places on the good is equivalent
to the value of the resources given up to produce it
• At the firm level, this efficiency is achieved at a
competitive market equilibrium, assuming firms are
_________________________
46
Profit Maximization
FYI
• Total Profit () = Total Revenue (TR) - Total Costs (TC)
– TR = P x Q
– TC is all economic costs, explicit and implicit
• Profit is maximized where TR/Q = TC/Q, or where
________________
• MR = TR/Q, additional revenue from producing
another unit of Q
• MC = TC/Q, additional cost from producing
another unit of Q
47
Profit Maximization
FYI
• In competitive industries, firms face constant
prices determined by the market, which
means P = MR
• Therefore the competitive market
equilibrium achieves allocative efficiency
because:
–  maximization requires: MR = MC
– Competitive markets imply: P = MR
– So  maximization in competition means: P = MC,
which defines allocative efficiency
48
FYI
Profit Maximization
Bottled Water
$
MC
P = MR
2.50
0.25
qE = 36
Quantity
49
(2) Technical Efficiency
• Technical Efficiency refers to production decisions that
generate _____________________given some stock of
resources
• Market forces can achieve technical efficiency so long
as competitive conditions prevail
– Competitive firms must minimize costs to remain
viable in the market because they cannot raise price
to cover the added cost of inefficient production
50
7. Welfare Measures
(1) Consumer Surplus (CS)
• Consumer surplus is the net benefit to buyers
estimated by the excess of marginal benefit
(MB) of consumption over market price (P),
aggregated over all units purchased
• Graphically measured as the triangular area
above the price and below the demand curve
up to the quantity sold
51
Consumer Surplus
Bottled Water Market
CS = ___________________________
= ____________
= $11.49 – $2.50
52
(2) Producer Surplus (PS)
• Producer surplus is the net gain to sellers of a
good estimated by the excess of the market
price (P) over marginal cost (MC), aggregated
over all units sold
• Graphically measured as the triangular area
above the MC curve up to the price level over
all units sold
53
Producer Surplus
Bottled Water Market
PS = ____________________________
= _____________
54
(3) Deadweight Loss (DWL)
• Society’s welfare can be captured through the
sum of CS and PS
• Comparing these measures before and after a
market disturbance helps quantify how society
is affected by that disturbance through
Deadweight Loss (DWL)
• DWL is the net loss of consumer and producer
surplus due to an allocatively inefficient market
event
55
DWL of Price Regulated above PE
Bottled Water
Policy forces price to $6.50
DWL = (C + E)
= ____________________________________
=_____________
56
• Refer to slide 46:
Greg Mankiw, Principles of Economics, Ch7—
An allocation of resources is efficient if it
maximizes total surplus. The market
equilibrium is efficient.
57