Chapter 4: Market Forces of Supply and Demand9/17/2012 12:47:00 PM

What is a Market? Group of buyers and sellers of a good or service. Buyers: determine demand of products. Sellers determine supply of products. Producers pay close attention to needs and wants of consumers. Competitive Market: A market that has so many buyers and sellers that each has a negligible impact on market price. 2 Characteristics for Perfectly Competitive Markets: o o 1- The goods offered for sale are all exactly the same. 2- Buyers and sellers are so numerous that no single buyer or seller has any influence over market price. Demand The Demand Curve: Relationship between Price and Quantity Demand Quantity Demand (QD): Amount of good that buyers are willing and can purchase. Law of Demand: Other things equal; Price of good rises=the quantity of demanded of the good falls & vice-versa. Demand Schedule: Table that shows the relationship between the price of a good and the quantity demanded. Demand Curve: Graph showing relationship between quantity demanded and price of the good. Market Demand vs Individual Demand Market Demand: Sum of all the individual demands for a particular good or service. Shifts in the Demand Curve If something happens to alter quantity demand at any price, the demand curve shifts. o o Shifts to the right Increase in Demand & Vice Versa Income: Lower income=Less to spend. o Normal Good: Good for which an increase in income leads to increase in demand. Inferior Good: Good for which an increase in income leads to a decrease in demand. Prices of Related Goods Substitutes: Two goods for which an increase in the price of one leads to an increase in the demand for another similar. Variables that can Shift Demand Curve: Farmers Perfectly Competitive What is a market? What are the characteristics of a perfectly competitive market? What is Competition?

 o o o Supply

Compliments: Increase in the price of one good leads to a decrease in the demand for another. Like PB w/o Jam.

Tastes: If you like something, you buy more of it. Expectations: Expect higher income next month, may choose to spend $$. Number of Buyers: Market demand depends on number of buyers.

The Supply Curve: Relationship between Price and Quantity Supplied: Quantity Supplied (QS): Amount of a good that sellers are willing and able to sell. Law of Supply: Other things equal; Quantity supplied of a good rises=Price of the good rises. Supply Schedule: Table that shows relationship between the price of a good and the quantity supplied. Supply Curve: Graph of the relationship between price of a good and quantity supplied. Shows what happens to quantity supplied of goods when price varies, holding all other variables constant. When variables change, shifts occur. Market Supply vs Individual Supply Market Supply: The sum of the supplies of all sellers. Profitable=Increase quantity produced=Curve shifts right. Variables that can shift the curve: o o o Equilibrium A situation in which the market price has reached the level which QS= QD. Point where supply and demand curves intersect. Price: The price that balances QS and QD. Quantity: QS and QD are at equilibrium price. Surplus: Situation in which QS > QD. Sometimes called excess supply. Shortage: Situation in which QD> QS. Sometimes called excess demand. Law of Supply and Demand: Claim that prices of goods adjust to bring QS & QD for goods into balance. 3 Steps to Analyzing Changes in Equilibrium 1. We decide whether the event shifts the supply curve, demand curve, or both. 2. We decide whether the curve shifts to the right or left. 3. We use the supply-and-demand diagram to compare the initial and new equilibrium, which shows how the shift affects the equilibrium price and quantity. Shifts in Curves vs Movements along Curves Input Prices: Price of input risesProducts less profitable = Less supply. Technology: Advance in TechReduces costs = More supply. # of Sellers Shifts in the Supply Curve:

Supply and Demand Together

o o EXAMPLES!

Shift in supply curve = Change in supply. Shift in demand curve = Change in demand. Movement along supply/demand curve: Change in QS/QD.

--Example-Change in Market Equilibrium due to Shift in Demand: (1) Hot weather changes peoples taste for Ice Cream. (2) Hot weather increases appetite for Ice Cream Curve shifts right due to higher demand and price. (3) Price rises ($2 - $2.50) and quantity changes (7 - 10).

--Example-Change in Market Equilibrium Due to a Shift in Supply : (1) Cost of production of ice cream increases = reduces supply. (2) Supply curve shifts left because total amount that firms are willing and able to sell is reduced. ( 3) Excess demand (shortage) causes price to rise ($2 - $2.50) (7 4 cones).

--Example-Shift in Both: o o o (1) Hot weather increases peoples wants for ice cream at any given price. Reduced supply of ice cream because of sugar price increase. (2) Demand Curve = To the Right. Supply Curve: To the Left. (3) Equilibrium price rises. Two Outcomes: (A) Demand increases substantially while supply slightly falls = Eq. Quantity rises. ( B) Supply falls substantially while demand slightly rises = Eq. Quantity falls. No Change in Supply Increase in Supply P Down / Q Up P Ambig / Up P Down / Q Ambig Decrease in Supply P Up / Q Down P Up / Q Ambig P Ambig / Q Down

No Change in Demand Increase In Demand Decrease in Demand

P Same / Q Same P Up / Q Up P Down / Q Down

In Market Economies, Prices are the mechanism for rationing scarce resources. Prices determine who produces each good and how much is produced. The Price System is the baton that the invisible hand uses to conduct the economic orchestra.

Chapter 7: Consumer and Producer Surplus

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Consumer Surplus Willingness to Pay o Elvis Presley Album: Whoever values the product the most would purchase the album. o Consumer Surplus: Willingness to pay Actual Price of Item. It measures the benefit a buyer receives from participating within a market. Using the Demand Curve to Measure Consumer Surplus o Demand Schedule is the chart of peoples willingness to pay. o The demand curve shows the peoples willingness to pay. o THE AREA BELOW THE DEMAND CRUVE AND ABOVE THE PRICE MESAURES THE CONSUMER SURPLUS IN A MARKET. How a Lower Price Raises Consumer Surplus o If PRICE is lowered, the resulting triangle below the demand curve and above the price is larger, therefore, a lower price results in an increased CS. o Consumer surplus increases after price is lowered because people would buy more of the good and new buyers would want to purchase it at the new price. What Does Consumer Surplus Measure? o Consumer Surplus is a good measure of economic well-being if policymakers want to respect the preferences of buyers. Producer Surplus Cost and the Willingness to Sell o Painting Houses: One must choose the person to do the best job at the lowest price but does the best possible job. o Cost: It is the value of everything the seller must give up to produce a good, like paint brushes and paint. o Producer Surplus: Amount a seller is paid Cost of Production. Benefit sellers receive from the market. Using the Supply Curve to Measure Producer Surplus o The area below the price and above the supply curve measures the producer surplus in a market. How a Higher Price Raises Producer Surplus o If COST is higher, the resulting triangle below the demand curve and above the price is larger, therefore, a lower price results in an increased PS. Market Efficiency The Benevolent Social Planner o Total Surplus = Value to Buyers Cost to Sellers o Efficiency Everyone in society is allocated the resources for the max total surplus. o Equity Property of distributing economic prosperity uniformly throughout. Evaluating the Market Equilibrium

1) Free markets allocate supply of goods to those who value them most highly (willingness to pay). 2) Free markets allocate demand for goods to those who can produce them at the lowest cost. 3) Free markets produce the quantity of goods in which the sum of CS and PS are maximized. Maximizing total surplus is achieved when the supply and demand curves intersect. Conclusion: Market Efficiency and Market Failure Market Failure: the inability of some unregulated markets to allocate resources efficiently. Results in externalities and market power.

Chapter 10: Externalities

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Externalities Paper companies produce a chemical called dioxin during manufacturing. It arises when a person engages in an activity that influences the well-being of a bystander but neither pays nor receives any compensation for that effect. They will continue to emit the dioxin because the firms have no consideration to the amount of pollution they are creating, nor do the people think about it when they are purchasing the product. This continues unless the government intervenes. Externalities and Market Efficiency Negative Externalities o Cost to society > Cost to Aluminum producers because they are ruining the environment and risking peoples well-being. o Social Cost Curve is above the supply curve. o Internalizing the Externality like by applying a tax would make people pay for these harmful effects they are causing society. o PEOPLE RESPOND TO INCENTIVES. Positive Externalities o Education leads to lower crime rates, a better government because people are more informed voters, and they may encourage the development of technological advancements. o Because Social Value > Private Value, the social-value curve lies above the demand curve. Public Policies Toward Externalities Command-and-Control Policies o The EPA dictates a max level of pollution that any factory may emit Market-Based Policy 1: Corrective Taxes and Subsidies. o