OUTLINE -- CHAPTER 3
Understanding Individual Markets: Demand and Supply
Lectures

Real World Examples

Why Study Supply and Demand ?

Structural Adjustment Policies

1. Privatization
2. Promotion of Competition
3. Limited and Reoriented Role for Government
4. Price Reform: Removing Controls
5. Joining the World Economy
6. Macroeconomic Stability

WHY are countries removing price controls??

• Why do more and more countries allow the market to set prices rather than the government?
• From what we know about the 5 Es of economics, why are we studying PRICES?

 

• Prices are important to achieve which of the Es?

Pure Capitalism and the Market System: The Market and the 5 Es Characteristics of a Market Economy (Capitalism) A. private property B. markets and prices C. role of self interest: incentives D. freedom of enterprise and choice E. competition 1. large numbers 2. free entry and exit 3. produce standardized products F. limited role for government The Market and the 5Es 1. Economic Growth Capitalist economies tend to have more rapid rates of growth 2. Allocative Efficiency: Producing what consumers want a. Capitalism and incentives (1) more profits = produce more (2) losses = produce less (3) consumer sovereignty and "dollar votes" b. The PRICE mechanism of capitalism helps it to achieve allocative efficiency and avoid shortages and surpluses 3. Productive Efficiency: Producing at a minimum cost a. Capitalism and incentives (1) profits = total revenues - total cost (2) minimizing costs means more profits b. The "correct" PRICE of resources is necessary to achieve productive efficiency. The price mechanism of capitalism helps it to achieve productive efficiency. 4. Equity There is no characteristic of capitalism which will guarantee equity Often, the government gets involved to help achieve equity 5. Full Employment Economists disagree over whether capitalism will result in full employment Some say yes, and if there is unemployment it is usually caused by government interference Some say no, and at times government involvement is needed to move the economy towards full employment

 

• Why Study Supply and Demand (more) ?

• Textbook: Two functions of prices:
  • guide resources
  • ration goods and services
  • EXAMPLE: Plywood after a hurricane

   

• Five Fundamental Questions (Chapter 2)
  1. What will be produced?
  2. How will goods and services be produced?
  3. Who will get the output?
  4. How will the system accommodate change?
  5. How will the system promote progress?

Preview:

• If the price of pizza increase, what happens to the demand for pizza?
• If the price of plywood increases what happens to the supply of plywood?

I. Demand

A. Definition

1. a schedule
2. various quantities
3. willing and able
4. various prices
5. given time period
6. ceteris paribus
7. demand is NOT how much we buy

B. Demand Schedule and Curve [sdtabblk.gif] [sdpoint.gif] [sdline.gif]
C. Law of Demand

1. there is an inverse relationship between price and quantity demanded
2. why?

a. common sense
b. diminishing marginal utility
c. income effect
d. substitution effect

D. Market Demand

1. definition
2. graphically (fig. 3-2)

E. Determinants of Demand (VODKA)

1. the price of the product
2. the non-price determinants of demand

IV. Two Kinds of Changes Involving Demand

A. Change in Quantity Demanded

1. caused ONLY by a change in the PRICE of the product
2. a movement ALONG a SINGLE demand curve

B. Change in Demand

1. shifting the demand curve / a new demand schedule

a. an increase in demand
b. a decrease in demand

2. caused by a CHANGE in the non-price determinants of demand

a. Pe -- expected price
b. Pog -- price of other goods

1) substitute goods
2) complementary goods
3) independent goods

c. I -- income

1) normal goods
2) inferior goods

d. N -- number of POTENTIAL consumers

1) population change
2) expanded marketing area
3) new competitor
(changes individual demand curve but NOT market demand curve)
4) change in eligible consumers (i.e. drinking age)

e. T -- tastes and preferences

3b Supply

II. Supply

A. Definition

1. a schedule
2. various quantities
3. willing and able
4. various prices
5. given time period
6. ceteris paribus
7. supply is NOT the quantity available for sale

B. Supply Schedule and Curve sssupply.gif sdspnt.gif sdsline.gif
C. Law of Supply

1. there is a direct relationship between price and quantity supplied
2. why?

a. common sense
b. increasing costs because some resources are fixed
c. increasing costs because not all resources are identical

D. Market Supply
E. Determinants of Supply

1. the price of the product
2. the non-price determinants of supply

V. Two Kinds of Changes Involving Supply

A. Change in Quantity Supplied schgqs.gif

1. caused ONLY by a change in the PRICE of the product
2. a movement ALONG a SINGLE supply curve

B. Change in Supply slineinc.gif

1. shifting the supply curve / a new supply schedule

a. an increase in supply
b. a decrease in supply

2. caused by a CHANGE in the non-price determinants of supply

a. Pe -- expected price
b. Pog -- price of other goods ALSO PRODUCED BY THE FIRM
c. Pres -- price of resources
d. T --technology
e. T --taxes and subsidies
f. N -- number of sellers

 

3c Market Equilibrium

III. Market Equilibrium -- Equilibrium Price and Quantity

A. Market Equilibrium

1. define equilibrium
2. find market equilibrium sdequil.gif

B. Market Disequilibrium

1. surpluses
2. shortages

VI. Changes in Demand AND Supply

A. S increases, D decreases

B. S decreases, D increases SDdisd.gif

C. S increases, D increases SDdisi.gif

D. S decreases, D decreases

REVIEW

VII. Supply and Demand in a Command Economy

A. Demand - still downward sloping

B. Supply

1. set by the government
2. not related to price

C. Graph

VIII. YELLOW PAGES: Using the Supply and Demand Tool

A. Question: What happens to price and QUANTITY?

B. Before you guess, answer the following questions:

(1) Which determinant has changed?

(2) Will it affect supply or demand?

(3) Will supply or demand increase or decrease?

(4) GRAPH IT! What happens to price and quantity?

IX. Examples / Review

• ONLINE REVIEW EXERCISE
• http://money.cnn.com/2003/02/10/pf/saving/oil_and_you/index.htm
• http://cnn.com/US/9907/27/gas.prices/
• http://cnnfn.com/2000/01/21/companies/airfuel/
• http://cnn.com/US/9908/09/rv.boom/
• [Determin] or [determinsm]

The Market System and Efficiency See: The supply and demand model and allocative efficiency A. . REVIEW: The Market System and Efficiency See: The supply and demand model and allocative efficiency 1. WHAT WE GET: a. Goal of businesses: Maximize Profits b. Therefore,they will produce where: the Market Equilibrium quantity the quantity where Qs=Qd the is "what we get"   Graphically: c. Assumptions: pure capitalism (see: chapter 2) 2. WHAT WE WANT: ALLOCATIVE EFFICIENCY a.. Review : (1) Allocative Efficiency definition - using our limited resources to produce: The quantity of goods and services that maximizes society's satisfaction using resources to produce more CDs that people want and fewer cassette tapes that they don't want no shortages and no surpluses (2) Benefit-Cost Analysis definition - the selection of ALL possible alternatives where the marginal benefits are greater than the marginal cost select all where: MB > MC up to where: MB = MC but never where: MB < MC B. Allocative Efficiency is achieved where: 1. MSB=MSC a. define Marginal Social Benefits (MSB) b. define Marginal Social Costs (MSC) c. therefore if society gets all quantities where: MSB > MSC up to where: MSB = MSC but never where: MSB < MSC this will be the quantity where society's Satisfaction will be maximized or the allocatively efficient quantity 2. Graphically:   C. THEREFORE: 1. Businesses will produce the profit maximizing or market equilibrium quantity - the quantity where Qd=Qs 2. Society wants the allocatively efficient quantity - the quantity where MSB=MSC 3. WHAT WE GET = WHAT WE WANT if: b. Market Demand = Marginal Social Benefits (D=MSB) 1. law of diminishing marginal utility 2. assuming no spillover benefits D=MSB c. Market Supply = Marginal Social Costs (S=MSC) 1. law of increasing costs 2. assuming no spillover costs S=MSC D. Competitive Markets and Allocative Efficiency (MSB=MSC) 1. if there are no spillover costs, then S = MSC, 2. if there are no spillover benefits, then D = MSB, 3. Graphically: 4. Then: WHAT WE GET = WHAT WE WANT and market economies achieve allocative efficiency   In a market economy with no spillover benefits and no spillover costs: the profit maximizing or market equilibrium quantity (what we get) WILL BE THE SAME AS the allocative efficient quantity (what we want)