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# Chapter 4 Microeconomics

9/19/2013 5:42:00 AM

Market:
A group of buyers and sellers of a particular good or service
Can be highly organized – New York Stock Exchange
Can be less organized – market for ice cream
 The basic competitive model builds on 3 assumptions: rational
consumers, profit-maximizing firms, and competitive markets.
These assumptions determine how consumers behave, how firms
behave, and how the market mediates their interactions.
 Government is ignored in the basic model in order to isolate private
decision making (the model ignores the government because we
need to see how an economy functions without input from the
government).
 Economists label this case perfect competition.
 Assume there are many firms selling “equivalent products” to many
consumers (what the consumers consider to be interchangeable)
Competitive Market:
Each has a negligible impact on market price
 Assume there is a “going price” or (“market price”)

If a firm charged any more than the going price then it would lose all its
sales
Next: a model with the highest (that is, the most intense) form of
competition
 In the perfect competition each firm is a price taker, which simply means
because it cannot influence the market price, it must accept that price
 Firms in competitive markets all charge the same price
Monopoly:
The only seller in the market
Sets the price
There are other types of markets
Between perfect competition and monopoly
Our model of a perfect competitive market has two types of decision maker:
Demand:

and population Economist often treat price as the most important determinant of the level of demand Individual Demand: Demand curve: gives the quantity demanded at each price while everything else is held constant A demand curve usually slopes downward from left to right When the price of a good increases the demand for that good usually  decreases when everything else is held constant Individual demand curves usually have a negative slope It has a negative slope because people usually tend to buy more of a good if it is less expensive Demand curve: a curve which shows the quantity demanded at each price 2 market demand curves usually have negative slopes As you increase the price people stop buying so you get this negative slope Suppose Q = 24 – 3P + V  When V = 0 Q = 24 – 3P      . social trends.     Describes how the amount or quantity of goods and services bought can change with changes in a number of variables like income.

the surpluses and shortages are temporary Law of Supply and Demand        The claim that the price of a good adjusts to bring the quantity supplied and the quantity demanded into balance Demand curve: Q^D = 500 -.Equilibrium           9/19/2013 5:42:00 AM Definition of equilibrium: a situation in which various forces are in balance Definition of a market’s equilibrium: a situation in which the market price has reached a level where the quantity supplied equals the quantity demanded At a market’s equilibrium.5P = 200 + 1P Solve for P: 600 = 1..5P Supply Curve: Q^s = -200 + 1P Set Q^D = Q^S 400 . economists say that market “clears” A shortage means that people who are willing to pay the going price cannot find the good There are instances when the market does not clear but rather suffers a shortage or surplus A surplus means that goods go unsold at the going price     Sellers compete to “move the merchandise” Consumers compete to get a “bargain” If you have a surplus the price will usually go down If you have a shortage they have an incentive to increase the price because consumers are willing to pay more for a good  The rate of adjustment depends on the kind of market as well as the size of surplus  In most free markets.5P P=400 Solve for Q: Q = 400-200 Q=200 . supply and demand are in balance(in that the quantity of the good that buyers are willing to and able to buy exactly balances the quantity that sellers are willing and able to sell Put the demand and supply curves together on the same graph Equilibrium is simply where they intersect The equilibrium price and quantity as the intersection of market demand and market supply When the price is such that quantity demanded equals quantity supplied.

and how the intersection determines the equilibrium price  Change in demand: a shift in the demand curve that occurs when a nonprice determinant of demand changes (ex: income)  Changes in the quantity demanded: a movement along a fixed demand curve for a good that occurs when the price of that good changes          Example where demand can shift from a change in income (Y): Q^D = 200 – 2P + 1/2Y Q^S = 3P – 100 Find Equilibrium P and Q when Y = 0 Q^D = Q^S 200 – 2P = 3P – 100 Solve for P: 300 = 5P P=60 Solve for Q: Q = 200 – 2(60) Q= 80 Find equilibrium P and Q when Y = 20  Increase in supply: the equilibrium price will fall and the equilibrium quantity will rise Increase in demand: equilibrium price rises. before 3 we had 4) Market for Hybrid Cars Increase in price of gas: demand shifts right The shift causes increase in price and quantity of hybrid cars New technology reduces cost of producing hybrid cars: . Q = 4 Suppose the supply curve shifts 3 units to the left New supply equation is Q^s = P-7          A    We have a new equilibrium 8 – 1/2P = P-7 P = 10 Q = 3 (before 10. and the equilibrium quantity rises Q^D = Q^S 8 -1/2P = P-4 p=8.Using Supply and Demand Curves:  Supply and demand are fundamental tools of economics  The key in being able to use supply and demand curves is being able to determine which curve is shifting. we had 8.

but effect on price is ambiguous: if demand increases more than supply. price will rise .    Supply shifts to the right because this event reduces cost. makes production more profitable at any given price This shift causes price to fall and quantity to rise Example: price of gas rises and new technology reduces production costs Both curves shift to the right. quantity rises.

 What can be the source of a shift in a demand curve?  A possible source: a change in tastes  A possible source: a change in income  An increase in income increases the demand for most goods (the demand curve shifts to the right)                When an income increases demand. the good is called a inferior good (such as people who once took the bus. the good is called a normal good When an increase in income decreases the demand. now have money to buy a car. when the price of coffee rises.4.The Market Forces of Supply and Demand9/19/2013 5:42:00 AM What might have causes this shift in the demand curve?  The shift could have not been caused by the change of price in the candy bar. Taking the bus was considered inferior) Whether a good is normal or inferior can depend on the “initial income level” and the “new income level” we’re considering An example: Low-income individuals commonly increase their purchases of secondhand clothes when their incomes increase a little. That would have shown as a movement along the demand curve.  A change in tastes could have potentially cause the shift seen in Figure 3. Middle-income individuals commonly reduce their purchases of secondhand clothes when their incomes increase a little (since they can afford to buy more new clothes instead) A possible source: a change in the price of another good When the price of coffee rises. there is movement along the demand curve for coffee More specifically. the demanded amount of coffee decreases When the demanded amount of coffee decreases the amount for tea increases The increase in the demand for tea causes the curve for tea to shift to the right Two goods are substitutes when the demand for one of the goods increases when the price of the other good increases Examples of substitutes: Coffee and tea Margarine and butter .

a shift in the curve happens when demand changes with prices staying the same Supply  Supply describes how the quantity of goods and services sold can change with changes in a number of variables like technology and the weathers. demand increases today (when the good is cheaper). thus shift to the left) Shifts in a Demand Curve Versus Movements Along a Demand Curve  Figure 3. the demand for cars decreases and the demand curve shifts to the left   A change in expectations If consumers believe the price will increase in the future.7 illustrates the difference between shifts in a demand curve and movement along a demand curve  A movement along a curve is caused by changes in the price. this shift the demand curve to the right  Changes in demographics (ex: fewer teens in a pop means less demand for goods popular with teens.  Definition of the supply curve: the quantity supplied at each price .       1989 wine and 1990 red wine BMW’s and Mercedes’ Candy Bars and granola bars When the demanded amount of peanut butter decreases. the demand for jelly decreases The decrease in the demand for jelly causes the demand curve for jelly to shift to the left Two goods are complements if the demand for one of the goods decreases when the price of the other good increases Examples of complements:  Peanut butter and jelly  Coffee and sugar  Pizza and soda  Movies and popcorn  Red wine and steak Some other sources of shifts in demand curves  Changes in the availability of credit  If banks reduce the number of auto loans they approve. Economists focus on price as the most important determinant of the level of supply.

when other things are held constant These “other things” are non-price determinants of supply Changes in them can shift the supply curve Sources of shifts in supply curves  A change in the natural environment  A change in the price of inputs .9 constructs a market supply curve for candy bars. the supply for that good usually increases. supply curves shift due to changes The supply curve shows how price affects quantity supplied. Market Supply: A market supply curve shows the quantity supplied at each price A market supply curve is formed by adding up the supply curves of each supplier The market supply curve is the horizontal sum of the supply curves of all the suppliers Just as individual supply curves have a positive slope.when everything else is held constant Why does the supply curve typically have a positive slope? Because suppliers find it more profitable to produce more goods when there are higher prices. Q = 5P When v=5 Q = 5P + 5 Shifts in Supply Curves Just like demand curves. It has a positive slope Let v denote another variable (besides p) that can affect Q Suppose Q = 5P + v When v=0.                    The supply curves the quantity supplied at each price when everything else is held constant A supply curve usually slopes upward from left to right When the price of a good increases. so do market supply curves Figure 3.

market economy: an economy that allocates resources through the decentralized decisions  of many firms and households as they interact in markets for goods and services . Equality means that those benefits are distributed uniformly among society’s members. such as the prospect of a punishment or a reward. rational people: people who systematically and purposefully do the best they can to achieve their objectives marginal change: a small incremental adjustment to a plan of action An incentive is something that induces a person to act. a higher price in a market provides an incentive for buyers to consume less and an incentive for sellers to produce more. The opportunity cost of an item is what you give up to get that item. In other words. Economics is the study of how society manages its scarce resources.9/19/2013 5:42:00 AM Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have. Efficiency means that society is getting the maximum benefits from its scarce resources.