Microecon Intro
Transcript of Microecon Intro
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Microeconomics:Theory of Supply and
Demand
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Overview
Market (who, what, how)
Supply and demand is an economic model Designed to explain how prices are determined in
certain types of markets
How the model of supply and demand works andhow to use it
1. The law of demand
2. The law of supply
3. The determination of market equilibrium4. Factors shifting demand or supply curves
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Markets
In economics, a market is not a place but rather agroup of buyers and sellers with the potential to
trade with each other Market is defined not by its location but by itsparticipants
First step in an economic analysis is to define andcharacterize the market or collection of markets to
analyzeEconomists think of the economy as a collection
of individual markets
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How Broadly Should We Define The
Market
Defining the market often requires economists to
group things together
Aggregation is the combining of a group of distinctthings into a single whole
Markets can be defined broadly or narrowly,
depending on our purpose
How broadly or narrowly markets are defined is one ofthe most important differences between
Macroeconomics and Microeconomics
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Defining Macroeconomic
MarketsGoods and services are aggregated to the
highestlevels
Macro models lump all consumer goods into
the single category consumption goods
Macro models will also analyze all capital
goods as one market Macroeconomists take an overall view of the
economy without getting bogged down in
details
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Defining Microeconomic
MarketsMarkets are defined narrowly
Focus on models that define much more
specific commodities
Always involves some aggregation
But stops it reaches the highest level of
generality that macroeconomics investigates
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Buyers and Sellers
Buyers and sellers in a market can be Households
Business firms
Government agencies All three can be both buyers and sellers in the same market, but
are not always
For purposes of simplification this text willusually follow these guidelines In markets for consumer goods, well view business
firms as the only sellers, and households as only buyers
In most of our discussions, well be leaving out themiddleman
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Competition in Markets
In imperfectly competitive markets, individual buyers orsellers can influence the price of the product
In perfectly competitive markets (or just competitive
markets), each buyer and seller takes the market price as agiven
What makes some markets imperfectly competitive andothers perfectly competitive? Perfectly competitive markets have many small buyers and sellers
Each is a small part of the market, and the product is standardized
Imperfectly competitive markets have just a few large buyers andsellers
Or else the product of each seller is unique in some way
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Using Supply and Demand
Supply and demand model is designed to explainhowprices are determinedin perfectly competitivemarkets
Perfect competition is rare but many markets comereasonably close
Perfect competition is a matter of degree rather than anall or nothing characteristic
Supply and demand is one of the most versatileand widely used models in the economists tool kit
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Demand
A households quantity demanded of a good
Specific amount household would choose to buy over
some time period, given
A particular price that must be paid for the good All other constraints on the household
Marketquantity demanded (or quantity
demanded) is the specific amount of a good that
all buyers in the market would choose to buy oversome time period, given
A particular price they must pay for the good
All other constraints on households
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Quantity Demanded
Implies a choice
How much households would like to buy when they take into
account the opportunity cost of their decisions?
Is hypothetical
Makes no assumptions about availability of the good
Stresses price
Price of the good is one variable among many that influences
quantity demanded Well assume that all other influences on demand are held constant,
so we can explore the relationship between price and quantity
demanded
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The Law of Demand
The price of a good rises and everythingelse remains the same, the quantity of the
good demanded will fall The words, everything else remains the sameare important
In the real world many variables changesimultaneously
However, in order to understand the economy wemust first understand each variable separately
Thus we assume that, everything else remains thesame, in order to understand how demand reacts to
price
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The Demand Schedule
Demand schedule
A list showing the quantity of a good that
consumers would choose to purchase atdifferent prices, with all other variables heldconstant
Demand and Quantities demanded
- demand is the entire relationship between priceand quantity
- quantities demanded are specific amount ofgoods buyers want to buy
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The Demand Curve
The market demand curve (or just demand
curve) shows the relationship between the
price of a good and the quantity demanded ,holding constant all other variables that
influence demand
Each point on the curve shows the total buyerswould choose to buy at a specific price
Law of demand tells us that demand curves
virtually always slope downward
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Figure 1: The Demand Curve
Number of Bottlesper Month
Price perBottle
A
B
$4.00
2.00
D
40,000 60,000
At $2.00 per bottle,60,000 bottles aredemanded (point B).
When the price is $4.00
per bottle, 40,000 bottlesare demanded (point A).
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Shifts vs. Movements Along
The Demand CurveMove along the demand curve
From a change in the price of the good we analyze
In maple syrup example, Figure 1 A fall in price would cause a movement to the right along the
demand curve (point A to B)
See figure 3(a)
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Figure 3(a): Movements Along
and Shifts of The Demand Curve
Quantity
Price
P2
Q2 Q1 Q3
P1
P3
Price increase moves usleftward alongdemandcurve
Price increase moves usrightward alongdemandcurve
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Shifts vs. Movements Along
The Demand CurveShift of demand curve
a change in other things than price of the good causes ashift in the demand curve itself, for example, income
In Figure 2
Demand curve has shifted to the right of the old curve(from Figure 1) as income has risen
A change in any variable that affects demandexcept
for the goods pricecauses the demand curve to shift
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Figure 2: A Shift of The
Demand Curve
B C
$2.00
60,000 80,000
D1D2
An increase in incomeshifts the demand curve formaple syrup from D1 to D2.
Number of Bottlesper Month
Price perBottle
At each price, more bottlesare demanded after theshift
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Change in Quantity Demanded vs.
Change in Demand
Language is important when discussing demand
Quantity demanded means
A particular amount that buyers would choose to buy at a
specific price
It is a number represented by asinglepointon a demand curve
When a change in the price of a good moves us along ademand curve, it is a change in quantity demand
The term demand means
The entire relationship between price and quantitydemandedand represented by the entire demand curve
When something other than price changes, causing the entiredemand curve to shift, it is a change in demand
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Income: Factors That Shift The
Demand CurveAn increase in income has effect of shifting
demand for normal goods to the right
However, a rise in income shifts demand forinferior goods to the left
A rise in income will increase the demandfor a normal good, and decrease the demand
for an inferior goodNormal good and inferior good are defined
by the relation between demand and income
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Wealth: Factors That Shift The
DemandC
urveYour wealthat any point in timeis the
total value of everything you own minus the
total dollar amount you owe
- Example
An increase in wealth will
Increase demand (shift the curve rightward) fora normal good
Decrease demand (shift the curve leftward) for
an inferior good
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Prices of Related Goods: Factors
that Shift the DemandC
urveSubstitutegood that can be used in place of
some other good and that fulfills more or less thesame purpose
A rise in the price of a substitute increases the demandfor a good, shifting the demand curve to the right
Complementused together with the good we areinterested in
A rise in the price of a complement decreases thedemand for a good, shifting the demand curve to theleft
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Other Factors That Shift the
DemandC
urve Population
As the population increases in an area Number of buyers will ordinarily increase
Demand for a good will increase
Expected Price An expectation that price will rise (fall) in the future shifts the
current demand curve rightward (leftward)
Tastes Combination of all the personal factors that go into determining
how a buyer feels about a good When tastes change toward a good, demand increases, and the
demand curve shifts to the right
When tastes change away from a good, demand decreases, and thedemand curve shifts to the left
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Small Summary
-- Factors Affecting DemandIncome (depends on goods nature: normal
or inferior)
Wealth (depends on goods nature)
Prices ofsubstitutes (positively related)
Prices ofcomplements (negatively related)
Population (positively related)
Expectedprice (positively related)
Tastes (positively related)
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Figure 3(b): Movements Along
and Shifts of The DemandC
urve
Quantity
Price
D2
D1
Entire demand curve shiftsrightward when: income or wealth price of substitute
price of complement population expected price tastes shift toward good
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Figure 3(c): Movements Along
and Shifts of The DemandC
urve
Quantity
Price
D1
D2
Entire demand curve shiftsleftward when: income or wealth price of substitute
price of complement population expected price tastes shift toward good
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Supply
A firms quantity suppliedof a good is the specificamount its managers would choose to sell oversome time period, given
A particular price for the good
All other constraints on the firm
Market quantity supplied (or quantity supplied) isthe specific amount of a good that all sellers in themarket would choose to sell over some timeperiod, given
A particular price for the good
All other constraints on firms
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Quantity Supplied
Implies a choice Quantity that gives firms the highest possible profits when they
take account of the constraints presented to them by the real world
Is hypothetical Does not make assumptions about firms ability to sell the good
How much would firms managers want to sell, given the price ofthe good and all other constraints they must consider?
Stresses price
The price of the good is just one variable among many thatinfluences quantity supplied
Well assume that all other influences on supply are held constant,so we can explore the relationship between price and quantitysupplied
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The Law of Supply
States that when the price of a good risesand everything else remains the same, the
quantity of the good supplied will rise The words, everything else remains the same
are important
In the real world many variables change
simultaneously However, in order to understand the economy we
must first understand each variable separately
We assume everything else remains the same inorder to understand how supply reacts to price
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The Supply Schedule and The Supply
CurveSupply scheduleshows quantities of a
good or service firms would choose to
produce and sell at different prices, with allother variables held constant
Supply curvegraphical depiction of a
supply schedule Shows quantity of a good or service supplied at
various prices, with all other variables held
constant
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Figure 4: The Supply Curve
F
G
2.00
S
40,000 60,000
$4.00
At $4.00 per bottle,quantity supplied is
60,000 bottles (pointG
).
When the price is $2.00per bottle, 40,000 bottlesare supplied (point F).
Number of Bottlesper Month
Price perBottle
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Shifts vs. Movements Along the Supply
CurveA change in the price of a good causes a
movement along the supply curve
In Figure 4 A rise (fall) in price would cause a rightward (leftward)
movement along the supply curve
A drop in transportation costs will cause a shift inthe supply curve itself
In Figure 5 Supply curve has shifted to the right of the old curve (from
Figure 4) as transportation costs have dropped
A change in any variable that affects supplyexcept for thegoods pricecauses the supply curve to shift
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Figure 5: A Shift of The Supply Curve
S2
GJ
S1
60,000
$4.00
80,000
A decrease in transportationcosts shifts the supply curve formaple syrup from S1 to S2.
Number of Bottlesper Month
Price perBottle
At each price, more bottlesare supplied after the shift
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Factors That Shift the Supply Curve
Input prices
A fall (rise) in the price of an input causes an increase
(decrease) in supply, shifting the supply curve to the
right (left)Price of Related Goods
When the price of an alternate good rises (falls), the
supply curve for the good in question shifts leftward
(rightward)Technology
Cost-saving technological advances increase the supply
of a good, shifting the supply curve to the right
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Factors That Shift the Supply Curve
Number of Firms
An increase (decrease) in the number of
sellerswith no other changesshifts thesupply curve to the right (left)
Expected Price
An expectation of a future price increase(decrease) shifts the current supply curve to the
left (right)
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Factors That Shift the Supply Curve
Changes in weather
Favorable weather
Increases crop yields Causes a rightward shift of the supply curve for that crop
Unfavorable weather
Destroys crops
Shrinks yields
Shifts the supply curve leftward
Other unfavorable natural events may effect all
firms in an area
Causing a leftward shift in the supply curve
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Figure 6(a): Changes in Supply
and in Quantity Supplied
P2
Q3 Q1 Q2
P1
P3
Quantity
Price Price increase movesus rightward alongsupply curve
S
Price increase moves
us leftward alongsupply curve
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Figure 6(b): Changes in Supply
and in Quantity Supplied
Quantity
Price
S2
S1Entire supply curve shiftsrightward when: price of input price of alternate good number of firms expected price technological advance favorable weather
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Figure 6(c): Changes in Supply
and in Quantity Supplied
Quantity
Price
S1
S2Entire supply curve shiftsrightward when: price of input
price of alternate good number of firms expected price unfavorable weather
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Summary: Factors That Shift
The SupplyC
urveThe short list of shift-variables for supply that we
have discussed is far from exhaustive
In some cases, even the threat of such events cancause serious effects on production
Basic principle is always the same
Anything that makes sellers want to sell more or less of
a good at any given price will shift supply curve
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Equilibrium: Putting Supply and
Demand TogetherWhen a market is in equilibrium
Both price of good and quantity bought and sold havesettled into a state ofrest
The equilibrium price and equilibrium quantity arevalues for price and quantity in the market but, onceachieved, will remain constant
Unless and until supply curve or demand curve shifts
The equilibrium price and equilibrium quantity
can be found on the vertical and horizontal axes,respectively At point where supply and demand curves cross
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Figure 7: Market Equilibrium
E
H
J1.00
$3.00
D
S
50,000 75,00025,000
Excess Demand
4. until price reaches itsequilibrium value of $3.00
.
2. causes the priceto rise . . .
3. shrinking theexcess demand . . .
1. At a price of $1.00 perbottle an excess demandof 50,000 bottles . . .
Number of Bottlesper Month
Price perBottle
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Excess Demand
Excess demand
At a given price, the excess of quantity
demanded over quantity supplied
Price of the good will rise as buyers
compete with each other to get more of the
good than is available
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Figure 8: Excess Supply and
Price Adjustment
3. shrinking theexcess supply . . .
K L
E
3.00
D
S
$5.00
50,00035,000 65,000
Excess Supply at $5.00
2.causes theprice to drop,
4. until price reaches itsequilibrium value of
$3.00.
Number of Bottlesper Month
Price perBottle
1. At a price of $5.00 perbottle an excess supplyof 30,000 bottles . . .
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Excess Supply
Excess Supply
At a given price, the excess of quantity supplied
over quantity demanded
Price of the good will fall as sellers compete
with each other to sell more of the good
than buyers want
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Solve for Equilibrium
AlgebraicallySuppose that demand is given by the
equation , where is
quantity demanded, P is the price of thegood. Supply is given by
where is quantity supplied.
What is the equilibrium price and quantity?
PQD 10140!
PQS
580!
DQ
sQ
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Income Rises: What Happens
When ThingsC
hangeIncome rises, causing an increase in demand
Rightward shift in the demand curve causes
rightward movement along the supply curve Equilibrium price and equilibrium quantity both
rise
Shift of one curve causes a movement alongthe other curve to new equilibrium point
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Figure 9
1. An increase indemand . . .
E
F'
3.00
D1
D2
S
$4.00
50,000 60,000
3. to a newequilibrium.
5. and equilibrium quantityincreases too.
2. moves us alongthe supplycurve . . .
Number of Bottles ofMaple Syrup per Period
Price perBottle
4.Equilibriumpriceincreases
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An Banjir Hits: What Happens When
Things Change
Banjir causes a decrease in supply
Weather is a shift variable for supply curve
Any change that shifts the supply curve leftward in amarket will increase the equilibrium price
And decrease the equilibrium quantity in that market
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Figure 10: A Shift of Supply and
A New Equilibrium
E'
E3.00
D
$5.00
50,00035,000
S2 S1
Number of Bottles
Price perBottle
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Using Supply and Demand: The
Invasion of KuwaitWhy did Iraqs invasion of Kuwait cause the
price of oil to rise?
Immediately after the invasion,United Statesled a worldwide embargo on oil from both Iraq
and Kuwait
A significant decrease in the oil industrysproductive capacity caused a shift in the supply
curve to the left
Price of oil increased
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Figure 12: The Market For
Oil
P2
D
E'
P1E
Q2 Q1
S2
S1
Barrels of Oil
Price per
Barrel of Oil
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Using Supply and Demand: The
Invasion of KuwaitWhy did the price of natural gas rise as well?
Oil is a substitute for natural gas
Rise in the price of a substitute increasesdemand for a good
Rise in price of oil caused demand curve for
natural gas to shift to the right
Thus, the price of natural gas rose
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Figure 13: The Market For
NaturalG
as
Cubic Feet ofNatural Gas
Price perCubicFoot of Natural
Gas
P4
P3
F
Q3 Q4
S
D2
F'
D1
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Figure 11: Changes in the
Market for Handheld PC
s
1. An increase insupply . . .
2. and a decreasein demand . . .
5. and quantitydecreased as well.
A
B
$400
D2003
S2002
S2003
D2002
$500
2.45 3.33 Millions of Handheld PCsperQuarter
Price perHandheld
PC
4.Price
decreased . . .
3. moved the market toa new equilibrium.
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Both Curves Shift
When just one curve shifts (and we know the
direction of the shift) we can determine the
direction that both equilibrium price and quantitywill move
When both curves shift (and we know the
direction of the shifts) we can determine the
direction for either price or quantitybut not both Direction of the other will depend on which curve shifts
by more
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The Three Step Process
Key Step 1Characterize the Market
Decide which market or markets best suit problem
being analyzed and identify decision makers (buyers
and sellers) who interact there
Key Step 2Find the Equilibrium
Describe conditions necessary for equilibrium in the
market, and a method for determining that equilibrium
Key Step 3What Happens When Things Change
Explore how events or government polices change
market equilibrium
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Summaries Through the study of the chapter, you will be able to Characterize a market.
Use a demand schedule and a demand curve to demonstrate the law ofdemand.
Explain the difference between a change in demand(shift of the curve)
and a change in quantity demanded(movement along the curve). List the factors that will lead to a change in demand, and give
examples of each.
Similar analysis for supply side.
Explain how equilibrium price and quantity are determined in acompetitive market.
Explain what will happen in a competitive market after a shift in thesupply curve, the demand curve, or both.
Describe the three steps economists take to answer almost anyquestion about the economy.