Longwood University
Personal Finance
Scott Wentland
434-395-2160Longwood University
201 High StreetFarmville, VA 23901
Longwood University
Markets
Part 1 – What are markets?
Longwood University
Individuals and Value
• Where does value really come from? – Individuals (last lecture)
• Looked at how individuals determine value for themselves (subjective value for goods we consume)
• Individuals think “on the margin”– Diamonds are more valuable than water, because an additional
diamond makes us much happier than an additional bottle of water (assuming we’re not in desert)
– But this story is incomplete…• Diamonds would be valuable to you, even if you didn’t
like diamonds…
Longwood University
Markets and Value
• Even if you didn’t like diamonds, you could always sell a diamond on the market…– Markets (this lecture)
• Markets are made up of individuals (consumers and producers) who trade with one another
– Buying/selling is the market’s way to address scarcity– Prices help buyers and sellers make good decisions and help
make the market “efficient”
• Markets can be best understood by understanding the laws of supply and demand
Longwood University
What is a market?
• Markets are everywhere and anywhere, where people buy and sell something for a price– This is a VERY general definition– Examples:
• Stock market• Shopping mall or flea market• Grocery store• Street corner (illegal or black markets are still markets)• Ebay or Amazon (markets don’t have to even be a
physical place)• Labor market (selling your services…wage = price)
– Prices don’t even have to be in cash, they can be barter exchanges
Longwood University
Why markets?
• Why do we have markets? – We don’t live in a world where everyone begins
with everything he or she will ever want/need– We learn this at lunch in grade school
• Mom packed pudding, I want chips• Joe’s mom packed chips, Joe wants pudding
– I trade my pudding for Joe’s chips– We’re both happier a more efficient allocation
• Markets help us allocate resources efficiently– (This is just one of many things markets do…)
• Why is resource allocation important?
Longwood University
Scarcity
• We live in a world of scarcity– Humans have infinite wants and needs
• Our resources are finite.
– In economics, scarcity is the idea that our wants/needs exceed our resources
• Even if our physical resources were infinite, we would still be constrained by time we cannot escape scarcity
• Markets help us get the most out of what we’ve got– Also provide incentives for advancement (more on
this later)
Longwood University
Markets vs. Central Planning
• An economy that lets markets (i.e. buyers/sellers) produce, control, and allocate resources is a market economy. – Goods and services are freely traded at mutually
agreeable prices– Factors of production (land, labor, capital) or inputs are
primarily owned privately (not by government)– Low government involvement in the day-to-day economy– Also called capitalism, free market capitalism, or
laissez faire capitalism
• Are markets the only way to allocate resources?
Longwood University
Markets vs. Central Planning
• Planned (or command) economy – The government (or “The People”):
• Decides what to produce, who produces it, and who gets it
• Decide how resources are allocated• Own the factors of production (land/natural resources,
labor, capital) and plan how they are used• Buying and selling in markets are largely prohibited
– Also called central planning or communism
Longwood University
A Spectrum of Economies
Longwood University
A Spectrum of Economies
Longwood University
A Spectrum of Economies
Longwood University
A Spectrum of Economies
Also called “mixed economies”…most economies are “mixed”
Next lecture: how do markets work?
Longwood University
Markets
Part 2 – How do markets work?
A (very brief) intro to supply & demand
Longwood University
How do markets work?
• Supply and demand– Supply represents the sellers
• In a pure free market many sellers
– Demand represents the buyers• In a pure free market many buyers
• In markets, buyers and sellers come together to exchange– For any given good, a price emerges as a market
price, as a result of negotiations between them
Longwood University
Demand
• Consumer have a limited income and want to maximize utility (or happiness)– Buyers always want the lowest price they can get– When something becomes cheap, consumers tend
to buy more– When something becomes expensive, consumers
economize and cut back on quantity of that
• Common sense, right?
Longwood University
Law of Demand
• Law of demand: “an increase in a product’s price results in a decrease in quantity demanded” holding all else constant1. Income
2. # of buyers in the market
3. Prices of other goods 1. Substitutes
2. Complements
4. Expectations
5. Tastes
• These may “shift demand” if they change– More about that in a full microeconomics course…
Longwood University
Demand CurveThe Demand Curve for Oil is a Function Showing the Quantity of Oil
Demanded at Different PricesPrice of Oil per Barrel
Quantity of Oil (MBD)
$55
$5
$20
5 5025
Demand
PriceQuantity Demanded
$55 5
$20 25
$5 50
Longwood University
Supply
• Producers/sellers want to maximize profit– Profit margin = Price – Average Cost
• They always want the highest price they can get
– When something becomes more expensive, businesses want to supply/sell more of their product
Longwood University
Law of Supply
• Law of supply: “an increase in a product’s price will result in an increase in quantity supplied by the market” holding all else constant
• Holding what else constant?
1. Technological Innovations
2. Input Prices
3. Taxes and Subsidies
4. Expectations
5. Entry or Exit of Producers
6. Changes in Opportunity Costs
Longwood University
Supply CurveThe Supply Curve for Oil is a Function Showing the Quantity of Oil
Supplied at Different Prices
Quantity of Oil (MBD)
Price of Oil per Barrel Supply Curve for Oil
503010
$5
$20
$55
PriceQuantity Supplied
$55 50
$20 30
$5 10
Longwood University
Equilibrium
• Buyers want the lowest price• Sellers want the highest price
– When they come together, they generally meet somewhere in the middle
– They work out mutually beneficial exchanges and a market price emerges
• Supply = Demand
Longwood University
Equilibrium
Demand Curve
Supply Curve
65
$30Equilibrium
Price
Equilibrium Quantity
Quantity of Oil (MBD)
Price of Oil per Barrel
Price is Determined by Supply and Demand
Longwood University
In Equilibrium
• An optimal price emerges out of buyers and sellers interacting in the market
• Why is this price optimal or efficient?# Supplied = # Demanded (at the equilibrium price)– The lowest cost, most efficient sellers are the ones
who supply at that price– The highest valued buyers are the ones who buy at
that price– All possible mutually beneficial trades have taken
place at that price• There are no sellers left who want to sell at a price that
another buyer would agree to.
Longwood University
In Equilibrium
• If we were to design an allocation of stuff at the beginning we would want: – The people who are best, lowest cost producers to
make stuff• We don’t want people in Alaska to grow oranges
wasteful and inefficient
– The people who have the highest value for stuff to get it and consume it
• We don’t want people who don’t like oranges to get them wasteful and inefficient
• Markets get us this efficient outcome, without anyone planning it
Longwood University
Equilibrium
• An equilibrium will emerge in any free market– Check Ebay for the price of a specific product
• Buyers bid until a price settles on some equilibrium price• If a similar item goes up for auction, it sells for about the
same amount (assuming nothing else has changed)
– Compare travel sites for any given flight• Equilibrium price is very close
• That equilibrium may change, as other things that affect supply and demand change– Supply and demand conditions constantly change– Markets are dynamic prices change
Longwood University
Value
• Back to our diamond/water paradox…– Diamonds are also valuable because they have a high
market price as a result of supply and demand• In the last lecture, we talked about from an individual
buyer’s perspective• Here, we take the entire market perspective
– Diamonds have a: • Low supply
– very rare, hard to find, labor intensive, few sellers
• High demand– Many uses, many buyers want them relative to supply
• High price.
– Water’s low market price is largely due to high supply
Longwood University
Conclusions
• Understanding markets through supply and demand helps us understand– Value and prices in a market economy– How market economies allocate resources efficiently
• Full microeconomics course– Learn a lot more about supply and demand
• How to use supply and demand to understand markets better
• Predict prices based on particular events• Predict how certain government policies (e.g. minimum
wage) affects markets
Longwood University
Thank You
http://en.wikipedia.org/wiki/Scarcity
http://en.wikipedia.org/wiki/Market_economy
http://en.wikipedia.org/wiki/Social_market_economy
http://en.wikipedia.org/wiki/Planned_economy
http://en.wikipedia.org/wiki/Factors_of_production
http://en.wikipedia.org/wiki/Supply_and_demand
Top Related