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MARKET. An arrangement which allows buyers and sellers to exchange money and goods. WHY DO MARKETS EXIST ?. We are not self-sufficient: (We specialize in what we do best.) We trade what we make for goods or services we need, or for money to buy goods and services we need.

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Market l.jpg
MARKET

An arrangement which allows buyers and sellers to exchange money and goods.


Why do markets exist l.jpg
WHY DO MARKETS EXIST ?

  • We are not self-sufficient:

    (We specialize in what we do best.)

  • We trade what we make for goods or services we need, or for money to buy goods and services we need.

    Markets facilitate specialization and exchange.


Two types of markets l.jpg
TWO TYPES OF MARKETS

  • INPUT (FACTOR) MARKETS --

    Firms pay resource owners (i.e., owners of labor, raw material, land, machinery and buildings) --households-- for the right to use their resources;

    firm -- Resource-owner interaction

  • OUTPUT (PRODUCT) MARKETS --

    Consumers --households-- pay firms for consumer goods;

    consumer -- firm interaction


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Two of Economy’s

Primary Participants

HOUSEHOLDS

FIRMS


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CIRCULAR FLOW OF AN

ECONOMY

Payment for

Products

Revenue from

Selling Products

PRODUCT MARKET

Products

Supplied

Products

demanded

FIRMS

HOUSEHOLDS

Inputs for

Production

Inputs

Supplied

Factor

Payments

Factor

Costs

FACTOR MARKET


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What Do Firms Do ?

  • Buy factors of production from households;

  • Transform factors of production into finished products and services;

  • Sell finished products and services to households.


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Firms Buy Factors of Production

  • LABOR MARKET

    -- Hire workers and pay wages and salaries in exchange for work.

  • CAPITAL MARKET

    -- Households use savings to provide funds that firms use to buy machines, buildings and equipment.

  • NATURAL RESOURCES MARKET

    -- Households sell land, minerals, oil, etc.... to firms for use in production.


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TYPES OF FIRMS

  • Sole Proprietorship

    owned by one individual;

    individual earns all profits, responsible for all debts;

    70% of all U.S. firms; 6% of total U.S. sales by firms.

  • Partnership

    owned by more than one individual;

    division of responsibilities and profits;

    each individual fully responsible for all firm’s debts;

    8% of all U.S. firms; 4% of total U.S. sales by firms.

  • Corporation

    legal entity owned by stockholders (i.e., many owners);

    owner’s liability for firm’s debt limited to value of stock;

    about 20% of all U.S. firms; 90% of all U.S. sales by firms.


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Corporation Country Relative Size

General Motors USA 1

Ford Motor USA 2

Exxon USA 3

Royal Dutch Shell The Netherlands 4

Toyota Japan 5

Hitachi Japan 6

IBM USA 7

Matsushita Japan 8

General Electric USA 9

Daimler-Benz Germany 10

Mobil USA 11

Nissan Motor Japan 12

British Petroleum United Kingdom 13

Samsung South Korea 14

Phillip Morris USA 15

IRI Italy 16

Siemans Germany 17

Volkswagon Germany 18

Chrysler USA 19

Toshiba Japan 20


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CURRENCY MARKETS AND EXCHANGE RATES

  • Foreign Exchange Market -- Entity which provides for the exchange of one currency for another;

  • Exchange Rate -- Rate at which one currency can be exchanged for another.


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SUPPLY AND DEMAND

• Market interaction;

• Represents buyers and sellers in a particular market;

• Predicts equilibrium price and quantity in a particular market.


Market demand l.jpg
MARKET DEMAND

How much of a particular product consumers are willing to buy during a particular time period.


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MARKET DEMANDHow much a Consumer Demands of a Product depends on:

  • Price of the product being demanded;

  • Consumer income;

  • Price of related goods;

  • The number of potential consumers (population);

  • Consumer taste and advertising;

  • Consumer expectations about future prices.


The demand curve l.jpg
THE DEMAND CURVE

  • Shows how consumers exchange money for goods and services;

  • Shows relationship between price of a good and quantity consumers willing to buy during a specific time period;

  • Total amount demanded of a product is the sum of all consumers’ demand.


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THE LAW OF DEMAND

The lower the price, the larger the quantity demanded.


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TWO DEMAND EFFECTS

1. Substitution Effect:

The demand for one good normally purchased will increase if its price relative to the price of another good(s) decreases: more of the original good may be substituted at its new price.

APPLES BANANAS

Original Price $2/pound $0.50/pound

sacrifice 4 pounds bananas 1/4pound apples

New Price $0.50/pound $0.50/pound

sacrifice 1 pound bananas 1 pound apples


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TWO DEMAND EFFECTS

2. Income Effect -

A lower price for a product means that a given amount of money will buy more of all goods.

Given: $5/week fruit budget; 1pound of apples/week;

APPLES OTHER FRUIT

Original Price $2/pound -------

Original spending$2 $3

New Price $0.50/pound ------

New spending $0.50 $3

$1.50 remains for purchase of any desired product.

Price drop increases real income.


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Change in Quantity Demanded

  • A change in the quantity resulting from a change in the price of a good;

  • Illustrated by movement along a demand curve.


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DEMAND

SCHEDULE

Price / Pound

$$$

$0.80

$0.60

$0.40

$0.20

DEMAND

Quantity Demanded

(Pounds / Day)

14,000

20,000

26,000

32,000

$1.00

Price per Pound of Apples

$0.80

$0.60

DEMAND

CURVE

$0.40

$$$

$0.20

14

20

26

32

38

Thousands of Pounds of Apples per day


What causes the demand curve to shift change in demand l.jpg
What Causes the Demand Curve to Shift(Change in Demand)

A demand curve shifts as the relationship between product price and the quantity of the good demanded changes.


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Demand Shift Causes

  • Change in income:

    --Normal Good: An increase in income increases demand, shifting demand curve right;

    --Inferior Good: A decrease in income increases demand, shifting demand curve right;


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DEMAND

$1.00

Price per Pound of Apples

$0.80

Rightward Shift

$0.60

$0.40

$$$

$0.20

14

20

26

32

38

Thousands of Pounds of Apples per day


Demand shift causes23 l.jpg
Demand Shift Causes

  • Change in income:

    --Normal Good: A decrease in income decreases demand, shifting demand curve left;

    --Inferior Good: An increase in income decreases demand, shifting demand curve left;


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DEMAND

$1.00

Price per Pound of Apples

$0.80

Leftward Shift

$0.60

$0.40

$$$

$0.20

14

20

26

32

38

Thousands of Pounds of Apples per day


Demand shift causes25 l.jpg
Demand Shift Causes

  • Change In Price of Related Good:

    -- Substitute Good: As price of one good increases, demand for other good increases;

    -- Complement Good: As price of one good decreases, demand for other good increases.


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DEMAND

$1.00

Price per Pound of Apples

$0.80

Rightward Shift

$0.60

$0.40

$$$

$0.20

14

20

26

32

38

Thousands of Pounds of Apples per day


Demand shift causes27 l.jpg
Demand Shift Causes

  • Change In Price of Related Good:

    -- Substitute Good: As price of one good decreases, demand for other good decreases;

    -- Complement Good: As price of one good increases, demand for other good decreases.


Slide28 l.jpg

DEMAND

$1.00

Price per Pound of Apples

$0.80

Leftward Shift

$0.60

$0.40

$$$

$0.20

14

20

26

32

38

Thousands of Pounds of Apples per day


Other factors affecting demand shift l.jpg
Other Factors Affecting Demand (Shift)

  • Population - An increase in population means more buyers, an increasing demand, and a rightward shift in the demand curve;

  • Consumer Tastes and Advertising - As advertising leads to greater consumer preference for a product, a rightward shift in demand occurs;

  • Consumer Expectations of Future Prices - If consumers expect future prices for a product to be higher in the future, they will demand more of the product now.


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Individual Demand Curve

Shows the relationship between the price of a good and the quantity that a single consumer is willing to buy (quantity demanded) during a particular time period.


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Individual Demand Curve

The result of a rational choice by the consumer, based on the associated benefits and costs of consuming a good.


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Individual Demand Curve

  • Given a Budget ($30);

  • Spend all budget on two goods: Hamburgers and tacos;

  • Consumption of Hamburgers depends on:

    • price of burgers;

    • price of tacos;

    • income;

    • underlying tastes or preferences


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How Many Burgers Does Bob Buy ?

Price

of

Burgers

Demand Curve

  • at $3 ?

    • 8

  • at $2 ?

    • 11

b

$3

c

$2

8

11

Burgers per Month


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The Principle of Opportunity Cost

The Opportunity Cost:

  • Of something is what you sacrifice to get it;

  • Of hamburgers is number of tacos given up to get one hamburger.

  • Of 1 hamburger is 3 tacos, if hamburgers cost $3 and tacos cost $1.

    Consumption of the first through eighth hamburger provides greater pleasure than consumption of the first taco.


Substitution effect l.jpg
Substitution Effect

Change in consumption resulting from change in price of one good relative to the prices of other goods.

If price of hamburgers decreases ($2), while price of tacos remains constant, more hamburgers will be substituted for tacos. (Opportunity cost of hamburgers, in terms of tacos decreases).


Income effect l.jpg
Income Effect

Change in consumption resulting from an increase in consumer’s real income.

Real income is measured in terms of the goods the money can buy.


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Income Effect

  • At the original price ($3), Bob buys 8 burgers (cost = $24) and 6 tacos (cost = $6), for total cost of $30.

  • If the price of burgers drops, Bob’s purchasing power increases.

  • Given lower price, Bob can buy more burgers and tacos.

  • Since Bob’s $30 can buy more burgers and tacos when the price of burgers decreases, Bob’s real incomeincreases.


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Income Effect

  • Normal Goods - Most goods:

    New clothing, air transportation, and meats are examples.

    Consumption of normal goods increases as real consumer income increases.


Income effect39 l.jpg
Income Effect

  • Inferior Goods - Consumption of inferior goods decreases as real consumer income increases. Examples:

    Used clothing, potatoes, inter-city bustransportation.


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The Market Demand Curve

  • Shows for each price, the quantity of a particular good demanded by all consumers.

  • It is the sum of quantities demanded by each consumer at a given price.


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The Market Demand

Price of

Burgers

Bob’s Demand

Ann’s Demand

$3.50

$3.00

Total Consumer

(Market)

Demand

$2.50

@ $3 market demand = 16

Bob’s 4 + Ann’s 12

@ 50¢ market demand = 28

Bob’s 8 + Ann’s 20

$2.00

$1.50

$1.00

$0.50

4

12

16

20

24

28

8

Burgers per Month


Market demand assumptions l.jpg
Market Demand Assumptions

  • All, except price of the good itself, are held constant:

    •Price of other goods,

    •Income,

    •Tastes,

    •Number of consumers.


Utility l.jpg
UTILITY

The benefit generated by consuming a good: the satisfaction or pleasure the consumer experiences when he or she consumes the good.


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Marginal Utility

The change in utility resulting from one additional unit of a good.


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The Law of Diminishing Marginal Utility

As consumption of a particular good increases, marginal utility decreases.


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Total

Utility

( TU )

UTILS

180

Burgers

160

MU

TU

140

1

26

26

120

2

24

50

100

80

3

22

72

60

4

20

92

40

5

18

110

20

6

16

126

7

14

140

1

2

3

4

5

6

7

8

Burgers / Month

8

12

152

Marginal

Utility

( MU )

UTILS

30

25

20

15

10

5

Burgers / Month

1

2

3

4

5

6

7

8


The marginal principle l.jpg
The Marginal Principle

Increase the level of an activity if its marginal benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the marginal benefit equals marginal cost.


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MARGINAL UTILITY

&

MARGINAL PRINCIPLE

Given: $30 budget; taco price = $1; burger price = $3;

Number

of Tacos

Marginal utility

tacos ( utils )

Marginal Cost

Burgers

Number of

burgers

Marginal utility

burgers ( utils )

5 18 15 1 3

6 16 12 2 6

7 14 9 3 9

8 12 6 4 12

9 10 3 5 15

10 8 0 6 18


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MARGINAL UTILITY

&

MARGINAL PRINCIPLE

Given: $30 budget; taco price = $1; burger price = $3;

Number

of Tacos

Marginal utility

tacos ( utils )

Marginal Cost

Burgers

Number of

burgers

Marginal utility

burgers ( utils )

5 18 15 1 3

6 16 12 2 6

7 14 9 3 9

8 12 6 4 12

9 10 3 5 15

10 8 0 6 18


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The Utility Maximizing Rule

A consumer will maximize his/her utility by picking the affordable combination of consumer goods that makes the marginal utility per dollar spent on one good equal to that of a second good.


The utility maximizing rule51 l.jpg
The Utility Maximizing Rule

Marginal Utility

of burgers

Marginal Utility

of Tacos

=

Price of

burgers

Price of

Tacos


Consumer surplus l.jpg
CONSUMER SURPLUS

The difference between the maximum amount that a consumer is willing to pay for a good or service and the price he or she pays for the product.


Demand curve and consumer surplus l.jpg
Demand Curve and Consumer Surplus

  • If Oscar’s demand for CDs is such that at:

    Price Quantity Oscar Will Buy

    $24 0

    $21 1

    $18 2

    $15 3

    $12 4

    $9 5


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CONSUMER SURPLUS FOR AN INDIVIDUAL CONSUMER

t

PRICE

OF

CD’s

($)

24

CDs Willing to Consumer

Pay Surplus

1 $21 $11

2 $18 $8

3 $15 $5

4 $12 $2

Total $26

u

22

v

20

18

$11

w

16

$8

14

x

$5

12

$2

Price = $10

10

y

Individual Demand

Curve

1

2

3

4

5

NUMBER OF CD’s PER MONTH


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