Markets: Demand, Supply, and Coordinating Process

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Law of Demand:Price of good rises (falls) quantity demanded of good decreases (increases), ceteris paribus Individual Demand Schedules for movie tickets (per week): Ticket Tickets bought Price JoPat 7.40 $95 5.00 $137 3.60 $1810 2.80 $2913 . Pat's Demand.

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Markets: Demand, Supply, and Coordinating Process

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1. Basic Market Process: Mutually beneficial for demanders & suppliers to come together to make exchanges $-price lowers transaction costs, coordinates exchanges, improving economic well-being Markets: Demand, Supply, and Coordinating Process

2. Law of Demand: Price of good rises (falls) quantity demanded of good decreases (increases), ceteris paribus Individual Demand Schedules for movie tickets (per week): Ticket Tickets bought Price Jo Pat 7.40 $ 9 5 5.00 $ 13 7 3.60 $ 18 10 2.80 $ 29 13

4. Changes in Demand, ceteris paribus Demand Determinants: Income Normal good Inferior good Preferences Price of Related Goods Substitutes vs. Compliments Expectations of Future Prices # of Buyers

5. Graphs: Change in Quantity Demanded for Movie Tickets Price of Movies Tickets Change, Quantity Demanded Changes, ceteris paribus

6. Graphs: Change in Demand for Movies Income Rises, then Demand? Inferior Good, Demand? Normal Good, Demand? Population growth (more buyers), then demand? Expectations of increase in ticket prices, demand this week?

7. Graphs: Change in Demand for Movies (cont.) Price of Popcorn Decreases, Demand for Movies? Compliment? Price of Video Rentals Decreases, Demand for Movies? Substitute? Change in Preferences

8. Demand as Marginal Benefit (Value) Curve Price is opportunity cost of consuming a good Why? Demand Curve reflects people’s marginal value of another unit of good Price reflects “willingness to pay” or give up Market Demand = Society’s Marginal Benefit (Value) of more of good

9. Concept of Supply Supplier costs are opportunity costs: Suppliers must pay to use resources Resource price reflects its next-best alternative $-value of resources’ foregone opportunities is cost of supplying good What’s cost (price) for land to build a home?

10. Law of Supply Good’s price rises (falls), quantity suppliers willing/able to supply rises (falls), ceteris paribus Individual Supply Schedules for Movies (e.g., movies theaters A & B) per week: Price per Ticket Tickets Supplied Firm A Firm B 7.40 $ 20 10 5.00 $ 13 7 3.60 $ 8 5 2.80 $ 5 3

12. Increasing Opportunity Costs of Supplying: Producing more means attracting resources away from uses with higher opportunity costs Drives up marginal costs of additional production. Why? Price must rise to induce suppliers to supply more Most Supply Curves Slope Up

13. Increasing Opport. Costs of Supply (cont.) Supply curve reflects opportunity cost of producing additional unit Market Supply = Social Marginal Costs of providing good/activity

14. Supply Determinants: Changes (Shifts) in Supply, ceteris paribus Price of Relevant Resources Technology Expectations of Future Prices Taxes and Subsidies Government Restrictions licenses, quotas,etc. # of Sellers

15. Price of Tickets Change, Quantity Supplied Changes, ceteris paribus Move along supply curve Graphs: Change in Quantity Supplied of Movie Tickets

16. Graphs: Changes in Supply for Movie Tickets Price of Resource Increase, Supply? Expectations of higher (lower) future prices, Supply? Tax per unit produced, Supply? Subsidy per unit output, Supply? Improved Technology? Govt. Restrictions?

17. Equilibrium Price and Quantity Market tends toward equilibrium price/quantity (PE and QE )

18. At P1, quantity supply > quantity demand Surplus (QS - QD) How will suppliers change price? Quantity supplied? How does price change impact quantity demanded?

19. At P2 , QS < QD Shortage (QD - QS) Lines, waiting, violence,... How will Suppliers change Price? Quantity supplied? How does price change impact quant. demanded?

20. Consumer Surplus: Difference btw. price buyers pay and what they’re willing to pay $ measure of benefit of paying less than willingness to pay Consumer Surplus of 1st unit is $7 - $5 = $2 Shaded Triangle: Total Consumer Surplus at market equilibrium

21. Supplier Surplus: Difference btw. price suppliers receive and price willing to accept $ measure of benefit of supplying good for more than willing to accept Supplier Surplus of 1st unit is $5 - $1 = $4 Shaded Triangle: Total Supplier Surplus at market equilibrium

22. Competitive Markets and Allocative Efficiency Consumer Surplus = area ABPE Supplier Surplus = area CBPE Market Surplus = area ABC Competitive Equilibrium maximizes market surplus What about Q1?

23. Economic Efficiency in Equilibrium Market Demand = Society’s Marginal Value of additional unit of good Price paid reflects buyers’ opportunity costs Market Supply = Society’s Marginal Costs of providing more of good At Equilibrium Market Price: Social Marginal Benefit (Demand) = Social Marginal Cost (Supply) Can’t re-allocate resources to make someone better off without hurting another

24. Production and Costs (Short Run) Focus on Total Cost, Average Total Cost, Marginal Cost Total Costs (TC) = Cost of using inputs to produce any given output (Q) Average Total Cost (ATC) = (TC) / (Q) Marginal Cost (MC) = D in TC of producing extra unit of output = (D TC) / (D Q)

25. Marginal Physical Product (MPP) and Marginal Cost MPP = Extra output from hiring another unit of input (e.g., labor hour): MPP = (D Output) / (D Input) Law of Diminishing Marginal Returns As more input added (to fixed inputs) at some point it’s additional productivity declines Adding extra worker increases output, but by incrementally less than previous worker. MPP may increase, but at some point declines

26. Diminishing Marginal Returns Underlies Concept of Marginal Cost (MC) MC = D in cost associated with D in Q = (D TC) / (D Q) Changing output means hiring extra inputs If MPP increases, MC of producing declines But as diminishing marginal returns sets in, MPP declines

27. Diminishing marginal returns means MC rises As input’s productivity (MPP) declines, why must (MC) increase? If extra workers become less productive, must hire more to produce another unit of output

28. MPP & MC move in Opposite Directions (using examples in text)

29. Shape of ATC Curve: Average-Marginal Rule Marginal > Average means average rises Marginal < Average means average falls “Marginal” pulls “Average” in same direction

30. Relation Between Average Total Cost and Marginal Cost ATC decreasing when MC < ATC ATC increasing when MC > ATC At minimum ATC, MC = ATC Minimized per unit cost

31. Theory of Perfect Competition Characteristics: Many sellers/buyers Sell identical product (perfect substitutes) Perfect information for buying/selling decisions No Barriers to Entry/Exit of firms

32. Competitive Firms are “Price Takers” Change price/output, no impact on market Firm “sees” perfectly elastic demand for its good at market price. Why? Implications: Firms can sell all they desire at market price Price increase--Buyers substitute to other sellers Price decrease--Firm loses profits

33. MR = extra revenue of selling 1 more unit = (DTR) / (DQ) Firm “takes” price and decides how much to sell. Firm’s MR = firm's demand = Market Price Example: Price Quantity Total Revenue Marginal Revenue (P) x (Q) (DTR) / (DQ) $5 1 $5 $5 5 2 10 5 5 3 15 5 Firm’s Demand = Marginal Revenue (MR)

34. Firm’s demand = MR = Market Price

35. Profit Maximization Firm’s Profit Maximizing Output Produce as long as MR > MC Firm earns marginal profit (on last unit, not all units) Producing when MR < MC means losses Why not stop producing where MR > MC? Profits maximized by producing up to: MR ( = P) = MC

36. Graph: Firm’s Profit-Maximizing Output

37. Graphing Firm’s Profits (example) Profits = Revenue - Total Cost = (P) x (q) - (ATC) x (q) = (15)x(100) - (10)x(100) = 500 Profits (shaded area)

38. Long Run Competitive Equilibrium Firms Enter/Exit Industry & Inputs Variable Long-Run Equilibrium Conditions: Firms max profits producing at P (=MR) = MC Firms Producing at Minimum ATC Zero Econ Profit: P = ATC No incentive for firms enter/exit industry. Why not? No incentive to change plant size

39. Long Run Competitive Equilibrium P = MC = Minimum ATC

40. Industry Adjustment to Increase Demand Market Demand rises, Price rises Raises firm’s demand/MR Firm raises output (new P = MR = MC) P > ATC, short-run profits attract firms. New firms increase market supply, reducing P This lowers firm’s demand/MR Firms enter & P falls until 0 econ profit earned Long-run equilibrium achieved Firms profit-seeking drives adjustment process

41. Long Run Adjustment Process (Increased Market Demand)

42. Efficiency Criterion & Perfectly Competitive Markets (1) Resource Allocative Efficiency Firms produce at MR = MC Since MR = P, then P = MC Marginal Benefit (demanders) = Marginal Cost (to suppliers of using society’s resources) Society’s marginal value of resources equals Society’s opportunity costs of resources Allocative Efficiency satisfied

43. Competitive Markets and Allocative Efficiency Consumer Surplus = area ABPE Supplier Surplus = area CBPE Market Surplus = area ABC Competitive Equil. maximizes market surplus What about Q1?

44. (2) Productive Efficiency Firms produce at Min. ATC in long-run Firms economizing on resource use Efficiency Criterion & Perfectly Competitive Markets (cont.)

45. Market Failures—Inefficient Resource Allocation Implications of Competitive Markets: Market outcome efficient, or maximizes overall economic well-being. Market Failures imply one or more assumptions of competitive model breaks down Can some outside intervention “correct” the problem?

46. Types of Market Failure Imperfect Competition Imperfect Information Public Goods Nonrival in consumption, cannot exclude people who don’t pay. Externalities Inequitable Income/Welfare Distribution

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