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Supply and Demand: An Introduction. Supply and Demand: An Introduction. How do consumers get the goods and services they want in the right quantities and qualities? Some goods and services are allocated by the market forces of supply and demand. Supply and Demand: An Introduction.

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Supply and demand an introduction

Supply and Demand:

An Introduction


Supply and demand an introduction

Supply and Demand: An Introduction

  • How do consumers get the goods and services they want in the right quantities and qualities?

    • Some goods and services are allocated by the market forces of supply and demand

Chapter 3 - Supply and Demand: An Introduction


Supply and demand an introduction1

Supply and Demand: An Introduction

  • Why do some goods and services have shortages or surpluses and others do not?

    • Some good and supplies services are regulated by government

Chapter 3 - Supply and Demand: An Introduction


What how and for whom central planning versus the market

What, How, and for Whom? Central Planning Versus the Market

  • Three Problems All Economic Systems Must Address

    • What should be produced?

    • How should it be produced?

    • For whom will it be produced?

Chapter 3 - Supply and Demand: An Introduction


What how and for whom central planning versus the market1

What, How, and for Whom? Central Planning Versus the Market

  • Centralized Economic Organizations

    • Agrarian society

    • Former Soviet Union

    • Cuba, North Korea

    • China

    • Bureaucracy

Chapter 3 - Supply and Demand: An Introduction


What how and for whom central planning versus the market2

What, How, and for Whom? Central Planning Versus the Market

  • A small number of individuals address

    • What

      • Establish production targets for factories and farms

    • How

      • Plan how to achieve the goals

    • For Whom

      • Distribute the goods and services produced

Chapter 3 - Supply and Demand: An Introduction


What how and for whom central planning versus the market3

What, How, and for Whom? Central Planning Versus the Market

  • Free-Market or Capitalist Economic Systems

    • Individual choices determine

      • Which careers to pursue

      • Which products to produce or buy

      • When to start and shut-down a business

      • Who gets what, which is decided by individual preferences and purchasing power

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets

Buyers and Sellers in Markets

  • A Market

    • Consists of all buyers and sellers of a good or service

  • What do you think?

    • What determines the price of pizza, gasoline, a car wash, or other goods and services?

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets1

Buyers and Sellers in Markets

  • The Demand Curve

    • A schedule or graph that tells us the quantity of a good that buyers wish to buy at each price

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets2

Buyers and Sellers in Markets

  • A Property of Demand

    • As price of a good or service goes down the quantity consumers wish to buy will increase

    • Therefore, the demand curve is downward-sloping

Chapter 3 - Supply and Demand: An Introduction


The daily demand curve for pizza in chicago

The Daily DemandCurve for Pizza in Chicago

Price

($ per slice)

4

3

2

Demand

Quantity

(1000s of slices per day)

8

12

16

Chapter 3 - Supply and Demand: An Introduction


Buyers and i markets

Buyers and i Markets

  • The Demand Curve

    • Why do buyers purchase a greater quantity at lower prices and vice-versa?

      • The substitution effect

      • The income effect

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets3

Buyers and Sellers in Markets

  • The Substitution Effect

    • The change in the quantity demanded of a good that results because buyers switch to substitutes when the price of the good changes

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets4

Buyers and Sellers in Markets

  • The Income Effect

    • The change in the quantity demanded of a good that results because a change in the price of a good changes the buyer’s purchasing power

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets5

Buyers and Sellers in Markets

  • The Cost-Benefit Principle

    • The reservation price is the benefit the buyer receives from the good

    • The cost of the good is its market price

    • If the reservation price (benefit) exceeds the market price (cost) the consumer will purchase the good

    • At higher prices, benefit will exceed cost for a smaller quantity than at lower prices

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets6

The buyers reservation price:The largest dollar amount the buyer would be willing to pay for a good

4

3

2

Demand

8

12

16

Buyers and Sellers in Markets

Price

($ per slice)

Quantity

(1000s of slices per day)

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets7

Buyers and Sellers in Markets

Horizontal Interpretation

Price

($ per slice)

Price determines quantity demanded

4

3

2

Demand

8

12

16

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets8

Buyers and Sellers in Markets

Vertical Interpretation

Price

($ per slice)

Quantity measures the marginal buyer’s reservation price

4

3

2

Demand

8

12

16

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets9

Buyers and Sellers in Markets

  • The Supply Curve

    • A curve or schedule showing the quantity of a good that sellers wish to sell at each price

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets10

Buyers and Sellers in Markets

  • Question

    • Will the opportunity cost of producing additional units of pizza increase or decrease?

      • Hint: Low-hanging-fruit principle

Chapter 3 - Supply and Demand: An Introduction


Buyers and sellers in markets11

Buyers and Sellers in Markets

  • The Supply Curve

    • Sellers must receive a higher price to produce additional units of a product to cover the higher opportunity costs of each additional unit

Chapter 3 - Supply and Demand: An Introduction


The daily supply curve for pizza in chicago

Supply

4

3

2

8

12

16

The Daily SupplyCurve for Pizza in Chicago

Price

($ per slice)

Quantity

(1000s of slices per day)

Chapter 3 - Supply and Demand: An Introduction


The daily supply curve for pizza in chicago1

The Daily SupplyCurve for Pizza in Chicago

Horizontal Interpretation

Price

($ per slice)

Supply

4

Shows the quantity produced for each price

3

2

Quantity

(1000s of slices per day)

8

12

16

Chapter 3 - Supply and Demand: An Introduction


The daily supply curve for pizza in chicago2

The Daily SupplyCurve for Pizza in Chicago

Vertical Interpretation

Price

($ per slice)

Supply

4

Shows the marginal cost (reservation price) for producing each additional unit

3

2

Quantity

(1000s of slices per day)

8

12

16

Chapter 3 - Supply and Demand: An Introduction


Market equilibrium

Market Equilibrium

  • Seller’s Reservation Price

    • The smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost

Chapter 3 - Supply and Demand: An Introduction


Market equilibrium1

Market Equilibrium

  • Equilibrium

    • A system is in equilibrium when there is no tendency for it to change

  • Market Equilibrium

    • Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price

Chapter 3 - Supply and Demand: An Introduction


The equilibrium price and quantity of pizza in chicago

Supply

Equilibrium at $3

Quantity Demanded =

Quantity Supplied

Demand

The Equilibrium Price and Quantity of Pizza in Chicago

Price

($ per slice)

4

3

2

Quantity

(1000s of slices per day)

8

12

16

Chapter 3 - Supply and Demand: An Introduction


Market equilibrium2

Market Equilibrium

  • Equilibrium Price and Equilibrium Quantity

    • The values of price and quantity for which quantity supplied and quantity demanded are equal

Chapter 3 - Supply and Demand: An Introduction


Market equilibrium3

Market Equilibrium

  • What Do You Think?

    • Would buyers prefer a lower price than the equilibrium price?

    • Would sellers prefer a higher price than the equilibrium price?

Chapter 3 - Supply and Demand: An Introduction


Excess supply

Excess supply = 8,000 slices per day

Supply

Demand

Excess Supply

Price

($ per slice)

4

3

2

Quantity

(1000s of slices per day)

8

12

16

Chapter 3 - Supply and Demand: An Introduction


Excess demand

Excess Demand

Price

($ per slice)

Supply

4

Excess demand = 8,000

slices per day

3

2

Demand

Quantity

(1000s of slices per day)

8

16

Chapter 3 - Supply and Demand: An Introduction


Points along the demand and supply curves of a pizza market

Points Along the Demand and Supply Curves of a Pizza Market

Chapter 3 - Supply and Demand: An Introduction


Graphing supply and demand and finding the equilibrium price and quantity

Graphing Supply and Demand and Finding the Equilibrium Price and Quantity

Price

($per slice)

Supply

5

4

The Equilibrium Price = $2.50

The Equilibrium Quantity = 5

3

2.50

2

1

Demand

Quantity

(1000s of slices per day)

0

2

4

6

8

10

5

Chapter 3 - Supply and Demand: An Introduction


Market equilibrium4

Market Equilibrium

  • What Do You Think?

    • Is the market equilibrium always an ideal outcome for all market participants?

Chapter 3 - Supply and Demand: An Introduction


An unregulated housing market

An Unregulated Housing Market

Monthly Rent

($/apartment)

Supply

What Do You Think?

Is $1600 more than some people can afford?

1600

Demand

Quantity

(Millions of apartments/day)

2

Chapter 3 - Supply and Demand: An Introduction


Rent controls

Rent Controls

Monthly Rent

($/apartment)

Supply

2400

Excess demand = 2 million apartments per month

1600

Controlled = 800

Demand

Quantity

(Millions of apartments/day)

0

1

2

3

Chapter 3 - Supply and Demand: An Introduction


Market equilibrium5

Market Equilibrium

  • Rent Controls Reconsidered

    • Other consequences of rent controls

      • Maintenance will decline and housing quality will fall

      • Illegal payments

      • Creation of co-ops and conversion to condominiums

      • Reduction in household mobility

      • Discrimination

Chapter 3 - Supply and Demand: An Introduction


Market equilibrium6

Market Equilibrium

  • What do you think?

    • How can we make housing affordable for poor people without using rent ceilings?

Chapter 3 - Supply and Demand: An Introduction


Rent controls1

Rent Controls

Monthly Rent

($/apartment)

Supply

1200

What is the impact of a rent control set at $1,200/month?

800

Demand

Quantity

(Millions of apartments/day)

0

1

2

3

Chapter 3 - Supply and Demand: An Introduction


Price controls in the pizza market

Price Controls in the Pizza Market

Price

($ per slice)

Supply

4

Excess demand = 8,000 slices per day

3

Price ceiling = 2

Demand

Quantity

(1000s of slices per day)

8

12

16

Chapter 3 - Supply and Demand: An Introduction


Market equilibrium7

Market Equilibrium

  • Pizza Price Controls?

    • Market responses to a pizza price ceiling

      • Long lines

      • Preferential treatment to selected customers

      • Alternative pricing strategies

      • Poorer quality ingredients

      • Black-market pizzas

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities

Predicting and Explaining Changes in Prices and Quantities

  • Distinguishing Between

    • A change in the quantity demanded

      • A movement along the demand curve that occurs in response to a change in price

    • A change in demand

      • A shift of the entire demand curve

Chapter 3 - Supply and Demand: An Introduction


An increase in quantity demanded vs an increase in demand

D

Increase in quantity demanded

D

An Increase in Quantity Demanded vs. an Increase in Demand

Price

($/can)

6

5

4

3

2

1

Quantity

(1000s of cans/day)

0

2

4

12

Chapter 3 - Supply and Demand: An Introduction


An increase in quantity demanded vs an increase in demand1

An Increase in Quantity Demanded vs. an Increase in Demand

Price

($/can)

D’

D

6

5

4

Increase in demand

3

2

D’

1

D

Quantity

(1000s of cans/day)

0

12

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities1

Predicting and Explaining Changes in Prices and Quantities

  • Change in the quantity supplied

    • A movement along the supply curve that occurs in response to a change in price

  • Change in supply

    • A shift of the entire supply curve

Chapter 3 - Supply and Demand: An Introduction


An increase in quantity supplied vs an increase in supply

S

Increase in quantity supplied

S

An Increase in Quantity Supplied vs. an Increase in Supply

Price

($/can)

6

5

4

3

2

1

Quantity

(1000s of cans/day)

0

2

4

6

8

10

Chapter 3 - Supply and Demand: An Introduction


An increase in quantity supplied vs an increase in supply1

An Increase in Quantity Supplied vs. an Increase in Supply

Price

($/can)

6

S

S’

5

4

3

Increase in supply

2

1

S

S’

Quantity

(1000s of cans/day)

0

2

4

6

8

10

Chapter 3 - Supply and Demand: An Introduction


The effect on the market for tennis balls of a decline in court rental fees

S

1.40

1.00

D’

D

40

58

The Effect on the Market for TennisBalls of a Decline in Court Rental Fees

Price

($/ball)

Quantity

(letters/month)

Chapter 3 - Supply and Demand: An Introduction


Effect on the market for overnight letter deliv ery of a decline in the price of internet access

Effect on the Market for Overnight Letter Deliv- ery of a Decline in the Price of Internet Access

Price

($/letter)

S

P

P’

D

D’

Quantity

(letters/month)

Q’

Q

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities2

Predicting and Explaining Changes in Prices and Quantities

  • Economic Naturalist

    • When the Federal Government implements a large pay increase for its employees, why do rents for apartments near Washington Metro stations go up relative to rents for apartments located far away from Metro stations?

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities3

Predicting and Explaining Changes in Prices and Quantities

  • Shifts in Demand

    • Complements

      • Two goods are complements in consumption if an increase (decrease) in the price of one cause a decrease (increase) in the demand for the other

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities4

Predicting and Explaining Changes in Prices and Quantities

  • Shifts in Demand

    • Substitutes

      • Two goods are substitutes in consumption if an increase (decrease) in the price of one causes an increase (decrease) in the demand for the other

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities5

Predicting and Explaining Changes in Prices and Quantities

  • Shifts in Demand

    • Changes In Demand

      • An increase (decrease) in the demand for a good will shift the demand curve to the right (left)

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities6

Predicting and Explaining Changes in Prices and Quantities

  • What do you think?

    • How will a decline in airfares affect inter-city bus fares and the price of hotel rooms in resort communities?

Chapter 3 - Supply and Demand: An Introduction


The effect of a federal pay raise on the rent for conveniently located apartments in washington d c

S

P’

P

D’

D

Q

Q’

The Effect of a Federal Pay Raise on the Rent for Conveniently Located Apartments in Washington D.C.

Rent

(dollars per month)

Conveniently located apartments

(units per month)

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities7

Predicting and Explaining Changes in Prices and Quantities

  • A Change In Income

    • Normal Good

      • One whose demand increases (decreases) when the incomes of buyers increase (decrease)

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities8

Predicting and Explaining Changes in Prices and Quantities

  • A Change In Income

    • Inferior Good

      • One whose demand decreases (increases) when the incomes of buyers increase (decrease)

Chapter 3 - Supply and Demand: An Introduction


The effect of the release of jurassic park on the market for toy dinosaurs

D’ = demand after release of movie

P’

D’

Q’

The Effect of the Release of JurassicPark on the Market for Toy Dinosaurs

Price

S

P

D

Toy Dinosaurs

(units per month)

Q

Chapter 3 - Supply and Demand: An Introduction


The effect of a credible rumor on the market for apple macintosh computers

D’ = demand after rumor of cheaper model soon to be released

P’

D’

Q’

The Effect of a Credible Rumor onthe Market for Apple Macintosh Computers

Price

S

P

D

Apple Computers

(units per month)

Q

Chapter 3 - Supply and Demand: An Introduction


The effect of the increase in the population of potential buyers

D’ = demand after increase in population

P’

D’

Q’

The Effect of the Increase inthe Population of Potential Buyers

Price

S

P

D

Housing NY City

(units per month)

Q

Chapter 3 - Supply and Demand: An Introduction


The effect on the skateboard market of an increase in the price of fiberglass

S’

80

800

The Effect on the Skateboard Market of an Increase in the Price of Fiberglass

Price

($/skateboard)

S

60

D

Quantity

(skateboards/month)

1000

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities9

Predicting and Explaining Changes in Prices and Quantities

  • What Do You Think?

    • Does the increase in the cost of fiberglass have any effect on the demand curve for skateboards?

Chapter 3 - Supply and Demand: An Introduction


The effect on the market for new houses of a decline in carpenters wage rates

S’

90

50

The Effect on the Market for New Houses of a Decline in Carpenters’ Wage Rates

Price

($1000/house)

S

120

D

Quantity

(houses/month)

40

Chapter 3 - Supply and Demand: An Introduction


The effect of technical change on the market for the term paper revisions

S’

7.50

36

The Effect of Technical Change on the Market for the Term Paper Revisions

Price

($/revision)

S

55

D

Quantity

(millions of revisions per year)

12

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and quantities10

Predicting and Explaining Changes in Prices and Quantities

  • Other determinants of supply

    • Weather

    • Expectations

    • Number of sellers

Chapter 3 - Supply and Demand: An Introduction


Four rules governing the effects of supply and demand shifts i

Four Rules Governing the Effects of Supply and Demand Shifts: I

An increase in demand will lead to an increase

in both the equilibrium price and quantity

Price

S

P’

P

D’

D

Quantity

Q

Q’

Chapter 3 - Supply and Demand: An Introduction


Four rules governing the effects of supply and demand shifts ii

Four Rules Governing the Effects of Supply and Demand Shifts: II

A decrease in demand will lead to a decrease

in both the equilibrium price and quantity

Price

S

P

P’

D

D’

Quantity

Q’

Q

Chapter 3 - Supply and Demand: An Introduction


Four rules governing the effects of supply and demand shifts iii

Four Rules Governing the Effects of Supply and Demand Shifts: III

An increase in supply will lead to a

decrease in the equilibrium price

and an increase in the equilibrium quantity

Price

S

S’

P

P’

D

Quantity

Q

Q’

Chapter 3 - Supply and Demand: An Introduction


Four rules governing the effects of supply and demand shifts iv

Four Rules Governing the Effects of Supply and Demand Shifts: IV

An decrease in supply will lead to

an increase in the equilibrium price

and a decrease in the equilibrium quantity

Price

S’

S

P’

P

D

Quantity

Q’

Q

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and demand

Predicting and Explaining Changes in Prices and Demand

  • Factors That Cause an Increase (rightward or upward shift) in Demand

    • A decrease in the price of complements to the good or service

    • An increase in the price of substitutes for the good or service

    • An increase in income (for a normal good)

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and demand1

Predicting and Explaining Changes in Prices and Demand

  • Factors That Cause an Increase (rightward or upward shift) in Demand

    • An increased preference by demanders for the good or service

    • An increase in the population of potential buyers

    • An expectation of higher prices in the future

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and demand2

Predicting and Explaining Changes in Prices and Demand

  • Factors That Cause an Increase (rightward or upward shift) in Supply

    • A decrease in the cost of materials, labor, or other inputs used in the production of the good or service

    • An improvement in technology that reduces the cost of producing the good or service

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and demand3

Predicting and Explaining Changes in Prices and Demand

  • Factors That Cause an Increase (rightward or upward shift) in Supply

    • An improvement in the weather, especially for agricultural products

    • An increase in the number of suppliers

    • An expectation of lower prices in the future

Chapter 3 - Supply and Demand: An Introduction


The effects of simultaneous shifts in supply and demand

S

S’

S’ after reduction in price of corn harvesting equipment

P

D’ after discovery that oils are harmful to people’s health

P’

D

D’

Q’

Q

The Effects of Simultaneous Shifts in Supply and Demand

The Market for Corn Tortilla Chips

Price

($/bag)

Millions of bags per month

Chapter 3 - Supply and Demand: An Introduction


The effects of simultaneous shifts in supply and demand1

S’ after reduction in price of corn harvesting equipment

S’

D’ after discovery that oils are harmful to people’s health

P’

D’

Q’

The Effects of Simultaneous Shifts in Supply and Demand

The Market for Corn Tortilla Chips

Price

($/bag)

S

P

D

Millions of bags per month

Q

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and demand4

Predicting and Explaining Changes in Prices and Demand

  • Assume

    • A vitamin found in corn chips helps protect against cancer and heart disease

    • A swarm of locusts destroys part of the corn crop

  • What Do You Think?

    • What will happen to the equilibrium price and quantity of corn chips?

Chapter 3 - Supply and Demand: An Introduction


Predicting and explaining changes in prices and demand5

Predicting and Explaining Changes in Prices and Demand

  • Economic Naturalist

    • Why do the prices of some goods, like airline tickets to Europe, go up during the months of heaviest consumption, while others, like sweet corn, go down?

Chapter 3 - Supply and Demand: An Introduction


Seasonal variation in air travel and corn markets

High Consumption due to High Demand

Price

($/ticket)

S

PS

PW

DS

DW

1000s of tickets

QW

QS

Seasonal Variation inAir Travel and Corn Markets

Chapter 3 - Supply and Demand: An Introduction


Seasonal variation in air travel and corn markets1

High Consumption due to High Supply

Price

($/bushel)

SW

SS

PS

PW

D

Millions of bushels

QW

QS

Seasonal Variation inAir Travel and Corn Markets

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare

Markets and Social Welfare

  • What Do You Think?

    • When are the prices and quantities determined in market equilibrium socially optimal, in the sense of maximizing total economic surplus?

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare1

Markets and Social Welfare

  • Cash On The Table

    • Assume

      • All exchange is purely voluntary

    • If so

      • The buyer’s reservation price exceeds the seller’s reservation price and both the buyer and seller receive an economic surplus

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare2

Markets and Social Welfare

  • Cash On The Table

    • Buyer’s surplus

      • The difference between the buyer’s reservation price and the price he or she actually pays

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare3

Markets and Social Welfare

  • Cash On The Table

    • Seller’s surplus

      • The difference between the price received by the seller and his or her reservation price

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare4

Markets and Social Welfare

  • Cash On The Table

    • Total surplus

      • The difference between the buyer’s reservation price and the seller’s reservation price

Chapter 3 - Supply and Demand: An Introduction


Price controls in the pizza market1

  • Assume

  • Buyer’s reservation P = $4

  • Sellers reservation P = $2

  • Pizza sells for $3

S

4

  • Buyer’s surplus: $4 - $3 = $1

  • Seller’s surplus: $3 - $2 = $1

  • Total surplus: $4 - $2 = $2

3

2

D

8

12

16

Price Controls in the Pizza Market

Price

($ per slice)

Quantity

(1000s of slices per day)

Chapter 3 - Supply and Demand: An Introduction


Price controls in the pizza market2

Price Controls in the Pizza Market

Excess demand = $8,000 slices/day

  • Assume price controls = $2

  • Quantity supplied falls to 8,000

  • Buyer’s reservation price ($4) is greater than seller’s ($2)

  • Both would benefit from additional production

  • There is CASH ON THE TABLE

Price

($ per slice)

4

3

2

D

S

Quantity

(1000s of slices per day)

8

12

16

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare5

Markets and Social Welfare

  • Cash On The Table

    • Economic metaphor for unexploited gains from exchange

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare6

Markets and Social Welfare

  • Smart For One, Dumb For All

    • Socially optimal quantity

      • The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good

    • The socially optimal quantity occurs when MC = MB

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare7

Markets and Social Welfare

  • Smart For One, Dumb For All

    • Economic efficiency occurs when all goods and services are produced and consumed at their respective socially optimal levels

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare8

Markets and Social Welfare

  • Smart For One, Dumb For All

    • Achieving economic efficiency

      • Maximizes the economic surplus

      • Increases the economic pie

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare9

Markets and Social Welfare

  • Smart For One, Dumb For All

    • When is the market equilibrium efficient?

      • When all costs of producing the good or service are borne directly by the seller

      • When all benefits from the good or service accrue directly to buyers

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare10

Markets and Social Welfare

  • Smart For One, Dumb For All

    • Inefficient market equilibrium

      • When some costs of production fall on people other than those who sell the good or service

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare11

Markets and Social Welfare

  • Example: Pollution

    • The market is in equilibrium: MC = MB

    • MC however underestimates the cost to society of producing the good

    • Therefore, the market produces more than the efficient amount and there is no incentive for producers and consumers to alter their behavior

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare12

Markets and Social Welfare

  • Smart For One, Dumb For All

    • Inefficient market equilibrium

      • When some benefits from the good or service accrue to people who did not buy the good or service

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare13

Markets and Social Welfare

  • Example: Vaccinations

    • The market is in equilibrium: MC = MB

    • MB underestimates the benefits to society of consuming the vaccinations

    • The market produces less than the efficient amount of vaccinations and there is no incentive for producers and consumers to alter their behavior

Chapter 3 - Supply and Demand: An Introduction


Markets and social welfare14

Markets and Social Welfare

  • Smart For One, Dumb For All

    • In these markets

      • Buyers and sellers are behaving rationally

      • Market equilibrium exists

      • There are no unexploited opportunities for individuals

      • Economic surplus is not maximized

Chapter 3 - Supply and Demand: An Introduction


Supply and demand an introduction

End of

Chapter


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