Understanding Economic Models: Markets, Supply, and Demand

1. Chapter 1. Appendix • Using models • scarcity & opportunity costs • decision-making in markets

2. With scarcity, must choose Economic system decides • what to produce? • how to produce? • for whom to produce?

3. who decides? • households, firms and government • decisions coordinated by markets • buyers and sellers meet • market set price that rations scarce resources

4. Using models • simplification of reality • better understand how something works • to use: • make assumptions • apply them to a framework • look at implications

5. if model is too simple • implications are not helpful • if model is too complicated • no implications • models are only as good as their assumptions

6. A model of markets • market for haircuts • model behavior of buyers • Demand • model the behavior of sellers • Supply • buyers & sellers determine quantity & price

7. Market • haircuts in CNY per week • what factors affect buyer decisions? • price of haircuts • income • population • fashion • price of substitutes

8. what factors affect sellers decisions? • price of haircuts • costs of haircuts • profitability of alternative business

9. Assume: • first look at relationship between quantity and price • hold other factors constant • men and women do not differ in buying decision • men and women not viewed differently by sellers

10. Demand • relationship between • quantity of haircuts demanded • price of haircuts • as price rises, Qd falls • holding other factors constant • Law of Demand

11. Demand schedule P Qd $30 15,000 $20 20,000 $10 25,000

12. Supply • relationship between • quantity of haircuts supplied • price of haircuts • as price rises, Qs rises • holding other factors constant • Law of Supply

13. Supply schedule P Qs $30 25,000 $20 20,000 $10 15,000

14. the market • supply and demand together • graph each schedule

15. P $30 $20 $10 D S Q haircuts 15K 20K 25K P = $20 Q = 20K

16. equilibrium • P=$20, Q=20,000 • Qs = Qd • with other factors constant, P & Q will stay at this point

17. Allow factors to change • CNY population increases • more people, • more haircuts demanded at every price • increase in demand

18. P $20 D’ D S Q haircuts 20K D increases: P increases Q increases

19. Allow factors to change • NY increases fee for cosmetology license • more costly to provide haircuts • fewer haircuts supplied • decrease in supply

20. P $20 S’ D S Q haircuts 20K S decreases: P increases Q decreases

21. Men vs. women & haircuts • assume sellers view women’s haircuts as more costly • at any price, sellers willing to provide fewer haircuts for women than for men • Women’s supply curve to the left of men’s supply curve

22. P S women D S men Q haircuts Women’s haircuts have a higher price

23. assume women are less price sensitive to haircuts than men • price increase causes small decrease in Qd • women’s demand for haircuts is less elastic than men’s • women’s demand curve is steeper than men’s

24. P D men S D women Q haircuts Women’s haircuts have a higher price

25. is this discrimination? • some laws forbid different prices for men vs. women • haircuts • drycleaning • is this fair? • is this efficient?

26. A model of opportunity cost • NY receives $40 million from Feds • use on combo of 2 projects • prison cells $10,000 each • SUNY student unions $4 million each

27. prisons 4000 student unions 10 graph all possible combos: any point on the line is efficient, using all $40 million any point inside the line is inefficient, using less than $40 million any point above the line is not possible, using more than $40 million

28. opportunity cost • choice between prison cells and student unions • if want 10 student unions, must give up all prisons cells • every 1 student union costs us 400 prison cells

29. opp. cost of 1 student union = lost benefits from not having 400 more prisons cells

30. NY state budget • many choices for spending AND raising revenue • whatever the choice, • something is given up -- some program not funded or -- private spending lost to taxes