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ECON 160 Week 4 • The functioning of Markets: The interaction of buyers and sellers. (Chapter 4)

Review • Economic competition: We compete for Economic competition goods by offering to trade \$ dollars. • Circular flow diagram: Shows the Circular flow diagram interaction of households and firms in two kinds of markets.

Circular Flow Diagram of the Exchange Economy Goods & Services HOUSEHOLDS Product Markets \$'s Revenue FIRMS \$'s Income Resources Goods & Services Resource Markets Inputs

NEW: Study of Markets • Markets are the interaction of buyers and sellers. Markets • Some markets are local, some worldwide. • Focus on buyers and sellers separately: Separate graphs for each group. • Ceteris paribus: look at one thing at a time; All other things held equal.

Marginal Value • Focusing on a buyer, we measure the personal marginal value of a good as the most \$’s you are willing to give up to acquire an additional unit. (How much you are willing to trade) • Graph the marginal value as a height above each additional unit per time period.

Marginal Value Declines • Plot the marginal value as a height above additional units. • As you have more of any good, the marginal value declines.

Marginal Value = The Most you are willing to pay for each additional unit

MVx \$ 10 \$ 9 \$ 8 \$ 7 \$ 6 \$ 5 \$ 4 \$ 3 \$ 2 \$ 1 Marginal Value The height above each additional unit = the most you are willing to pay 1 2 3 4 5 6 7 8 9 10 Qtyx/T

How much are you willing to Buy? • By comparing the marginal value with the \$ Price at which the good is available, we can read the quantity you are willing to buy at each \$ price. (horizontal distance) • Demand: A schedule of the alternative Demand quantities that an individual is willing and able to buy at alternative \$ prices.

\$Price x Demand Curve \$ 10 \$ 9 \$ 8 \$ 7 \$ 6 \$ 5 \$ 4 \$ 3 \$ 2 \$ 1 MVx = Demand X 1 2 3 4 5 6 7 8 9 10 Qtyx/T

Demand for X \$Px \$ 10 \$ 9 \$ 8 \$ 7 \$ 6 \$ 5 \$ 4 \$ 3 \$ 2 \$ 1 Dx Demand shows the amounts purchased at alternative prices (horizontal distances at each price) Demand x Dx 1 2 3 4 5 6 7 8 9 10 Qtyx /T

First Law of Demand • The higher the price of a good, the smaller the quantity demanded; the lower the price of a good, the greater the quantity demanded. • Demand is downward sloping. • A change in price leads to a change in quantity demanded = a movement along the function

Change in Price Vrs. Change in Demand • A change in price is a move on the demand schedule. • A change in demand is a shift of the function due to something else changing.

Increase in Demand \$Px \$ 10 \$ 9 \$ 8 \$ 7 \$ 6 \$ 5 \$ 4 \$ 3 \$ 2 \$ 1 D x’ Dx Increase in demand is a rightward shift (greater quantity demanded at each price. ) Dx 1 2 3 4 5 6 7 8 9 Dx’ 10 11 12 Qtyx /T

Determinants of Demand • What factors determine the position of demand ? • What changes in other factors will cause demand to increase (shift right) or decrease (shift left)?

Determinants of Demand: (Shift Factors) • Taste & preference: how much you like the good. If T&P increase, demand increases. (Rightward shift). • Income: a change in income affects demand. – Normal good: increase in income increases demand. (Right Shift) – Inferior good: increase in income decreases demand. (Left Shift)

Determinants of Demand, Continued • Price of other goods: – Substitutes: most other goods are substitutes; An increase in the price of a substitute increases demand (rightward shift). – Complements: Goods used together; an increase in the price of complements decreases demand (leftward shift).

Determinants of Demand, Continued • Future Price Expectations: an increase in the expected future price will increase demand today.

Market Demand • The market demand is the sum of the individual demands of the buyers. • An increase in the number of buyers will increase market demand.

Market Supply • Supply is a schedule of the alternative quantities which sellers are willing and able to sell at alternative prices.

Market Supply • Supply is a schedule of the alternative quantities which sellers are willing and able to sell at alternative prices. • Supply is generally a positive relationship: at higher prices the quantity supplied is larger.

Supply Curve \$Price \$10 8 6 4 2 2 4 6 8 10 12 14 16 Qty x/ T

The Height of the Supply Curve is based on Marginal Cost of Production \$Price \$10 8 6 4 2 2 4 6 8 10 12 14 16 Qty x/ T

Change in Quantity Vrs Shift in Supply • If sellers can get a higher price, the increase in quantity supplied is a movement on the supply curve. • If some other factor changes, the supply curve will shift. • An increase in supply is a rightward shift. • A decrease in supply is a leftward shift.

Determinants of Supply: (Shift Factors) • 1. Price of inputs: an increase in price of inputs will decrease supply (leftward shift). • 2. Value of Alternative Outputs: As the value of alternative outputs increases, supply decreases. • 3. Change in technology: an increase in technology will increase supply (rightward shift). • 4. Number of sellers: as more sellers enter a market the supply shifts rightward.

The Market \$Price \$ 4 3 2. 50 Demand Surplus at this \$ Price Supply 2. 00 1. 50 1. 00 . 50 . 25 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T

\$Price \$ 4 3 The Market Demand 2. 50 Supply 2. 00 1. 50 1. 00 . 50 . 25 Shortage at this \$ Price 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T

\$Price 4 3 2. 50 Demand Market Equilibrium Dx = Sx at Pe Supply 2. 00 1. 50 Pe 1. 00 Pe . 50 . 25 100 200 300 400 500 600 700 800 900 1000 1100 Q x/ T Qe

Market: Demand & Supply \$Px Demand \$ 10 \$ 9 \$ 8 \$ 7 Pe \$ 6 \$ 5 \$ 4 \$ 3 \$ 2 \$ 1 Supply At the equilibrium Price, the Dx = Sx Sx 1 2 Dx 3 4 5 6 Qe 7 8 9 10 11 12 Qtyx /T

Effects of Increase in Demand on Price and Quantity \$Px D 1 Do \$ 10 \$ 9 \$ 8 \$ 7 Pe \$ 6 \$ 5 \$ 4 \$ 3 \$ 2 \$ 1 Supply Increases Price and Quantity D 1 Sx 1 2 Do 3 4 5 6 Qe 7 8 9 10 11 12 Qtyx /T

Demand Determines Price \$Px D 3 \$ 10 \$ 9 \$ 8 \$ 7 \$ 6 \$ 5 \$ 4 \$ 3 \$ 2 \$ 1 Supply: Response D 2 Demand pulls forth output D 1 D 3 Sx D 2 D 1 1 2 3 4 5 6 7 8 9 10 11 12 Qtyx /T

\$Px Effects of an Increase in Supply on Price and Quantity S 0 Demand \$ 10 \$ 9 \$ 8 \$ 7 Pe \$ 6 \$ 5 \$ 4 \$ 3 \$ 2 \$ 1 S 1 Price decreases and Quantity increases S 0 Dx S 1 1 2 3 4 5 6 Qe 7 8 9 10 11 12 Qtyx /T