Econ 101-04 Notes
Econ 101-04 Notes EC101-05
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This 7 page Class Notes was uploaded by Prasanna Notetaker on Wednesday February 24, 2016. The Class Notes belongs to EC101-05 at Southeast Missouri State University taught by Mr. Brian Gehring in Spring 2016. Since its upload, it has received 14 views.
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Date Created: 02/24/16
The Market Model Markets are all around us. We participate in many markets each week. If a market exists, then a buyer and a seller of the same product have agreed to an exchange at mutually acceptable terms. This means that at least one person is willing and able to buy a product from a seller at a price that is acceptable to both the buyer and seller. Demand for, and supply of the product must exist to have a market. In order to fully understand the market model, it is necessary to understand demand and supply. Let’s look at the demand side first. Demand represents the interests of the buyers, or consumers, in the market. It is the willingness and ability of consumers to buy different quantities at different prices during a specific time period. The demand schedule consists of a price column and a quantity demanded column. For each price listed, there is a quantity demanded value that represents the quantity of the product the consumer(s) would be willing and able to purchase at the respective price. Each price listed in the price column is a price per unit, not a total price paid for all units demanded at that price. In the absence of information that indicates otherwise, all units purchased in a market are purchased at the same price per unit. Each quantity demanded listed in the quantity demanded column is for its respective price. Consumers, collectively, will purchase 10 units if the price is $35. If the equilibrium price is $30 then we should expect all consumers in the market who are willing to pay $30, or more, per unit to buy a total of 15 units. We expect only one price in the market. We do not expect consumers to buy 31 units (15+10+6=31) if the price is $30. If the price is $40 then consumers will buy 6 units. If the price is $35 then consumers will purchase an additional 4 units (10 total). In this example, consumers are not willing to buy more than 10 units if the price is $35. They are not willing to pay more than $35 for the tenth unit in the time period that applies. Demand Schedule Price Quantity Demanded 40 6 35 10 30 15 25 21 P 4 0 3 5 Demand 3 0 2 6 10 15 21 Q Each point on the demand curve is based on values in the demand schedule for a particular time period. The values in the demand schedule are based on the determinants of demand. The determinants determine how many units consumers are willing and able to purchase at the various prices listed in the demand schedule. Each point on the demand curve represents a maximum price the potential buyers are willing to pay per unit for the quantity associated with the point on the curve. Alternatively, each point can be viewed to represent the maximum quantity the potential buyers are willing to purchase at the price associated with each pointEither way the demand curve is viewed, it represents maximum values acceptable to the buyer side of the market. This means that no point above the demand curve would be acceptable to buyers. The prices above the curve are too high, and the buyer could get a better value for his dollar if he purchased something else with the same money. Any point below the demand curve is acceptable because such points represent prices that are below the maximum the buyers would be willing and able to pay. The demand curve should not have a positive slope. A demand curve with a negative slope is typical because of several reasons. One reason is that people will get less satisfaction from each additional unit consumed than from the previous one in a given time period. Therefore, they will be willing to pay less for each additional unit. Another reason is that people don’t want to buy as many of a product at a higher price because there usually are substitutes or alternatives that will give better value for the dollar if the price of the product gets too high. This means that as the price rises, the quantity demanded falls. The supply side of the market represents the producers and sellers. The supply schedule is similar to the demand schedule except the quantity supplied will get larger as the price rises. Each price is a price per unit. In the absence of information that indicates otherwise, it is assumed that all units that are sold are sold at the same price. In the supply schedule below, sellers would not be willing to sell more than 50 units if the price is $20. If they sell 50 units, the minimum price they would be willing to accept for the th 50 unit is $20. Supply Schedule Price Quantity Supplied 30 70 25 60 20 50 15 40 P 3 0 Supply 2 5 2 0 1 40 50 60 Q 70 A supply schedule has all the values that would be used to plot the supply curve. The determinants of supply determine what the values in the supply schedule are, and they determine where the supply curve will be in the graph. The supply curve represents the willingness and ability of sellers to sell various quantities at various prices during a specific time period. Sellers are often in a business that produces a product or provides a service. They are interested in maximizing their income. If businesses don’t get a price that is high enough to cover their costs, then they will incur a loss. They need to determine what is the lowest price they can accept and still have an incentive to stay in business and continue producing the product or providing the service. In the short run, it typically costs a firm more to produce an additional unit of a product than it did to produce the previous unit in the same time period. This is why the supply curve has a positive slope. With each additional unit of a product in a given time period, the minimum price acceptable to the seller rises. For this reason, the points on the supply curve represents minimum values in terms of price that are acceptable to the sellers. Alternatively, the points represent the maximum number of units the seller would be willing to sell at the various prices. Demand and supply can be for a narrowly defined product, or a broadly defined one. Demand can represent one individual, or many individuals. Supply can represent one seller, or many sellers. There is the demand for soda beverages. There is the demand for Pepsi soda beverages. There is demand for diet Pepsi beverages. In this case, we would expect the demand to be less for the diet Pepsi beverage than for all soda beverages combined. We expect the demand for the Corvette in Cape Girardeau to be less than it would be in St. Louis, simply because there are so many more people in St Louis, and not much change in average income. There can be one person’s demand for a particular model Corvette, and there can be the same person’s demand for a car (which can include any make and model.) The scope of inclusion of kinds of product will affect demand. The scope of inclusion of people (number of people) also affects demand. Something similar can be stated about supply. There is the supply of soda beverages by all companies that produce them. There is the supply of the diet Pepsi product by one company. There is the supply of soda beverages in Missouri, and there is the supply of soda beverages in the United States. The scope obviously makes a big impact on demand and supply. In fact, in order to make a meaningful assessment of supply and demand in a market, it would be necessary to know the scope. It is also necessary to know the time period involved. The demand for potato chips will be greater over a one month period than for a one week period. When a reference is made to a market demand and/or supply, it includes all people and pertinent businesses within the defined market (such as in Cape Girardeau.) Within the market, there can still be individual demand and individual business supply. Each one of the individual consumers is included in the market demand. Each pertinent business supply is included in the market supply. When speaking of the quantity demanded, this represents the number of units buyers/potential buyers are willing and able to buy at a particular price (such as in the demand schedule on a particular line.) Similarly, the quantity supplied represents the number of units sellers are willing and able to sell at a particular price. Of course, the quantity demanded (willingness and ability) and quantity supplied (willingness and ability) change as the price changes. When the price changes, the quantity demanded and quantity supplied change. The market has both curves in it with a unique point where they intersect. That point is equilibrium, where the market is in balance. That is where the quantity supplied equals quantity demanded at the same price (equilibrium price.) This is the only price at which a surplus or a shortage will not exist. The equilibrium price is always determined by the supply and demand schedules, or the graph that is determined from the schedules. The actual price is what is observed in the market, such as what is actually being paid for the items. In the real world, the actual price may not equal the equilibrium price. This may be due to misinformation or mistakes on the part of market participants. In a market with complete information and efficiency, we would expect the actual price to equal the equilibrium price. When the actual price is higher than the equilibrium price, then the sellers will want to sell more than the consumers will want to buy. In other words, the quantity supplied will exceed the quantity demanded at the actual price. If that occurs, then a surplus will result. Sellers will recognize that they will need to lower the price to get rid of the surplus and avoid accumulating more of the product. As the price falls, producers will want to produce and sell less. However, as the price falls, consumers will want to purchase more. In other words, quantity demanded increases. Finally, when the price falls enough, the quantity supplied will equal quantity demanded, and the market will be in balance. If the actual market price is below the equilibrium price, then the quantity demanded exceeds the quantity supplied at that price, and a shortage results. In the case of a shortage, some customers will be willing to pay a price higher than the market price, and they will bid the price higher. As the price rises, the producers will want to produce more of the product. As the market adjusts, the quantity demanded will fall while the quantity supplied will rise. This eliminates the shortage and brings the market into balance. In the absence of information that indicates that the market is not in balance (such as government intervention, misinformation, etc.), we assume that prices adjust freely, and that it is in balance. If the market is not in balance, then we expect the price to adjust to bring it into balance. We do not expect demand or supply to change to bring the market into balance. Once again, balance is where quantity supplied equals quantity demanded at the same price. If the quantity supplied does not equal quantity demanded at the actual price, then the market is not in balance. A surplus or shortage will exist. In theory, we assume that all people in a market pay the equilibrium price, and that the seller gets the equilibrium price for each unit sold. This is the case in the absence of information that indicates otherwise. Of course, most people who buy the product would be willing to pay more than the equilibrium price, given that the demand curve is above the equilibrium price for nearly all units purchased. The seller would be willing to accept less than the equilibrium price for nearly all units sold, given that the supply curve for most of the units sold is below the equilibrium price. Nonetheless, there is typically one market price for all people in the market. Bear in mind that demand consists of many prices and quantities demanded. If the price of a product changes, then we expect the quantity demanded to change, not demand. The price change could be caused by a change in supply, which changes the equilibrium price. Demand will only change when a non-price determinant of demand changes. A change in supply is not a non-price determinant of demand. So a change in price will cause the quantity demanded to change, but it will not cause demand to change. A change in price is represented by a movement along a demand curve, or a movement up or down a demand schedule from line to line. It does not cause a movement of the demand curve, and it does not change the demand schedule. It is a movement to a new line in the demand schedule. If there is a change in demand, then there would be new quantities demanded for each price in the demand schedule, and a new demand curve (or a shift of it). The same principle applies with supply and a change in supply. A change in the price of a product does not change supply. It changes the quantity supplied. This could be due to a change in demand that causes the equilibrium price to change. The change in price is represented by a movement along the supply curve, not a movement of the supply curve. It causes a movement to a different line in the supply schedule, not a whole new set of quantity supplied values in the schedule. If supply changes, then the quantity supplied values in the supply schedule change, which is accompanied by a change in the supply curve (a shift of it.) A market typically doesn’t remain static. Supply and demand change over time. The correct way to illustrate increases in supply or demand is to illustrate a rightward shift of the curve. A decrease in either one is illustrated with a leftward shift of the curve. The original demand curve is identified with D1. The demand after it has changed (the new curve) should be identified with D2. The original supply curve is identified with S1. The new curve is identified with S2. Since the equilibrium is determined by supply and demand (the intersection point), the equilibrium will change as supply and/or demand change. By Brian Gehring
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