Principles of Microeconomics

1. Principles of
Microeconomics
Lecture three

2. content
▪ Economic model
▪ Market equilibrium, supply and demand
▪ Demand Graphs, Shift, Movement, Math
▪ Supply Graphs, Shift, Movement, Math
▪ Equilibrium
▪ Shortage Surplus
▪ Predicting Price when D or S changes
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3. What is a economic model?
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4. What is an economic model?
An economic model is
▪ simplified framework designed to illustrate complex processes,
often but not always using mathematical techniques.
▪ simplified description of reality
▪ abstraction from details to understand clearly the main forces
driving the economy.
▪ useful in describing and predicting how the world works.
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5. What is an economic model?
▪ Model Assumptions
▪ Models rely on simplifying assumptions
▪ Drive the conclusions of the model. When analyzing a model it
is crucial to spell out the assumptions underlying the model.
▪ Good assumptions help build a model that accounts for the
observations and predicts well.
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6. What is an economic model?
▪ Variables
▪ dependent variable – the one that is being explained
▪ independent variables as they provide the explanation that causes
the change
▪ Example:
▪ Quantity Demanded of a product (Q)
▪ is influenced by
▪ Available Income (I)
▪ Preference for the product (T)
▪ Price of the product (P)
▪ Q is dependent .. The others are independent
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7. What is an economic model?
Example: supply and demand
▪ purpose - explain and analyze prices and
quantities traded in a competitive market. T
▪ model’s mathematical equations - level of
supply and demand as a function of price
▪ Assumptions:
▪ market-clearing price is determined by the
requirement that supply equal demand at
that price.
▪ demand is assumed to decline as price
increases
▪ supply is assumed to increase with price
increases
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8. What is an economic model?
▪ Hurricane Irma has decreased
expected yields of oranges.
▪ Does this affect supply or demand of
orange juice?
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9. What is an economic model?
▪ A new study has shown that orange
juice makes you very very smart in
university.
▪ Does this affect supply or demand of
orange juice?
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10. Supply and Demand
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11. Economic Coordination
To make coordination work, four complimentary social
institutions have evolved over the centuries:
▪ Firms
▪ Markets
▪ Property rights
▪ Money
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12. Economic Coordination
▪ A firm is an economic unit that hires factors of production and
organizes those factors to produce and sell goods and services.
▪ A market is any arrangement that enables buyers and sellers to get
information and do business with each other.
▪ Property rights are the social arrangements that govern ownership,
use, and disposal of resources, goods or services.
▪ Money is any commodity or token that is generally acceptable as a
means of payment.
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13. Economic Coordination
▪ Circular Flows Through
Markets
▪ illustrates how households
and firms interact in the
market economy.
▪ Factors of production, and
…
▪ goods and services flow in
one direction.
▪ Money flows in the
opposite direction.
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14. Economic Coordination
▪ Coordinating Decisions
▪ Markets coordinate
individual decisions through
price adjustments.
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15. Economic Coordination terms
▪In some cases –
▪markets work well as they match what consumers want
with what firms produce
▪markets do not work well no matching .. Shortage ..
Excess…Market Failure
▪Economics tries to explain why and why not and how best
to organize markets
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16. Economic Coordination
Competitive Market and Price
▪ Competitive market is a market that has many buyers and
many sellers so no single buyer or seller can influence the
price.
▪ Invisible hand in play
▪ Money price - amount of money needed to buy a good.
▪ Relative price - ratio of its price of a good relative the price of
the next best alternative good—is its opportunity cost.
▪ Ex: price of orange juice: price of apple $4/$2
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17. How are prices Set? Why are these
goods expensive?
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18. Why are some goods cheap and
others expensive?
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19. Market equilibrium, supply and
demand
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20. How is the market price of a good
determined?
▪ Using demand curve …
▪ The quantity of a good that buyers are willing and able to
buy at each price
▪ Using supply curve …
▪ The quantity of a good that sellers are willing to sell at each
price
Review price where Qs = Qd
that is Market equilibrium
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21. How is the market price of a good
determined?
Applied in a market for a
▪ specific type and quality Ex: coffee - gourmet blend, 12 oz.,
caffeinated, dark roast
▪ particular period of time
▪ ceteris paribus.
Market Equilibrium
▪ Qd= Qs
▪ Meaning no product in excess and no product in shortage
▪ Does not mean everyone is happy or fair
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22. Demand, Supply & Market
Equilibrium: An economic model
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23. Demand
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24. Demand
If you demand something, then you
1. Want it,
2. Can afford it, and
3. Have made a definite plan to buy it.
▪ Wants are the unlimited desires or wishes people have for
goods and services. Demand reflects a decision about which
wants to satisfy.
▪ The quantity demanded of a good or service is the amount
that consumers plan to buy during a particular time period,
and at a particular price.
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25. Demand & Type of Goods
▪ Normal Goods are goods for which quantity demanded goes
up when income is higher and vice versa
▪ Inferior Goods are goods for which quantity demanded falls
when income rises.
▪ Substitutes are goods that can serve as replacements for one
another; when the price of one increases, people switch to the
substitute. Perfect substitutes (rare) are almost identical
products.
▪ Complements are goods that “go together”; a decrease in the
price of one results in an increase in quantity demanded for
the other, and vice versa.
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26. Example: Demand & Type of
Goods
Coffee price increases??
What happens to quantity demanded of tea?
Recession occurs ( and thus income levels
decrease)
What happens to quantity demanded for normal
goods?
What happens to quantity demanded for inferior
goods?
Price of hot dogs and fries increases
What happens to quantity demanded for
ketchup?
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27. Demand Curve
Demand Curve and Demand
Schedule
◦ demand refers to the entire
relationship between the price of
the good and quantity demanded
of the good.
◦ demand curve shows the
relationship
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28. Demand Curve Characteristics
Downward sloping -
▪ law of demand – Quantity demanded of a good changes as the
price of the good changes – all else held the same
▪ Why ? Two reasons:
▪ Substitution effect
▪ Income effect
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29. Demand
▪ Substitution Effect
▪ When the relative price (opportunity cost) of a good or service
rises, people seek substitutes for it, so the quantity demanded
of the good or service decreases.
▪ Ex: coffee increases – buy tea
▪ Income Effect
▪ When the price of a good or service rises relative to income,
people cannot afford all the things they previously bought, so
the quantity demanded of the good or service decreases.
▪ $20 feels like less if price of everything increases
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30. Demand Curve & Math
▪ Show me the math!
▪ All demand curves follow this
general equation..
▪ QD = c – dP
▪ c = intercept
▪ So if If P = 0 how many demanded
by consumers?
▪ d = slope of demand curve
▪ QD = 24 - 4P
24
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31. Demand example
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32. Demand
Movement Along the Demand
Curve
▪ rise in the price
▪ decrease in the quantity
demanded and a movement up
along the demand curve.
▪ fall in the price
▪ increase in the quantity
demanded and a movement
down along the demand curve.
▪ All else held the same
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33. Demand
▪ What would make you change your demand?
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34. Demand
Shift of the Demand Curve
1. The prices of related
goods
2. Expected future prices
3. Income
4. Expected future income
and credit
5. Population
6. Preferences
▪ All else held the same
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35. Demand
▪ Prices of Related Goods
▪ A substitute is a good that can be used in place of another
good.
▪ A complement is a good that is used in conjunction with
another good.
▪ Examples??
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36. Demand
▪ Expected Future Prices
▪ If the price of a good is expected to rise in the future, current
demand for the good increases and the demand curve shifts
rightward.
▪ Income
▪ When income increases, consumers buy more of most goods
and the demand curve shifts rightward.
▪ A normal good is one for which demand increases as income
increases.
▪ An inferior good is a good for which demand decreases as
income increases.
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37. Demand
▪ Expected Future Income and Credit
▪ When income is expected to increase in the future or when
credit is easy to obtain, the demand might increase now.
▪ Population
▪ The larger the population, the greater is the demand for all
goods.
▪ Preferences (Tastes)
▪ People with the same income have different demands if they
have different preferences.
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38. Note the difference …
Change in price of a good or service
leads to
Change in quantity demanded
(Movement along the curve)
due to shift in supply curve.
Change in six factors
leads to
Change in demand
(Shift of curve)
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39. Supply
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40. Supply
The quantity supplied of a good or service is the amount that
producers plan to sell during a given time period at a particular
price.
If a firm supplies a good or service, then the firm
▪ 1. Has the resources and the technology to produce it,
▪ 2. Can profit from producing it, and
▪ 3. Has made a definite plan to produce and sell it.
▪ Resources and technology determine what it is possible to
produce. Supply reflects a decision about which technologically
feasible items to produce.
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41. Supply
▪ Supply Curve and Supply Schedule
▪ The term supply refers to the
entire relationship between the
quantity supplied and the price of
a good.
▪ The supply curve shows the
relationship between the quantity
supplied of a good and its price
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42. Supply Curve Characteristics
▪ Upward sloping basis law of supply
(positive relationship between price and quantity)
law of supply
▪ Why is this the case?
1. Principle of Increasing Opportunity Cost
▪ The higher the price, the more firms are willing to produce
and sell.. because any higher opportunity costs can be
covered by the higher price
▪ So more product is supplied to the market.
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43. Supply Curve Characteristics
2. Rising marginal cost of production
▪ As more units are produced, costs of producing one more unit
rises.. increasing marginal cost of production
▪ That means that firms need to sell their extra output at a
higher price to cover this rising marginal cost of production
▪ The upward slope reflects the higher price needed to cover
the higher marginal cost of production
▪ Producers are willing to supply a good only if they can at
least cover their marginal cost of production.
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44. Supply Curve & Math
Show me the math!
All supply curves follow this general
equation..
Qs = a + bP
a = intercept
if P =0 how many supplied to
the market by firm?
b = inverse slope of curve
Slope = rise over run but this is an
inverse as the P & Q are switched in
the graph.
(b=4 means what???)
Qs = 0 + 4P
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45. Supply
A rise in the price, other
things remaining the
same, brings an increase
in the quantity supplied.
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46. Supply
▪ A Change in Supply– Shift of the Curve
▪ Six main factors
▪ The six main factors that change supply of a good are
1. The prices of factors of production
2. The prices of related goods produced
3. Expected future prices
4. The number of suppliers
5. Technology
6. State of nature
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47. Supply
▪ Prices of Factors of Production
▪ If the price of a factor of production used to produce a good
rises, the minimum price that a supplier is willing to accept for
producing each quantity of that good rises.
▪ So a rise in the price of a factor of production decreases supply
and shifts the supply curve leftward.
▪ What are those factors of production?
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48. Supply
▪ Prices of Related Goods Produced
▪ A substitute in production for a good is another good that can
be produced using the same resources.
▪ The supply of a good increases if the price of a substitute in
production falls.
▪ Goods are complements in production if they must be
produced together.
▪ The supply of a good increases if the price of a complement
in production rises.
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49. Supply
▪ Expected Future Prices
▪ If the price of a good is expected to rise in the future, supply of
the good today decreases and the supply curve shifts leftward.
▪ The Number of Suppliers
▪ The larger the number of suppliers of a good, the greater is the
supply of the good. An increase in the number of suppliers
shifts the supply curve rightward.
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50. Supply
▪ Technology
▪ Advances in technology create new products and lower the
cost of producing existing products.
▪ So advances in technology increase supply and shift the
supply curve rightward.
▪ The State of Nature
▪ The state of nature includes all the natural forces that
influence production—for example, the weather.
▪ A natural disaster decreases supply and shifts the supply
curve leftward.
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51. Supply
▪ A Shift of the Supply Curve
▪ main factors (6 items)
changes
▪ supply changes and the
supply curve shifts
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52. Note the difference …
Change in price of a good or service
leads to
Change in quantity supplied
(Movement along the curve
Because the demand curve has shifted)
Change in costs, input prices, technology, or prices of related goods and
services
leads to
Change in supply
(Shift of curve)
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53. Market equilibrium
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54. Market Equilibrium
So how does a market work then?
interaction between buyers and sellers.
Market Equilibrium occurs when
▪ Qd= Qs
▪ Meaning no product in excess and no
product in shortage
▪ no tendency for the market price to
change
▪ Does not mean everyone is happy
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55. Market Equilibrium
Who is happy?
Who is not happy?
Consider the first economic question
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56. Market Equilibrium
Is this the invisible hand at work?
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57. Example: Market Equilibrium
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58. Example: Market Equilibrium
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59. Using the model – predicting the
effects of change
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60. Predicting Changes in Price and
Quantity
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61. When Demand or Supply shifts..what
happens to equilibrium
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62. Questions
▪ How do markets work?
▪ Right products … Right place .. Right time .. Right amount .. Etc. etc.
▪ What are the tradeoffs for these three types of markets?
▪ Can you get market equilibrium using the equation?
▪ How are the curves developed?
▪ Are they different for each market or product?
▪ Can there be upward demand curves?
▪ Can there be downward supply curves?
▪ Is price always on the Vertical axis and Quantity on the horizontal?
Why?
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63. Questions
▪ How do these curves relate to a equation .. That Y = a + bX?
▪ Can you get market equilibrium using the equation?
▪ How are the curves developed?
▪ Are they different for each market or product?
▪ Can there be upward demand curves?
▪ Can there be downward supply curves?
▪ Is price always on the Vertical axis and Quantity on the
horizontal? Why?
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64. ▪ Define markets incl free and centrally planned
▪ Define supply curve & the equation especially the slope!
▪ Define demand curve & the equation especially the slope!
▪ Understand market equilibrium and how it gets out of
equilibrium
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65. ▪ Define excess supply (surplus) & excess demand (shortage) & calculate
amounts
▪ Explain how market returns to equilibrium under surpluses and
shortages.
▪ Explain difference between change in quantity demanded and change
in demand.
▪ Explain difference between change in quantity supplied and change in
supply.
▪ Identify factors which shift supply curve.
▪ Identify factors which shift demand curve
▪ Practice to keep all the D and S shifts straight and what happens with
P and Q then as well.
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