Markets – The Basics
Wants: Wish Lists
Scarcity: Wants exceed Possibilities
Limited Resources: Limited labor,
limited natural resources,limited plants, factories, …
Possibilities
Each individual’s wish list is huge. When we added the wish lists of all individuals together
we would have an astronomically long list of wants.
It is utterly impossible for our economy to produce
enough goods and services to meet everyone’s wants given that we only have a
limited number of workers, factories, farms, etc.
Review: The Economics Problem Scarcity
Scarcity exists in all economies; that is, wants
exceed possibilities everywhere.
Different economies have used different
allocation mechanisms to
cope with scarcity.
Conclusions
Investment Goods
Consumption Goods
All resources used to produce investment goods: tools,
factories, plants, etc.
All resources used to produce consumption goods: food,
clothing, beer, etc.
Resources from the production of investment goods to the production of
consumption goods.
Production Possibility Curve: An Illustration of the Possibilities – A Conceptual Tool
Opportunity Cost: What is foregone when an activity is pursued.
Investment Goods
Consumption Goods
Question: What would happen
over time?
Rich
Poor
Production Possibility Curve: All the combinations of consumption goods and
investment goods that are possible for an economy to
produce with its limited resources
Question: How does a society decide where to operate on its production possibility curve?
That is, what allocation mechanism is used to determine where on an economy’s production
possibility frontier it operates?
Decision: Every society faces the problem of scarcity and hence must “decide” on the combination of
consumption goods and investment goods to produce.
Question: What difference does if make?
Central Planning versus Markets: Deciding where to operate on the production possibility curve
Investment Goods
Consumption Goods
1985
1920
Central Planning: Former Soviet Union from 1920 to 1985
Markets
A central planning bureau decides explicitly where to operate on the production possibility curve and devises a detailed plan to implement its decision.
A very different way for an economy to determine where to operate on its production possibility curve.
Central Planx bushels of wheat
y ingots of steelz tractors
etc.
1920 Decision: Rapid industrialization
1985 Decision: Increase the production of consumer goods
Bad news: Few consumption goods were produced
Good news: Many investment goods were produced
Production possibility curve shifted
out dramatically
A problem serious became evident
Soviet Union collapsed and market reforms occurred in the Soviet Union and eastern Europe
For example, many workers simply did not show up at their job. Some of those who did showed up drunk.
Project: Market for Personal Computers in the 1980's
Personal Computers Cost of 16 Bit New NewPrice Quantity Processors Operating Word New
Year ($ per PC) (millions) ($ per bit) Systems Processors Spreadsheets1982 1,700 3.5 18 WordStar Multiplan1983 Windows Word Lotus 1-2-31984 1,900 7.5 121985 Windows 1.0 WordPerfect1986 2,700 7.0 181987 Windows 2.0 Excel1988 2,900 9.5 9
Between 1982 and 1984 Between 1984 and 1986 Between 1986 and 1988
Price roseby $200
Price rose by $800
Price rose by $200
Quantity rose by 4 million
Quantity fellby .5 million
Quantity rose by 2.5 million
Question: How can we explain this erratic behavior?
Market demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____,
given that everything else relevant to the demand for beer remains the same?
Market supply curve: How many cans of beer would firms produce (the quantity
supplied), IF the price of beer were _____, given that everything else relevant to the
supply of beer remains the same?
Equilibrium:Quantity Demanded = Quantity Supplied
P
Q
S
Market Demand and Supply Curves
P
QD
S
P*
Q*
P
QD
If P = .50
If P = 1.00
If P = 1.50
If P = 2.00
If P = .50
If P = 1.00
If P = 1.50
If P = 2.00
2.001.501.00.50 2.001.501.00.50
Question: Does the market demand curve by itself tell us what the price will equal?
Question: Does the market supply curve by itself tell us what the price will equal?
Answer: No.
Answer: No.
Question: Why then have we gone to the trouble of
introducing the demand and supply curves?
Question: Why is the demand curve downward sloping?
Question: Why is the supply curve upward sloping?
Claim: When we combine the two curves we can determine
what the price will equal.P* = Equilibrium price
Q* = Equilibrium quantity
Question: Why is the equilibrium important?
Actual Price, Equilibrium Price, and Market ForcesMarket demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____, given that everything else relevant to the demand for beer remains the same?
Market supply curve: How many cans of beer would firms produce (the quantity supplied), IF the priceof beer were _____, given that everything else relevant to the supply of beer remains the same?
Equilibrium:Quantity Demanded = Quantity Supplied
P
Q
D
S
P*
Q*
If Actual Price < Equilibrium Price
Quantity Demanded > Quantity Supplied
Shortage exists
Actual Price rises
If Actual Price > Equilibrium Price
Quantity Demanded < Quantity Supplied
Surplus exists
Actual Price falls
Shortage
Surplus
Market Forces
Inventories fall
Inventories rise
Until the equilibrium is reached and the actual price equals the equilibrium price
Size of shortage decreases
Size of surplus decreases
Market Forces: Actual Price
equalsEquilibrium Price
Review: Actual Price, Equilibrium Price, and Market ForcesMarket demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____, given that everything else relevant to the demand for beer remains the same?
Market supply curve: How many cans of beer would firms produce (the quantity supplied), IF the price of beer were _____, given that everything else relevant to the supply of beer remains the same?
Equilibrium:Quantity Demanded = Quantity Supplied
P
Q
D
S
P*
Q*
If Actual Price < Equilibrium Price
Quantity Demanded > Quantity Supplied
Shortage exists
Actual Price rises
If Actual Price > Equilibrium Price
Quantity Demanded < Quantity Supplied
Surplus exists
Actual Price falls
Shortage
Surplus
Review: Market Forces
Inventories fall
Inventories rise
Until the equilibrium is reached and the actual price equals the equilibrium price
Size of shortage decreases
Size of surplus decreases
Market Forces: Actual Price
equalsEquilibrium Price
Market demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____,
given that everything else relevant to the demand for beer remains the same?
Market supply curve: How many cans of beer would firms produce (the quantity
supplied), IF the price of beer were _____, given that everything else relevant to the
supply of beer remains the same?
Equilibrium: Quantity Demanded = Quantity Supplied
P
Q
S
“Given That Everything Else … Remains the Same” – Shifts of a Curve
P
QD
S
P*
Q*
P
QD
If P = .50
If P = 1.00
If P = 1.50
If P = 2.00
If P = .50
If P = 1.00
If P = 1.50
If P = 2.00
2.001.501.00.50
Price of wine rises.
D’
D’
P**
Q**
Question: Would this affect demand or supply
or neither?
At the old equilibrium price, P*, Quantity Demand > Quantity Supplied
A shortage exists.
Price rises until
Quantity Demanded = Quantity Supply
An equilibrium is reestablished
Market demand curve: How many cans of beer would consumers purchase (the quantity demanded), IF the price of beer were _____,
given that everything else relevant to the demand for beer remains the same?
Market supply curve: How many cans of beer would firms produce (the quantity
supplied), IF the price of beer were _____, given that everything else relevant to the
supply of beer remains the same?
Equilibrium: Quantity Demanded = Quantity Supplied
P
Q
S
“Given That Everything Else … Remains the Same” – Shifts of a Curve
P
QD
S
P*
Q*
P
QD
If P = .50
If P = 1.00
If P = 1.50
If P = 2.00
If P = .50
If P = 1.00
If P = 1.50
If P = 2.00
2.001.501.00.50
Price of barley, hops, etc. falls
S’
S’
P**
Q**
Question: Would this affect demand or supply
or neither?
At the old equilibrium price, P*, Quantity Demand < Quantity Supplied
A surplus exists.
Price falls until
Quantity Demanded = Quantity Supply
An equilibrium is reestablished
Summary
Market demand curve: How many cans of beer would consumers
purchase (the quantity demanded), IF the price of beer were _____,
given that everything else relevant to the demand for beer remains the same?
Market supply curve: How many cans of beer would firms
produce (the quantity supplied), IF the price of beer were _____,
given that everything else relevant to the supply of beer remains the same?
Equilibrium:Quantity Demanded = Quantity Supplied
Shifts
Change in something OTHER THAN the price of beer ITSELF
Movements along
Change in the price of beer ITSELF
The demand curve for beer can SHIFT ONLY if something that affects demand OTHER THAN the
BEER PRICE changes.
The supply curve for beer can SHIFT ONLY if something that affects supply OTHER THAN the
BEER PRICE changes.
The slopes of the demand and supply curves for beer capture the effect of a change in the BEER PRICE itself; a change in the price of beer leads to a
MOVEMENT ALONG the demand and supply curves for beer
A Dated but Instructive Example: Electronic Pocket Calculators in the 1970’sCalculators Production Cost Data
Price Quantity Semiconductor Display AssemblyYear ($/calculator) (millions) chip ($/chip) ($/digit) time (min)1971 320 1
1972 200 5 15.001.00
30
1973 10012
1974 5020
1975 4023
1976 3524
3.00.30
5
100
200
300
5 10 15 20 25
P
Q
1971
1972
1973
19741975
1976
Questions:As a consequence of market forces, how would you expect the quantity demanded and quantity supplied in each year to be related?
Consider the graph below that plots the quantity and price for each year. As a consequence of market forces, what does each year’s point in the graph represent?
For each year, where do the market demand curve and market supply curve intersect?
Electronic Pocket Calculators in the 1970’s – DemandCalculators Production Cost Data
Price Quantity Semiconductor Display AssemblyYear ($/calculator) (millions) chip ($/chip) ($/digit) time (min)1971 320 1
1972 200 5 15.001.00
30
1973 10012
1974 5020
1975 4023
1976 3524
3.00.30
5
100
200
300
5 10 15 20 25
P
Q
1971
1972
1973
19741975
1976
First the market demand curve.
Question: Did the demand curve have to shift?
Question: Do we have any information suggesting that the demand curve shifted?
D1971-1976
Answer: No – The demand curve is a downward sloping curve. We can draw a downward sloping curve through the points.
Answer: No – The production data should not affect the demand for calculators.
Electronic Pocket Calculators in the 1970’s – Supply Calculators Production Cost Data
Price Quantity Semiconductor Display AssemblyYear ($/calculator) (millions) chip ($/chip) ($/digit) time (min)1971 320 1
1972 200 5 15.001.00
30
1973 10012
1974 5020
1975 4023
1976 3524
3.00.30
5
100
200
300
5 10 15 20 25
P
Q
1971
1972
1973
19741975
1976
Now the market supply curveS1971 S1972
S1973
S1974
S1975
S1976
Question: Did the supply curve have to shift?
Question: What caused the supply curve to shift?
Answer: Yes – The supply curve is upward sloping. We can’t draw an upwards sloping curve through the points.
Electronic Pocket Calculators in the 1970’sCalculators Production Cost Data
Price Quantity Semiconductor Display AssemblyYear ($/calculator) (millions) chip ($/chip) ($/digit) time (min)1971 320 1
1972 200 5 15.001.00
30
1973 10012
1974 5020
1975 4023
1976 3524
3.00.30
5
100
200
300
5 10 15 20 25
P
1971
1972
1973
19741975
1976
Putting the demand and supply curves together.S1971 S1972
S1973
S1974
S1975
S1976
QD1971-1976
The U.S. Corn Industry – 2011-2013
Year
Corn Price(dollars per
bushel)
Corn Quantity
(billions of bushels)
July & August rainfall in
Akron, Iowa (inches)
Cattle Herds (millions of
heads)
Ethanol (millions of barrels per day)
Beef exports
(billions of pounds)
2011 6.22 12.4 4.7 100 46.7 2.792012 6.89 10.8 1.3 98 44.7 2.452013 4.50 13.9 5.4 98 44.4 2.58
Q
P
4.00
5.00
6.00
7.00
10.0 12.011.0 13.0 14.0
20122011
2013
D2012
D2011
D2012-2013
S2012 S2011
S2013
Now the market supply curve
2011-2012 Shifts left
2012-2013 Shifts right
First the market demand curve
2011-2012 Shifts left
2012-2013 Remained about stationary
Putting the market demand and the market supply curves together