Micro Handout 2: Market Basics

Transcription

1 Amherst College epartment of Economics Economics 111 ection 5 Fall 2015 Review: The Economics Problem carcity uestion: Why is there a problem? Micro Handout 2: Market Basics 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 Wants: Wish Lists Limited Resources: Limited labor, limited natural resources, limited plants, factories, Possibilities 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. carcity: Wants exceeds Possibilities Conclusions carcity exists in all economies; that is, wants exceed possibilities everywhere. ifferent economies have used different allocation mechanisms to cope with scarcity.

2 2 Production Possibility Frontier (Curve): An Illustration of the Possibilities A Conceptual Tool Example: All the combinations of consumption goods and investment goods that are possible for society to produce with its limited resources. ecision: Every society faces the problem of scarcity and hence must decide on the combination of consumption goods and investment goods to produce. uestions: What is the opportunity cost of consumption goods? uestion: What do we mean by opportunity cost? Answer: Investment Goods Consumption Goods What difference does this decision make? How can we use the production possibility frontier to illustrate the difference between rich and poor economies? Investment Goods Consumption Goods 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?

3 3 Centralized ecision Making: oviet Union from 1920 to 1985 Investment Goods Consumption Goods 1920 ecision: Bad news: Good news: 1985 ecision:

4 4 ecentralized ecision Making: Markets Another Way to Make the ecisions The taple of the Office in 1980: A Typewriter In 1980 an office was not complete without a typewriter. The 1980 s saw a transformation, however. The typewriter lost its dominance and the personal computer emerged as the indispensible office tool. It was in the 1980 s that personal computers changed our everyday lives. Project: Explain the Changes in the Prices and uantities of Personal Computers in the 1980 s. In 1977, the Apple II debuted on the personal computer market. Four years later, in 1981, IBM unveiled its PC. By today s standard, we would only describe these computers as grossly primitive. The maximum amount of memory available was 256 kilobytes. The IBM PC did not have a hard drive, only two 5-1/4 floppies with a capacity of 360 kilobytes each. Needless to say, the 1980 s saw tremendous changes in the personal computer market. The following table reports on the price and quantity of personal computers produced in the United tates from 1982 through 1988: Personal Computers Cost of 16 Bit New New Price uantity Processors Operating Word New Year ($ per PC) (millions) ($ per bit) ystems Processors preadsheets , Wordtar Multiplan 1983 Windows Word Lotus , Windows 1.0 WordPerfect , Windows 2.0 Excel , Between 1982 and 1988 the number of personal computers produced annually nearly tripled; the price nearly doubled. The price and quantity did not increase in a steady manner, however. Between 1982 and 1984 Between 1984 and 1986 Between 1986 and 1988 ã é ã é ã é Price rose uantity rose Price rose uantity fell Price rose uantity rose by $200 by 4 million by $800 by.5 million by $ million uestion: How can we explain the erratic behavior?

5 5 Market emand Curve uestion: What does the market demand curve for beer tell us? Answer: The market demand curve for beer answers the following series of hypothetical questions: 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 upply Curve uestion: What does the market supply curve for beer tell us? Answer: The market supply curve for beer answers the following series of hypothetical questions: 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? The market demand curve is sloping. Why? The market supply curve is sloping. Why? uestions: oes the demand curve by itself determine what the price of beer actually equals? Explain. oes the supply curve by itself determine what the price of beer actually equals? Explain. Why then have we gone to the trouble of introducing the demand and supply curves? Market Equilibrium The equilibrium price is the price at which the quantity demanded the quantity supplied: Equilibrium uantity emanded uantity upplied uestion: Why is the equilibrium important?

6 6 Actual Price, Equilibrium Price, and Market Forces Claim: Market forces push the actual price to the equilibrium price. If Actual Price < Equilibrium Price If Actual Price > Equilibrium Price uantity emanded uantity upplied uantity emanded uantity upplied exists exists Inventories Inventories Actual Price Actual Price ize of ize of é ã P Market P* * uestion: Eventually, how will the actual price and the equilibrium price be related?

7 Amherst College epartment of Economics Economics 111 ection 5 Fall 2015 Micro Handout 3: Market Applications Review: Market emand and upply Curves Market emand 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 upply 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 In equilibrium uantity emanded = uantity upplied emand and supply are equal partners in determining the equilibrium price and quantity. Market Forces, the Equilibrium Price, and the Actual Price If Actual Price < Equilibrium Price If Actual Price > Equilibrium Price uantity emanded > uantity upplied uantity emanded < uantity upplied hortage exists urplus exists Actual Price rises Actual Price falls until the equilibrium is reached until the equilibrium is reached P P* surplus shortage * Market forces push the actual price toward its equilibrium level. Assuming that the actual price is free to move, the actual price will equal the equilibrium price in short order.

8 2 Given That Everything Else Remains the ame hifts of a Curve To explain the role of this phrase, first focus on demand. The phrase given that everything else relevant to the demand for beer remains the same refers to all factors that affect the demand for beer other than the price of beer itself. While the quantity of beer demanded certainly depends on the price of beer, many other factors affect the quantity demanded also: Claim: When one of these other factors changes, that is, when something relevant to the demand for beer changes other than the price of beer itself, the entire demand curve for beer will shift. uppose the price of wine increases. Recall the hypothetical questions that the market demand curve answers: If the price of beer were $.50, consumers would now purchase beer than before since the price of wine is now greater. If the price of beer were $1.00, consumers would now purchase beer than before since the price of wine is now greater. If the price of beer were $1.50, consumers would now purchase beer than before since the price of wine is now greater. If the price of beer were $2.00, consumers would now purchase beer than before since the price of wine is now greater. Geometrically, an increase in the price of wine causes the market demand curve for beer to shift to the. uestion: How would an increase in wine prices affect the equilibrium price and quantity of beer? To address this question we turn to the market At the old equilibrium price, P*: uantity emanded uantity upplied A exists Price until uantity emanded uantity upplied An equilibrium is P P* Market *

9 3 Next, let us turn our attention to supply. The phrase given that everything else relevant to the supply of beer remains the same refers to all factors that affect the supply of beer other than the price of beer itself. While the quantity of beer supplied certainly depends on the price of beer, many other factors affect the quantity supplied also: Claim: When one of these other factors changes, that is, when something relevant to the supply of beer changes other than the price of beer itself, the entire supply curve for beer will shift. uppose the price of grain (barley, oats, etc.) decreases. Recall the hypothetical questions that the market supply curve answers: uestion: How would this affect beer production costs? uestion: Would this make beer a more or less profitable item to produce? uestion: How would this affect the supply curve for beer? o If the price of beer were $.50, firms would now produce beer than before since the price of grain is now less. o If the price of beer were $1.00, firms would now produce beer than before since the price of grain is now less. o If the price of beer were $1.50, firms would now produce beer than before since the price of grain is now less. o If the price of beer were $2.00, firms would now produce beer than before since the price of grain is now less. Geometrically, a decrease in the price of grain causes the market supply curve for beer to shift to the. uestion: How would a decrease in barley prices affect the equilibrium price and quantity of beer? To address this question we turn to the market: At the old equilibrium price, P*: uantity emanded uantity upplied A exists Price until P Market uantity emanded uantity upplied An equilibrium is P* *

10 4 ummary Market emand 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 upply 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: uantity emanded = uantity upplied hifts Movements Along Change in something OTHER Change in the price of BEER ITELF THAN the price of BEER ITELF ã é The slopes of the demand and supply The demand curve for beer The supply curve of beer curves for beer capture the effect can HIFT ONLY if can HIFT ONLY if of a change in the BEER PRICE itself; something that affects something that affects a change in the price of beer leads demand OTHER THAN supply OTHER THAN to a MOVEMENT ALONG the the BEER PRICE changes. the BEER PRICE changes. demand and supply curves for beer.

11 5 A ated but Instructive Example: Electronic Pocket Calculators in the 1970 s Calculators Production Cost ata Price uantity emiconductor isplay Assembly Year ($/calculator) (millions) chip ($/chip) ($/digit) time (min) uestions: As a consequence of market forces, how would you expect the quantity demanded and quantity supplied in each year to be related? uantity emanded uantity upplied Consider the graph below that plots the quantity and price for each year. As a consequence of market forces, what does each year s point in the graph represent? For each year, where do the demand curve and supply curve intersect? Focus on the Market emand Curve Is the demand curve downward sloping or upward sloping? Based on the points you have plotted, did the demand curve have to shift from 1971 to 1976 or could the demand curve have remained stationary during these years? P ($/calculator) o the data appearing above include any information suggesting that the demand curve shifted? (millions of calculators)

12 6 Focus on the Market upply Curve Is the supply curve downward sloping or upward sloping? Based on the points you have plotted, did the supply curve have to shift from 1971 to 1976 or could the supply curve have remained stationary during these years? P ($/calculator) o the data appearing above include any information suggesting that the supply curve shifted? Putting the Market emand and upply Curves Together (millions of calculators) P ($/calculator) (millions of calculators)

13 7 The U.. Corn Industry A severe drought stuck the U.. mid-west in the summer of This had a dramatic impact on the corn industry. Corn Price (dollars per bushel) Corn uantity (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) Year id the demand curve have to shift? Yes No. Explain id the supply curve have to shift? Yes No. Explain Is there a reason that the demand curve did shift? Yes No. Explain Is there a reason that the supply curve did shift? Yes No. Explain id the demand curve have to shift? Yes No. Explain id the supply curve have to shift? Yes No. Explain Is there a reason that the demand curve did shift? Yes No. Explain Is there a reason that the supply curve did shift? Yes No. Explain Price ($ per bushel) Price ($ per bushel) uantity (billions of bushels) uantity (billions of bushels)