Economics 2023-02 Principles of Microeconomics Professor Jim Cobbe Welcome!

1. Economics 2023-02 Principles of Microeconomics Professor Jim Cobbe Welcome! Please move in toward the middle of the row!

2. Economics 2023-02 Class 6

3. PRS • Before we do anything else, set up PRS. • Please turn on your clicker. If it is already on, restart it. • Check your garnet ID [FSU email address before the @fsu.edu] is correct in your clicker; get it right if there is a typo. • Now ‘join’ the class. Scan for classes and select ECO 2023-02.

4. Aplia! • The grace period for payment will expire in 3 days (January 28, 2007). 286 students (of 417) have paid. • 423 students are registered at FSU for ECO 2023-02 • That means there are [only?] six real procrastinators who have not yet registered for Aplia: do it or drop!

5. Today’s Class • Is about demand and supply. You probably think you know it already, but you may not know it as well, or as in detail, as we want you to know it. • This is one of the fundamental tools of economics, so it is worth understanding it as well as you possibly can.

6. Why do diamonds cost more than water?

7. Why do Picasso’s paintings sell for more than Leroy Nieman’s?

8. Is it cost of production that determines prices (as Adam Smith thought)?

9. Or is it willingness to pay that determines prices (as Stanley Jevons thought)?

10. Alfred Marshall (Principles of Economics, 1890) was the first to explain clearly how both costs and willingness to pay interact to determine market prices.

11. The market for any good or service consists of all (actual or potential) buyers or sellers of that good or service.

12. The Model of a Competitive Market • We are going to build the standard model of a competitive market • This model assumes: • A homogeneous, perfectly divisible ‘private’ good [or service] • Many [potential] buyers and many [potential] sellers, all small compared to the market • Perfect, costless, information, and no ‘transactions costs’

13. The Model of a Competitive Market • We will also build the model initially allowing only the own-price of the good itself, and the quantity exchanged in a fixed time, to change • Everything else is held constant – ceteris paribus in jargon [Latin in this case – ‘other things equal’] • Later, this lets us reason by asking ‘what happens if’ one of the things held constant does change.

14. Our model • Very few real world markets truly meet all the assumptions [try to think of some] • However, the model works well in many real world situations, and much of this course is about the consequences of ‘relaxing’ some of the assumptions [i.e., what happens if one or more of the assumptions is NOT met]

15. Suppose, with zero risk of detection for either of us, I offered to sell you an A; no more work, you get the A for the course. What’s the most you would pay? • $1,000 • $500 • $250 • $100 • $75 • $50 • $25

16. The market for lobsters in Portland, Maine, on July 20, 2004

17. The demand curve is the set of all price-quantity pairs for which all buyers are satisfied.("Satisfied" means being able to buy the amount they want to at each given price -- jargon.)

18. Horizontal interpretation of the demand curve: If buyers face a price of $4/lobster, they will wish to purchase 4000 lobsters a day.

19. Vertical interpretation of the demand curve: If buyers are currently buying 4000 lobsters a day, the demand curve tells us that buyers would be willing to pay at most $4 for one additional lobster.

20. Demand curves slope downward for two reasons. • As the good becomes more expensive, at least some people switch to substitutes. 2. As the good becomes more expensive, at least some people can’t afford to buy as much [or any] of it.

21. Suppose now I ask you to rake my yard for cash. It will take you two hours’ hard, boring, labor. What’s the smallest sum you would do it for? • $5 • $10 • $15 • $20 • $25 • $50 • $75 • $100

22. The supply curve is the set of price-quantity pairs for which all sellers are satisfied. ("Satisfied" means being able to sell the amount they want to at each price -- jargon.)

23. Horizontal interpretation of the supply curve: If sellers face a price of $4/lobster, they will wish to sell 2000 lobsters a day.

24. Vertical interpretation of the supply curve: If sellers are currently selling 2000 lobsters a day, the marginal cost of a lobster is $4.

25. One reason the supply curve slopes upward is the low-hanging-fruit principle. (Harvest the lobsters closest to shore first.) More generally, as we expand the production of any good, we turn first to those whose opportunity costs of producing that good are lowest, and only later to others with higher opportunity costs.

26. Market Equilibrium Quantity and Price Equilibrium occurs at the price-quantity pair for which both buyers and sellers are satisfied.

27. At the market equilibrium price of $6 per lobster, buyers and sellers are each able to buy or sell as many lobsters as they wish to.

28. Asituation in which price exceeds its equilibrium value is called one of excess supply, or surplus. At $8, there is an excess supply of 2000 lobsters in this market.

29. A situation in which price lies below its equilibrium value is referred to as one of excess demand.At a price of $4 in this lobster market, there is an excess demand of 2000 lobsters.

30. At the market equilibrium price of $6, both excess demand and excess supply are exactly zero.

31. Example 6.1. At a price of $2 in this hypothetical lobster market, how much excess demand for lobsters will there be? How much excess supply will there be at a price of $10?

32. At a price of $2 in this hypothetical lobster market, how much excess demand for lobsters will there be? • 5000 lbs/day • 4000 lbs/day • 1000 lbs/day • 3000 lbs/day

33. How much excess supply will there be at a price of $10? • 1000 lbs/day • 2000 lbs/day • 3000 lbs/day • 4000 lbs/day • 5000 lbs/day

34. The Trading Locus When price differs from the equilibrium price, trading in the marketplace will be constrained-- by the behavior of buyers if the price lies above equilibrium, by the behavior of sellers if below.

35. Movement Toward the Equilibrium Price and Quantity At prices above equilibrium, sellers are not selling as much as they want to. The impulse of a dissatisfied seller is to reduce his price. At prices below the equilibrium value, buyers cannot obtain the quantities they wish to purchase. Some buyers adjust by offering slightly higher prices.

36. Thus, when price lies either above or below its equilibrium value, there is an automatic tendency for it to adjust toward equilibrium.

37. Caveats and Notes • - This is the model of a competitive market, which requires many, small, buyers and sellers. If that condition is not met, for example if there is only one or a few sellers, we may not be able to draw both the curves – there is no supply curve under monopoly. Wait until later in the semester! • - A neat thing about the competitive supply and demand model is that the equilibrium is stable – unless something changes, there is no reason for price or quantity to change. • - Sketching the demand and supply curves and asking if they shift – if this happens, will people want to buy or sell more [or less] at the same price[tells you if the curve moves] – allows one to make a qualitative prediction about at least one of price and quantity.

38. Kinds of Equilibrium

39. Market Equilibrium • One of the neat things about the market is that the Demand and Supply model shows that market equilibrium is generally stable • I.e., it is like • If the ball moves a little, it will go back where it started; if conditions don’t change, but price is perturbed [moved] a little from equilibrium, it will go back where it started.

40. Economic Naturalism • Think of our examples of markets that fit all our assumptions • Do they have stable prices? • Think of examples of markets where prices are stable • Do they fit all our assumptions? • How do we explain this apparent paradox?

41. An extraordinary feature of this equilibrating process is that no one consciously plans or directs it. The actual steps that consumers and producers must take to move toward equilibrium are often indescribably complex. Suppliers looking to expand their operations, for example, must choose from a bewilderingly large menu of equipment options. Buyers, for their part, face literally millions of choices about how to spend their money.

42. And yet the adjustment toward equilibrium results more or less automatically from the natural reactions of self-interested individuals facing either surpluses or shortages.

44. Example 6.2. Should Collegetown Rents Be Regulated?

45. Suppose the supply and demand curves for two-bedroom Collegetown rental apartments are as shown.

46. The city council is concerned that many students cannot afford the equilibrium rent of $1000 per month and is considering a regulation forbidding landlords from charging more than $500. What will be the likely consequences of adopting this regulation?

47. Rent Controls Produce Excess Demand in the Housing Market

48. Responses to excess demand in a regulated housing market: finder’s fees key deposits required purchase of window treatments required furniture rental excessive damage deposits curtailed maintenance condominium conversion

49. There are much more effective ways to help poor people than to give them apartments and other goods at artificially low prices. For example, income transfers: Wage subsidies Public service jobs Or housing vouchers – a ‘tied’ income transfer that can only be used to pay [part or all] of someone’s rent

50. Cash on the Table When a regulation prevents the price of an apartment, or any other good, from reaching its equilibrium level, the total economic surplus (economic benefits less opportunity costs) available for buyers and sellers is diminished. Mutually beneficial exchanges are always possible when a market is out of equilibrium. When people have failed to take advantage of all mutually beneficial exchanges, there is "cash on the table."