Scott Wentland wentlandsa@longwood 434-395-2160

1. Scott Wentland wentlandsa@longwood.edu 434-395-2160 Longwood University201 High StreetFarmville, VA 23901

2. Markets Part 1 – What are markets?

3. Where does value really come from? • Individuals(last lecture) • Looked at how individuals determine value for themselves (subjective value for goods we consume) • Individuals think “on the margin” • Diamonds are more valuable than water, because an additional diamond makes us much happier than an additional bottle of water (assuming we’re not in desert) • But this story is incomplete… • Diamonds would be valuable to you, even if you didn’t like diamonds…

4. Even if you didn’t like diamonds, you could always sell a diamond on the market… • Markets(this lecture) • Markets are made up of individuals (consumers and producers) who trade with one another • Buying/selling is the market’s way to address scarcity • Prices help buyers and sellers make good decisions and help make the market “efficient” • Markets can be best understood by understanding the laws of supply and demand

5. Markets are everywhere and anywhere, where people buy and sell something for a price • This is a VERY general definition • Examples: • Stock market • Shopping mall or flea market • Grocery store • Street corner (illegal or black markets are still markets) • Ebay or Amazon (markets don’t have to even be a physical place) • Labor market (selling your services…wage = price) • Prices don’t even have to be in cash, they can be barter exchanges

6. Why do we have markets? • We don’t live in a world where everyone begins with everything he or she will ever want/need • We learn this at lunch in grade school • Mom packed pudding, I want chips • Joe’s mom packed chips, Joe wants pudding • I trade my pudding for Joe’s chips • We’re both happier  a more efficient allocation • Markets help us allocate resources efficiently • (This is just one of many things markets do…) • Why is resource allocation important?

7. We live in a world of scarcity • Humans have infinite wants and needs • Our resources are finite. • In economics, scarcity is the idea that our wants/needs exceed our resources • Even if our physical resources were infinite, we would still be constrained by time we cannot escape scarcity • Markets help us get the most out of what we’ve got • Also provide incentives for advancement (more on this later)

8. An economy that lets markets (i.e. buyers/sellers) produce, control, and allocate resources is a market economy. • Goods and services are freely traded at mutually agreeable prices • Factors of production (land, labor, capital) or inputs are primarily owned privately (not by government) • Low government involvement in the day-to-day economy • Also called capitalism, free market capitalism, or laissez faire capitalism • Are markets the only way to allocate resources?

9. Planned (or command) economy • The government (or “The People”): • Decides what to produce, who produces it, and who gets it • Decide how resources are allocated • Own the factors of production (land/natural resources, labor, capital) and plan how they are used • Buying and selling in markets are largely prohibited • Also called central planning or communism

13. Also called “mixed economies”…most economies are “mixed” Next lecture: how do markets work?

14. Markets Part 2 – How do markets work? A (very brief) intro to supply & demand

15. Supply and demand • Supply represents the sellers • In a pure free market  many sellers • Demand  represents the buyers • In a pure free market  many buyers • In markets, buyers and sellers come together to exchange • For any given good, a price emerges as a market price, as a result of negotiations between them

16. Consumer have a limited income and want to maximize utility (or happiness) • Buyers always want the lowest price they can get • When something becomes cheap, consumers tend to buy more • When something becomes expensive, consumers economize and cut back on quantity of that • Common sense, right?

17. Law of demand: “an increase in a product’s price results in a decrease in quantity demanded” holding all else constant • Income • # of buyers in the market • Prices of other goods • Substitutes • Complements • Expectations • Tastes • These may “shift demand” if they change • More about that in a full microeconomics course…

18. Demand Curve The Demand Curve for Oil is a Function Showing the Quantity of Oil Demanded at Different Prices Price of Oil per Barrel $55 $20 $5 Demand Quantity of Oil (MBD) 5 25 50

19. Producers/sellers want to maximize profit • Profit margin = Price – Average Cost • They always want the highest price they can get • When something becomes more expensive, businesses want to supply/sell more of their product

20. Law of supply: “an increase in a product’s price will result in an increase in quantity supplied by the market” holding all else constant • Holding what else constant? • Technological Innovations • Input Prices • Taxes and Subsidies • Expectations • Entry or Exit of Producers • Changes in Opportunity Costs

21. Supply Curve The Supply Curve for Oil is a Function Showing the Quantity of Oil Supplied at Different Prices Price of Oil per Barrel Supply Curve for Oil $55 $20 $5 Quantity of Oil (MBD) 10 50 30

22. Buyers want the lowest price • Sellers want the highest price • When they come together, they generally meet somewhere in the middle • They work out mutually beneficial exchanges and a market price emerges • Supply = Demand

23. Equilibrium Price is Determined by Supply and Demand Price of Oil per Barrel Supply Curve Equilibrium Price $30 Demand Curve Quantity of Oil (MBD) 65 Equilibrium Quantity

24. An optimal price emerges out of buyers and sellers interacting in the market • Why is this price optimal or efficient? # Supplied = # Demanded (at the equilibrium price) • The lowest cost, most efficient sellers are the ones who supply at that price • The highest valued buyers are the ones who buy at that price • All possible mutually beneficial trades have taken place at that price • There are no sellers left who want to sell at a price that another buyer would agree to.

25. If we were to design an allocation of stuff at the beginning we would want: • The people who are best, lowest cost producers to make stuff • We don’t want people in Alaska to grow oranges  wasteful and inefficient • The people who have the highest value for stuff to get it and consume it • We don’t want people who don’t like oranges to get them  wasteful and inefficient • Markets get us this efficient outcome, without anyone planning it

26. An equilibrium will emerge in any free market • Check Ebay for the price of a specific product • Buyers bid until a price settles on some equilibrium price • If a similar item goes up for auction, it sells for about the same amount (assuming nothing else has changed) • Compare travel sites for any given flight • Equilibrium price is very close • That equilibrium may change, as other things that affect supply and demand change • Supply and demand conditions constantly change • Markets are dynamic  prices change

27. Back to our diamond/water paradox… • Diamonds are also valuable because they have a high market price as a result of supply and demand • In the last lecture, we talked about from an individual buyer’s perspective • Here, we take the entire market perspective • Diamonds have a: • Low supply • very rare, hard to find, labor intensive, few sellers • High demand • Many uses, many buyers want them relative to supply • High price. • Water’s low market price is largely due to high supply

28. Understanding markets through supply and demand helps us understand • Value and prices in a market economy • How market economies allocate resources efficiently • Full microeconomics course • Learn a lot more about supply and demand • How to use supply and demand to understand markets better • Predict prices based on particular events • Predict how certain government policies (e.g. minimum wage) affects markets

29. http://en.wikipedia.org/wiki/Scarcity http://en.wikipedia.org/wiki/Market_economy http://en.wikipedia.org/wiki/Social_market_economy http://en.wikipedia.org/wiki/Planned_economy http://en.wikipedia.org/wiki/Factors_of_production http://en.wikipedia.org/wiki/Supply_and_demand