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Extra Slides for Review (Slides 1-30) 1. Demand

Extra Slides for Review (Slides 1-30) 1. Demand . Tony’s Demand Schedule & Curve. Price of Coffee. Quantity of Coffee. 0. Price. Tony’s Q d. Dani’s Q d. $0.00. 16. +. 8. =. 24. 1.00. 14. +. 7. =. 21. 2.00. 12. +. 6. =. 18. 3.00. 10. +. 5. =. 15. 4.00. 8. +. 4.

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Extra Slides for Review (Slides 1-30) 1. Demand

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  1. Extra Slides for Review (Slides 1-30)1. Demand

  2. Tony’s Demand Schedule & Curve Price of Coffee Quantity of Coffee 0

  3. Price Tony’s Qd Dani’s Qd $0.00 16 + 8 = 24 1.00 14 + 7 = 21 2.00 12 + 6 = 18 3.00 10 + 5 = 15 4.00 8 + 4 = 12 5.00 6 + 3 = 9 6.00 4 + 2 = 6 0 Market Demand versus Individual Demand • The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price. • Suppose Tony and Dani are the only two buyers in the coffee market. (Qd = quantity demanded) Market Qd

  4. The Market Demand Curve for Coffee 0 P Q

  5. Willingness to Pay (WTP) A buyer’s willingness to pay for a good is the maximumamount the buyer will pay for that good. WTP measures how much the buyer values the good. Example: 4 buyers’ WTP for an iPod the Red Hot Chili Peppers

  6. WTP and the Demand Curve Q:If price of iPod is $200, who will buy an iPod, and what is quantity demanded? A: Flea & Anthonywill buy an iPod, Chad & John will not. Hence, Qd = __when P = $200.

  7. WTP and the Demand Curve P (price of iPod) who buys Qd Derive the demand schedule: $301 & up nobody 0 251 – 300 Flea 1 176 – 250 Anthony, Flea 2 126 – 175 Chad, Anthony, Flea 3 0 – 125 John, Chad, Anthony, Flea 4

  8. WTP and the Demand Curve P Qd=0 Qd=1 Qd=2 $175 Qd=3 $125 Qd=4 Q

  9. About the Staircase Shape… P This D curve looks like a staircase with 4 steps. If there were a huge # of buyers, as in a competitive market, there would be a huge # of very tiny steps, and it would look more like a smooth curve. Q

  10. Shifts of D Curve • Economic variables held constant when specifying demand include income, wealth, prices of related goods, preferences, price expectations, the number of buyers… • If one of the above variables change, the demand curve will shift.

  11. P Q 0 Suppose the number of buyers increases. Then, at each price, quantity demanded will increase (by 5 in this example). D curve shifts to the right.

  12. 2. Supply

  13. Starbucks’ Supply Schedule & Curve 0 P Q

  14. Price Starbucks Jitters $0.00 0 + 0 = 0 1.00 3 + 2 = 5 2.00 6 + 4 = 10 3.00 9 + 6 = 15 4.00 12 + 8 = 20 5.00 15 + 10 = 25 6.00 18 + 12 = 30 0 Market Supply versus Individual Supply • The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price. • Suppose Starbucks and Jitters are the only two sellers in this market. (Qs = quantity supplied) Market Qs

  15. P Q The Market Supply Curve 0

  16. Cost and the Supply Curve • Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost). • Includes cost of all resources used to produce good, including value of the seller’s time. • Example: Costs of 3 sellers in the lawn-cutting business. A seller will only produce and sell the good if the price exceeds his/her cost. Hence, cost is a measure of willingness to sell.

  17. Cost and the Supply Curve P Qs Derive the supply schedule from the cost data: $0 – 9 0 10 – 19 1 20 – 34 2 35 & up 3

  18. P Q Cost and the Supply Curve $35

  19. Shifts of S Curve • Economic variables held constant when deriving a supply curveinclude production technology, input prices, taxes and subsidies, and price expectations

  20. Example: input prices 0 • Examples of inputs: for coffee: milk, sugar, coffee machines, buildings… • A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right.

  21. P Q Example: input prices 0 Suppose the price of milk falls. At each price, the quantity of coffee supplied will increase (by 5 in this example).

  22. 3. Welfare Measures

  23. (1) Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus the buyer actually pays. Suppose P = $260. Flea’s CS = $300 – 260 = $__. The others get no CS because they do not buy an iPod at this price. Total CS = $___.

  24. Flea’s WTP CS and the Demand Curve P P = $260 Flea’s CS = $300 – 260 = ___ Total CS = ___ Q

  25. Flea’s WTP Anthony’s WTP CS and the Demand Curve P Instead, suppose P = $220 Flea’s CS = $300 – 220 = ___ Anthony’s CS =$250 – 220 = ___ Total CS = ____ Q

  26. CS and the Demand Curve P The lesson: Total CS equals the area below the demand curve & above the price. Q

  27. Price per pair P h 1000s of pairs of shoes D Q CS with Lots of Buyers & a Smooth D Curve The Demand for Shoes Q: P = $30, CS=? A: CS is the area below the D curve and above the P. Recall: area of a triangle equals ½ x base x height So, CS=½ x 15 x $30 = _____ $

  28. (2) Producer Surplus P Producer surplus (PS): the amount a seller is paid for a good minus the seller’s cost. Q

  29. Kitty’s cost Hunter’s cost Angelo’s cost Producer Surplus and the S Curve P Suppose P = $25 Angelo’s PS = ___ Hunter’s PS = ___ Total PS = ____ $25 Total PS equals the area below the price and above the supply curve. Q

  30. Price per pair P S h 1000s of pairs of shoes Q PS with Lots of Sellers & a Smooth S Curve The supply of shoes Q: P=$40, PS=? A: PS is the area below the P and above the S curve. The height of this triangle is $40 – 15 = $25. So,PS= _____________ = $312.5 $15

  31. Modeling the Market Process: A Review of the Basics Chapter 2

  32. 1. Market Models: Fundamentals • Defining the Relevant Market • A market: the interaction between _________&___________to exchange a well-defined commodity • Defining the market context is one of critical steps in economic analysis • Specifying the Market Model • Qualitative and quantitative relationship

  33. 2. Supply and Demand: An Overview • Primary objective of the supply and demand model is to facilitate an analysis of market conditions and any observed change in price • Sellers’ decisions are modeled through a _______ function and buyers’ decisions are modeled through a _______ function

  34. Competitive Market for Private Goods • Private goods are commodities that have two characteristics: excludable and rival in consumption • A competitive market is characterized by: • A large number of buyers and sellers with no control over price • The product is homogenous or standardized • The absence of entry barriers • Perfect information

  35. Important Characteristics of Goods • A good is excludable if a person can be prevented from using it if he does not pay for it. • excludable: fish tacos • not excludable: national defense • A good is rival in consumption if one person’s use/consumption of it diminishes others’ use/consumption. • rival: fish tacos • not rival: national defense

  36. 3. Demand • Demand refers to the quantities of a good the consumer is willing and able to buy at a set of prices during some time period, ceteris paribus (c.p.) • The willingness to pay (WTP), or demand price, measures the marginal benefit (MB) from consuming another unit of the good • Law of Demand says there is an _________ relationship between price (P) and quantity demanded of a good (qd), c.p.

  37. Market demand captures the decisions of all consumers willing and able to purchase a good • For a private good, market demand is found by horizontally summing individual demands

  38. Market DemandBottled Water (P) Price $11.50 P = –0.01QD + 11.5 D 1,150 (QD) Quantity

  39. 4. Supply • Supply refers to the quantities of a good the producer is willing and able to bring to market at a given set of prices during some time period, c.p. • Law of Supply – there is a direct relationship between price (P) and quantity supplied (qs) of a good, c.p. • Rising marginal cost (MC) supports this positive relationship (willingness to sell should cover MC)

  40. Market Supply captures the combined decisions of all producers in a given industry • Derived by horizontally summing the individual supply functions

  41. Market SupplyBottled Water (P) Price S P = 0.0025QS + 0.25 0.25 (QS) Quantity

  42. 5. Market Equilibrium • Supply and demand together determine a unique equilibrium price (PE) and equilibrium quantity (QE), at which point there is no tendency for change • PE occurs where ____________ • Model for bottled water • D: P = –0.01QD + 11.5 • S: P = 0.0025QS + 0.25 • Equilibrium found where –0.01QD + 11.5 = 0.0025QS + 0.25, or where QE = 900 and PE = _________

  43. Price 11.50 S 2.50 0.25 D Quantity 900 Market EquilibriumBottled Water PE QE

  44. FYI Market Adjustment to Equilibrium • Disequilibrium occurs if the prevailing market price is at some level other than the equilibrium level • If actual price is below its equilibrium level, there will be a shortage • Shortage = excess demand = QD – QS • If actual price is above its equilibrium level, there will be a surplus • Surplus = excess supply = QS – QD • Price movements serve as a signal that a shortage or surplus exists, whereas price stability suggests equilibrium

  45. 6. Efficiency Criteria(1) Allocative Efficiency • At the market level, allocative efficiency requires that resources be appropriated such that additional benefits to society are equal to additional costs incurred, i.e., _____________ • The value society places on the good is equivalent to the value of the resources given up to produce it • At the firm level, this efficiency is achieved at a competitive market equilibrium, assuming firms are _________________________

  46. FYI Profit Maximization • Total Profit () = Total Revenue (TR) - Total Costs (TC) • TR = P x Q • TC is all economic costs, explicit and implicit • Profit is maximized where TR/Q = TC/Q, or where ________________ • MR = TR/Q, additional revenue from producing another unit of Q • MC = TC/Q, additional cost from producing another unit of Q

  47. FYI Profit Maximization • In competitive industries, firms face constant prices determined by the market, which means P = MR • Therefore the competitive market equilibrium achieves allocative efficiency because: •  maximization requires: MR = MC • Competitive markets imply: P = MR • So maximization in competition means: P = MC, which defines allocative efficiency

  48. $ MC P = MR 2.50 0.25 qE = 36 Quantity FYI Profit MaximizationBottled Water

  49. (2) Technical Efficiency • Technical Efficiency refers to production decisions that generate _____________________given some stock of resources • Market forces can achieve technical efficiency so long as competitive conditions prevail • Competitive firms must minimize costs to remain viable in the market because they cannot raise price to cover the added cost of inefficient production

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