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