Chapter 4 Microeconomics

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Market:
A group of buyers and sellers of a particular good or service
Can be highly organized New York Stock Exchange
Can be less organized market for ice cream
The basic competitive model builds on 3 assumptions: rational
consumers, profit-maximizing firms, and competitive markets.
These assumptions determine how consumers behave, how firms
behave, and how the market mediates their interactions.
Government is ignored in the basic model in order to isolate private
decision making (the model ignores the government because we
need to see how an economy functions without input from the
government).
Economists label this case perfect competition.
Assume there are many firms selling equivalent products to many
consumers (what the consumers consider to be interchangeable)
Competitive Market:
Many buyers and many sellers
Each has a negligible impact on market price
Assume there is a going price or (market price)

If a firm charged any more than the going price then it would lose all its
sales
Next: a model with the highest (that is, the most intense) form of
competition
In the perfect competition each firm is a price taker, which simply means
because it cannot influence the market price, it must accept that price
Firms in competitive markets all charge the same price
Monopoly:
The only seller in the market
Sets the price
There are other types of markets
Between perfect competition and monopoly
Our model of a perfect competitive market has two types of decision maker:
Buyers and Sellers
Demand:

Describes how the amount or quantity of goods and services bought can
change with changes in a number of variables like income, social trends,
and population
Economist often treat price as the most important determinant of the
level of demand
Individual Demand:
Demand curve: gives the quantity demanded at each price while
everything else is held constant
A demand curve usually slopes downward from left to right
When the price of a good increases the demand for that good usually

decreases when everything else is held constant

Individual demand curves usually have a negative slope
It has a negative slope because people usually tend to buy more of a
good if it is less expensive
Demand curve: a curve which shows the quantity demanded at each price
2 market demand curves usually have negative slopes
As you increase the price people stop buying so you get this negative
slope
Suppose Q = 24 3P + V

When V = 0 Q = 24 3P

Equilibrium

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Definition of equilibrium: a situation in which various forces are in

balance
Definition of a markets equilibrium: a situation in which the market
price has reached a level where the quantity supplied equals the quantity
demanded
At a markets equilibrium, supply and demand are in balance(in that the
quantity of the good that buyers are willing to and able to buy exactly
balances the quantity that sellers are willing and able to sell
Put the demand and supply curves together on the same graph
Equilibrium is simply where they intersect
The equilibrium price and quantity as the intersection of market demand
and market supply
When the price is such that quantity demanded equals quantity supplied,
economists say that market clears
A shortage means that people who are willing to pay the going price
cannot find the good
There are instances when the market does not clear but rather suffers a
shortage or surplus
A surplus means that goods go unsold at the going price

Sellers compete to move the merchandise

Consumers compete to get a bargain
If you have a surplus the price will usually go down
If you have a shortage they have an incentive to increase the price
because consumers are willing to pay more for a good
The rate of adjustment depends on the kind of market as well as the size
of surplus
In most free markets, the surpluses and shortages are temporary
Law of Supply and Demand

The claim that the price of a good adjusts to bring the quantity supplied
and the quantity demanded into balance
Demand curve: Q^D = 500 -.5P
Supply Curve: Q^s = -200 + 1P
Set Q^D = Q^S
400 - .5P = 200 + 1P
Solve for P: 600 = 1.5P P=400
Solve for Q: Q = 400-200 Q=200

Using Supply and Demand Curves:

Supply and demand are fundamental tools of economics
The key in being able to use supply and demand curves is being able to
determine which curve is shifting, and how the intersection determines
the equilibrium price
Change in demand: a shift in the demand curve that occurs when a nonprice determinant of demand changes (ex: income)
Changes in the quantity demanded: a movement along a fixed demand
curve for a good that occurs when the price of that good changes

Example where demand can shift from a change in income (Y):

Q^D = 200 2P + 1/2Y
Q^S = 3P 100
Find Equilibrium P and Q when Y = 0
Q^D = Q^S
200 2P = 3P 100
Solve for P: 300 = 5P P=60
Solve for Q: Q = 200 2(60) Q= 80
Find equilibrium P and Q when Y = 20

Increase in supply: the equilibrium price will fall and the equilibrium
quantity will rise
Increase in demand: equilibrium price rises, and the equilibrium quantity
rises
Q^D = Q^S
8 -1/2P = P-4
p=8, Q = 4
Suppose the supply curve shifts 3 units to the left
New supply equation is Q^s = P-7

We have a new equilibrium

8 1/2P = P-7
P = 10 Q = 3 (before 10, we had 8, before 3 we had 4)
Market for Hybrid Cars
Increase in price of gas: demand shifts right
The shift causes increase in price and quantity of hybrid cars
New technology reduces cost of producing hybrid cars:

Supply shifts to the right because this event reduces cost, makes
production more profitable at any given price
This shift causes price to fall and quantity to rise
Example: price of gas rises and new technology reduces production costs
Both curves shift to the right, quantity rises, but effect on price is
ambiguous: if demand increases more than supply, price will rise

The Market Forces of Supply and Demand9/19/2013 5:42:00 AM

What might have causes this shift in the demand curve?
The shift could have not been caused by the change of price in the candy
bar. That would have shown as a movement along the demand curve.
A change in tastes could have potentially cause the shift seen in Figure
3.4.
What can be the source of a shift in a demand curve?
A possible source: a change in tastes
A possible source: a change in income
An increase in income increases the demand for most goods (the demand
curve shifts to the right)

When an income increases demand, the good is called a normal good

When an increase in income decreases the demand, the good is called a
inferior good (such as people who once took the bus, now have money
to buy a car. Taking the bus was considered inferior)
Whether a good is normal or inferior can depend on the initial income
level and the new income level were considering
An example:
Low-income individuals commonly increase their purchases of secondhand clothes when their incomes increase a little.
Middle-income individuals commonly reduce their purchases of secondhand clothes when their incomes increase a little (since they can afford to
buy more new clothes instead)
A possible source: a change in the price of another good
When the price of coffee rises, there is movement along the demand
curve for coffee
More specifically, when the price of coffee rises, the demanded amount of
coffee decreases
When the demanded amount of coffee decreases the amount for tea
increases
The increase in the demand for tea causes the curve for tea to shift to the
right
Two goods are substitutes when the demand for one of the goods
increases when the price of the other good increases
Examples of substitutes:
Coffee and tea
Margarine and butter

1989 wine and 1990 red wine

BMWs and Mercedes
Candy Bars and granola bars
When the demanded amount of peanut butter decreases, the demand for
jelly decreases
The decrease in the demand for jelly causes the demand curve for jelly to
shift to the left
Two goods are complements if the demand for one of the goods
decreases when the price of the other good increases
Examples of complements:

Peanut butter and jelly

Coffee and sugar
Pizza and soda
Movies and popcorn
Red wine and steak
Some other sources of shifts in demand curves
Changes in the availability of credit
If banks reduce the number of auto loans they approve, the demand for
cars decreases and the demand curve shifts to the left

A change in expectations
If consumers believe the price will increase in the future, demand
increases today (when the good is cheaper); this shift the demand curve
to the right
Changes in demographics (ex: fewer teens in a pop means less demand
for goods popular with teens, thus shift to the left)
Shifts in a Demand Curve Versus Movements Along a Demand Curve
Figure 3.7 illustrates the difference between shifts in a demand curve and
movement along a demand curve

A movement along a curve is caused by changes in the price, a shift in

the curve happens when demand changes with prices staying the same
Supply
Supply describes how the quantity of goods and services sold can change
with changes in a number of variables like technology and the weathers.
Economists focus on price as the most important determinant of the level
of supply.
Definition of the supply curve: the quantity supplied at each price

The supply curves the quantity supplied at each price when everything
else is held constant
A supply curve usually slopes upward from left to right
When the price of a good increases, the supply for that good usually
increases- when everything else is held constant
Why does the supply curve typically have a positive slope?
Because suppliers find it more profitable to produce more goods when
there are higher prices.
Market Supply:
A market supply curve shows the quantity supplied at each price
A market supply curve is formed by adding up the supply curves of each
supplier
The market supply curve is the horizontal sum of the supply curves of all
the suppliers
Just as individual supply curves have a positive slope, so do market
supply curves
Figure 3.9 constructs a market supply curve for candy bars. It has a
positive slope
Let v denote another variable (besides p) that can affect Q
Suppose Q = 5P + v
When v=0, Q = 5P
When v=5 Q = 5P + 5
Shifts in Supply Curves
Just like demand curves, supply curves shift due to changes
The supply curve shows how price affects quantity supplied, when other
things are held constant
These other things are non-price determinants of supply
Changes in them can shift the supply curve

Sources of shifts in supply curves

A change in the natural environment
A change in the price of inputs

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Scarcity means that society has limited resources and therefore cannot
produce all the goods and services people wish to have.
Economics is the study of how society manages its scarce resources.
Efficiency means that society is getting the maximum benefits from its
scarce resources.
Equality means that those benefits are distributed uniformly among
societys members.
The opportunity cost of an item is what you give up to get that item.
rational people: people who systematically and purposefully do the best
they can to achieve their objectives
marginal change: a small incremental adjustment to a plan of action
An incentive is something that induces a person to act, such as the
prospect of a punishment or a reward.
In other words, a higher price in a market provides an incentive for buyers
to consume less and an incentive for sellers to produce more.
market economy: an economy that allocates resources through the
decentralized decisions of many firms and households as they interact in
markets for goods and services