Download Lecture 3: Open Markets

Economics for Leaders
Lesson 3: Open Markets
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Economic Reasoning Principle # 3:
People respond to incentives in
predictable ways.
• Choices are influenced by incentives, the
rewards that encourage and the punishments
that discourage actions. When incentives
change, behavior changes in predictable ways.
Economic Reasoning Principle # 4:
Institutions are the “rules of the game”
that influence choices.
• Laws, customs, moral principles, superstitions,
and cultural values influence people’s choices.
These basic institutions controlling behavior
set out and establish the incentive structure
and the basic design of the economic system.
Choose Between Alternatives
People do things that make them better off.
Do it if……
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Where do prices come from?
Prices are the result of interaction between
buyers and sellers (demanders and suppliers).
Prices are determined in the marketplace.
We just saw this happen!
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Production (Supply)
People do things that make them better off.
For a producer, the benefit is the price
received from selling the good.
For the producer, the cost is the opportunity
cost of the materials and risk involved in
producing the good.
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The World is Full of People
The World is Full of People
Let’s Graph it
Law Of Supply
sellers could produce other things
price → opportunity cost
high price →
produce more
higher price means more incentive to produce this
good relative to what else you could do
supply represents marginal (opportunity) cost
willingness to sell (corn/ethanol)
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Sellers
Consumption (Demand)
People do things that make them better off.
For a buyer, the benefit is the satisfaction from
consuming the good.
For a buyer, the cost is the price paid for the
good (what is given up).
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The World is Full of People
The World is Full of People
Let’s Graph it
Law Of Demand
consumers could purchase other things
price → opportunity cost
high price → purchase less
higher price means less incentive to consume this
good relative to what else you could do
demand represents value (compared to alternatives)
willingness to pay (gasoline)
Buyers
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How Do Markets Work?
Buyers and sellers each perform cost/benefit analysis.
Buyers
Price is a measure of relative scarcity.
Price represents opportunity cost.
Price sends signals/incentives to players.
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Sellers
Buyers
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Equilibrium
Sellers
Buyers
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Equilibrium
Sellers
Buyers
Dis-quilibrium
Sellers
Buyers
Dis-quilibrium
Sellers
Buyers
Equilibrium
Sellers
Property rights, information, interaction and
competition.
Price squeezes to where Qs = Qd & market
clears.
This price facilitates all transactions that can
make both a buyer and a seller better off.
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What If Something Changes?
price
income, price of other goods, tastes & preferences
Recall the market for ice cream.
Suppose the weather gets hotter.
What would you expect to happen?
Buyers
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↑ T&P
Price of
Ice-Cream
Cone
1. Hot weather increases
the demand for ice cream . . .
D shifts
right
Supply
shortage at
P1
New equilibrium
$2.50
2.00
2. . . . resulting
in a higher
price . . .
ΔD
Disequilibrium
P adjusts
Qs responds
Law of S
Initial
equilibrium
D
D
7
3. . . . and a higher
quantity sold.
10
Quantity of
Ice-Cream Cones
P ↑ to restore equilibrium (sellers respond, Qs ↑)
new equilibrium: higher P & higher Q
What If Something Changes?
price
price of inputs, technology, weather
Recall the market for ice cream.
Suppose the price of sugar increases.
What would you expect to happen?
Sellers
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↑ P input
Price of
Ice-Cream
Cone
S2
S shifts
left
1. An increase in the
price of sugar reduces
the supply of ice cream. . .
S1
shortage
at P1
New
equilibrium
$2.50
Initial equilibrium
2.00
2. . . . resulting
in a higher
price of ice
cream . . .
ΔS
Disequilibrium
P adjusts
Qd responds
Law of D
Demand
4
7
3. . . . and a lower
quantity sold.
Quantity of
Ice-Cream Cones
P ↑ to restore equilibrium (buyers respond, Qd ↓)
new equilibrium: higher P & lower Q
Big Ideas
Scarcity implies/necessitates rationing.
Rationing implies/necessitates competition.
Markets coordinate information & competition.
Markets allocate scarce resources to the
production of the goods and services.
Markets distribute produced goods and
services to society.
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Big Ideas
Goods go to consumers with the highest value.
Goods are produced by sellers with the lowest
opportunity cost.
The well-being of society is maximized.
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Big Ideas
Markets dynamically adjust to reflect changes
in relative scarcity and preferences.
People respond to incentives in predictable
ways.
Profit is the Motivator!
Competition is the Regulator!
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