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Why are markets important? In order to reap the benefits from specialization, trade must be organized and easy to conduct. Markets which are part of a “market system” facilitate trade. 1 Market System: Characteristics 1.) Markets Market: any arrangement that enables buyers and sellers to get information and do business (trade) with each other. Markets pool information about buyers’ and sellers’ plans and then summarize this information in one number: the price 2 1.) Markets Prices: – Move in response to decisions of buyers and sellers. – Send signals to buyers & sellers i.e., provide information and incentives to buyers and sellers. Function as the rationing device – Money serves as a medium of exchange, eliminating the need for barter 3 1.) Markets Invisible Hand – In markets, buyers & sellers act in their own self interest responding to the incentives provided by changing prices. – Self interested behaviour becomes cooperative action resulting in good solutions for individuals & for society as a whole to the what, how, for whom questions 4 Market System: Circular Flow Decision Makers: – Buyers & Sellers/Households & Firms key players in the market system. – Govt. is also an important decision makerto be added later Markets: – Two kinds of markets make up the “market system”: –Goods Markets & –Resource Markets 5 Revenue Spending Goods Market Firms Sell Goods & HH Buy Goods & services services sold bought Firms Households make & sell buy & consume goods & services goods & services hire factors of sell factors of production production Land, Labour Production and Capital Inputs Factor Market HH Sell Firms Buy Wages, Profits, Income 6 and rent Market System: Decision Makers: 1.) Households – Buyers – consumers/demanders of final goods & services – Sellers – owners/suppliers of scarce resources (factors of production) Rational decision makers in –1. spending income (buying) & –2. allocating/supplying their resources (selling) 7 Market System: Decision Makers: 2.) Firms/Producers – Sellers/suppliers of goods and services – Buyers/demanders of resources Rational decision makers in –1. Production/selling decisions –2. Hiring/buying resources 8 Market System: Markets The 2 kinds of markets in which households & firms meet are: – 1. Markets for Goods & Services households demand/buy firms supply/sell – 2. Markets for Factors of Production (resources/inputs) households supply/sell firms demand/buy 9 Three Basic Economic Questions 1) WHAT and how much will be produced? 2) HOW will it be produced? 3) For WHOM will it be produced? Pure Command Economy An economic system characterized by public ownership of all property resources 3 economic questions answered by a central government Pure Capitalist Economy An economic system characterized by private ownership of all property resources 3 economic questions answered by household and firm interaction Canada – A Mixed Economy Property resources are owned privately and publicly Decisions are made by the private sector and the government Ie) Cost of a pizza – private decision Ie) Taxes and social assistance – government decision Ie) Tuition – mixed decision Demand & Supply Markets for Goods & Services – All the important factors affecting market exchange & therefore market price, can be divided into 2 categories: those affecting demand and those affecting supply. 14 Demand: Definition A schedule showing amounts of a product that consumers are willing and able to purchase at each specific price during some specified time period: everything else held constant. 15 The Law of Demand There is an inverse relationship between the quantity of anything that people will want to purchase and the price they must pay to obtain it: ceteris paribus This causes demand curves to be downward sloping When prices increase, people buy less When prices decrease, people buy more 16 The Individual’s Demand Schedule A B C D E 5.00 4.00 3.00 2.00 1.00 5 Qn/yr 20 30 40 60 50 Price of CD-R ($) Price/Unit $ A B 4 C 3 2 Change in Price Movement along 1 the Demand 0 10 20 30 D E 40 Number of CD-R’s per Year 50 17 Movement Along Demand/ Changes in Quantity Demanded A change in a good’s own price change in quantity demanded – the same thing as a movement along – results in a the same demand curve. 18 A Shift in the Demand Suppose universities Curve outlaw the use of personal computers Decrease in Demand Price of CD-R’s ($) 5 Suppose the federal government gives every student a personal computer. 4 3 Increase in Demand 2 1 0 D3 20 40 60 D1 D2 80 100 120 140 Quantity of CD-R’s Demanded (millions of constant-quality units per year) 19 Shifts/Changes in Demand* A change in one or more of the nonprice determinants of demand (income, tastes, etc) change in demand * – also called a shift in demand* – results in a *The whole demand schedule 20 “Everything Else” : The “Determinants”/ “Shifters” of “Demand” Factors other than Price which affect “Demand” : 1) Income, wealth 2) Tastes and preferences 3) The price of related goods – Complements – Substitutes 4) Expectations – Future prices – Income – Product availability 5) Population (market size) What movement would these factors cause? 21 Compliments and Substitutes Compliment: a good that is consumed WITH another good – Ie: Ketchup and hot dogs – Demand for good A DECREASES when the price of a compliment increases Substitute: a good that is consumed IN PLACE OF another good – Ie: Hamburgers and hot dogs – Demand for good A INCREASES when the price of a substitute increases 22 Review of Demand Terminology Demand: a schedule of quantities that will be bought/unit of time, at various prices, ceteris paribus. Quantity Demanded: a specific amount that will be demanded /unit of time at a specific price, ceteris paribus. Distinguish between a change in the Quantity Demanded and a shift in Demand. 23 A policy to discourage smoking (no smoking in public buildings) shifts the demand curve left Price of Cigarettes, per pack Price of Cigarettes, per pack Shift vrs. Movement $2 D’ 10 A tax raises the price of cigarettes, resulting in a movement along the demand curve $4 $2 D D 20 Number of Cigarettes smoked per day 10 20 Number of Cigarettes smoked per day 24 Normal vrs. Inferior Goods For inferior goods, Demand increases When income decrease Price of Kraft Dinner Price of Chicken For normal goods, Demand decreases With income $2 D’ 10 $2 D’ D 20 Chicken eaten in a month D 10 20 30 Kraft Dinner eaten in a month 25 Supply: Profit The Cost side of the profit equation depends on the Costs of Production which depend on the kinds of inputs used the amount of each input used prices of inputs used technology 26 Supply: Definition A schedule that shows how much of a product a firm will supply at alternative prices for a given time period “ceteris paribus”. 27 The Law of Supply • The price of a product or service and the quantity supplied are directly related: “ceteris paribus” • Causes an upward sloping supply curve • The higher the price of a good, the more sellers will make available • The lower the price of a good, the fewer sellers will make available • All else being equal 28 The Individual Producer’s Supply Schedule Qnty of F $5 550 G 4 400 H 3 350 I 2 250 J 1 200 5 Price of CD-R ($) Price / CD-R CD-R Supplied (thousands / year) F G 4 H 3 I 2 1 J Change in Price Movement along The Supply 0 100 200 300400500 600 Quantity of CD-R Supplied (thousands of constant-quality units per year) 29 Movement Along Supply/ Changes in Quantity Supplied – A change in a good’s own price change in quantity supplied. that is, a movement along the supply curve. leads to a 30 A Shift in the Supply Curve When supply decreases the quantity supplied will be less at each price: eg, employees form a union and successfully negotiate higher wages. Price of CD-R ($) 5 S2 a b 4 3 b c d S2 S1 d 2 1 0 20 40 60 When supply increases the quantity supplied will be greater at each price: eg, producer finds that she can use some cheaper materials due to a technology change. 80 100 120 140 Quantity of CD-R Supplied (millions of constant-quality units per year) 31 Shifts/Changes in Supply A change in one or more of the non-price determinants of supply leads to a – change in supply which is the same thing as a – shift of the supply curve. 32 “Everything Else” : The “Determinants”/“Shifters” of Supply Factors Supply other than Price that affect – 1) Cost of inputs (price in factor markets) – 2) Technology and Productivity – 3) Taxes and Subsidies – 4) Price Expectations (in the product market) – 5) Number of firms in the industry How will these shift supply? 33 Market Equilibrium Price & Quantity Market: where prices tend toward equality through the continuous interaction of buyers and sellers: the market forces of demand and supply 34 Market Equilibrium Price & Quantity Perfectly Competitive Market Buyers & sellers numerous enough that no single buyer/seller can influence the price Buyers & sellers are free to enter or exit the market at any time Each party to the market exchange has full information Single Equilibrium Price 35 Putting Demand and Supply Together: Finding Market Equilibrium (1) (2) (3) Price per Constant-Quality CD-R Quantity Supplied (CD-R per year) Quantity Demanded (CD-R per year) (4) Difference (2) - (3) (CD-R per year) (5) Condition $5 100 million 20 million 80 million Excess quantity supplied (surplus) 4 80 million 40 million 40 million Excess quantity supplied (surplus) 3 60 million 60 million 0 2 40 million 80 million -40 million Excess quantity demanded (shortage) 1 20 million 100 million -80 million Excess quantity demanded (shortage) 36 Market Equilibrium: Definition The condition in a S market when quantity supplied equals quantity demanded at a QD= QS particular price; a point from where there tends to be B no movement Excess quantity supplied at price $5 Price per CD-R ($) 5 4 Market clearing, or equilibrium, price 3 E 2 A 1 Excess quantity demanded at price $1 0 20 40 60 80 D 100 Quantity of CD-R (millions of constant-quality units per year) 37 The Law of Supply & Demand The expression used to describe the fact that the price of any good will adjust until the price is such that the quantity demanded is equal to the quantity supplied, and the market clears resulting in a single market clearing or equilibrium price. 38 Adjustment Example: Gas Prices Summer: Gas prices at equilibrium at $1.07 per liter Winter arrives and certain drivers limit or end their driving for the season (shift in demand) The liter new market equilibrium is $0.70 per 39 The Price System/Market System The equilibrium price rations the limited amount of a good produced by the most willing and able suppliers, or sellers, to the most willing and able demanders or buyers. – Prices signal what is relatively scarce and relatively abundant – Prices provide information and incentives –Prices ration 40 Changes in Market Equilibrium: Shifts in Demand &/or Supply •Suppose something in the demand &/or the supply ceteris paribus envelope(s) changes. •How is the MARKET affected? – 1.) Decide whether Demand &/or Supply is affected. – 2.) Decide in which direction the affected Demand &/or Supply will move. – 3.) Use a Demand and Supply diagram to determine the new equilibrium. 41