Download Markets

1
Markets
Chapter 3
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duplicated, or posted to a publicly accessible website, in whole or in part.
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Examples of Markets
Markets are where people make comparisons. Buyers and sellers interact with
the goal of an exchange taking place.
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posted to a publicly accessible website, in whole or in part.
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duplicated, or posted to a publicly accessible website, in whole or in part.
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Willingness to Pay and Consumer
Benefits
A demand curve identifies the
maximum amount consumers are
willing to pay for any given amount
of a good.
The difference between the amount
consumers are willing to pay and
the amount they have to pay is called
consumer surplus.
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posted to a publicly accessible website, in whole or in part.
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Demand and Quantity Demanded
A movement from A to B on demand
curve D is referred to as an increase
in the quantity demanded.
A
B
A shift in the demand curve from
D to D1 is referred to as an increase
in demand.
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D1
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Demand Shifters
Information: learning that the
consumption of macaroons
increases the risk of heart attack,
shifts the demand curve from
D1 to D2.
Income or wealth: if an increase
in income shifts the demand for
macaroons from D1 to D2 we say
macaroons are an inferior good.
Prices of related goods: if the price of a substitute for macaroons decreases, the
Demand for macaroons will shift from D1 to D2.
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posted to a publicly accessible website, in whole or in part.
8
From Individual to Market Demand
The market demand curve is the horizontal summation of all the demand curves of
individual consumers.
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posted to a publicly accessible website, in whole or in part.
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duplicated, or posted to a publicly accessible website, in whole or in part.
10
The Profit Motive and the Gains to
Producers
The supply curve shows the
minimum price that sellers
will accept for
various quantities of a good.
The difference between the
minimum price they will accept
and the price they receive is
referred to as the producer
surplus.
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posted to a publicly accessible website, in whole or in part.
11
Supply and Quantity Supplied
The movement from A to B on supply
curve, S is referred to as an increase
in the quantity supplied.
B
A
A shift in the supply curve from S
to S1 is referred to as an increase
in supply.
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posted to a publicly accessible website, in whole or in part.
S1
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From Individual to Market Supply
The horizontal sum of the individual seller’s supply curves is the market supply.
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13
Market Equilibrium
When a market comes to rest
and there are no additional
mutually acceptable
trades to be made, we say the
market has reached an
equilibrium.
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posted to a publicly accessible website, in whole or in part.
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Market Equilibrium - Example
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15
Market Equilibrium - Example
Given the market demand and an initial endowment of the good, 3 for Ahmed,
3 for Becky, 2 for Carl, 1 for Deb and 0 for Enzo, a market equilibrium price
of $4 will emerge from trading between the parties.
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posted to a publicly accessible website, in whole or in part.
16
Changes in Equilibrium – An Increase in
Demand
Suppose that Deb experiences an increase in demand. The market demand
will increase to D’ and the equilibrium price will rise to $5.
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posted to a publicly accessible website, in whole or in part.
17
Changes in Equilibrium – A Decrease in
Supply
Suppose two units of the good were destroyed, decreasing the supply to
S’. This would increase the equilibrium price still further to $6.
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posted to a publicly accessible website, in whole or in part.
18
Comparing Equilibria
Consider the initial equilibrium between
supply (S) and demand (D) with a price
of $13 and quantity of 12.5. Suppose
there is a decrease in the price of an input
of $4 so the supply curve shifts down by
$4 to S’. What happens to the equilibrium
price?
As shown in the diagram, equilibrium price
falls, but not by $4. It only falls by $2.50,
to $10.50.
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posted to a publicly accessible website, in whole or in part.
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Why Equilibrium Matters – A Price
Ceiling
Here we see what happens when we
try to circumvent the equilibrium
by imposing a price ceiling of
$11.00. At the ceiling price we see
that a shortage of the good will
exist. The amount consumers
wish to purchase at the ceiling price
exceeds the amount sellers wish to
sell.
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posted to a publicly accessible website, in whole or in part.
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Why Equilibrium Matters – A Price Floor
Here we see what happens when we try to
circumvent the market by imposing a price
floor of $15.00. At the floor price we see
that a surplus will exist. The amount that
sellers wish to sell at the floor price exceed
the amount consumers wish to buy.
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posted to a publicly accessible website, in whole or in part.
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duplicated, or posted to a publicly accessible website, in whole or in part.
22
Recycling Paper
Will recycling paper save forests? Many
people believe that the answer is yes. But,
the supply and demand model suggest
otherwise. Here is the supply (S) and
demand (D) For pulpwood before
recycling. The equilibrium price is $70
per cord with 100 million cords exchanged.
Recycling reduces the demand for pulpwood
to D’ reducing the price and quantity
exchanged. Recycling paper reduces the
need for trees for the production of paper,
but will the trees be cut to clear space for
agricultural or commercial or residential
use instead?
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posted to a publicly accessible website, in whole or in part.
23
Who Benefits from a Price Ceiling?
Here is the market for loans, with the
given supply and demand curve, $800
billion would be saved and borrowed
at an interest rate of 8%
If regulations set a ceiling on the interest
rate banks could pay depositors at 4%,
then depositors would only want to
deposit $400 billion. The rate that
banks could then charge to ration the
available funds would be 12%.
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posted to a publicly accessible website, in whole or in part.
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duplicated, or posted to a publicly accessible website, in whole or in part.
25
Elasticity of Demand
Price elasticity of demand is the responsiveness of quantity demanded to
changes in the price of a good.
For two points on the demand curve that are close together, we can express
price elasticity as:
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Elasticity of Demand
Value
Name
Effect of lower
price on
spending
ED < 1
Inelastic
Raises
ED = 1
Unit Elastic
Constant
ED > 1
Elastic
Lowers
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Elasticity of Demand
The more and better the substitutes for a
good, the higher the elasticity of demand
will be.
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posted to a publicly accessible website, in whole or in part.
28
Some Other Elasticities – Income
Elasticity
Income elasticity is the responsiveness of quantity
demanded to changes in income.
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posted to a publicly accessible website, in whole or in part.
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Some Other Elasticities – Cross
Elasticity
The cross elasticity of demand for good X is the
responsiveness of the quantity of X demanded
to changes in the price of good Y.
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posted to a publicly accessible website, in whole or in part.
30
Some Other Elasticities – Elasticity of
Supply
The elasticity of supply is the responsiveness
of the quantity supplied to changes in price.
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posted to a publicly accessible website, in whole or in part.
31
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duplicated, or posted to a publicly accessible website, in whole or in part.
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How Prices Convey Information – Adam
Smith
In the Wealth of Nations, Adam Smith provides a clear
example of the extent of the coordination problem needed
to produce something as common as a woolen coat.
The shepherd, the sorter of the wool, the wool-comber or carder,
the dyer, the scribbler, the spinner, the weaver, the fuller, the dresser,
with many others, must all join their different arts in order to complete
even this homely production.
And this is only the start of it!
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posted to a publicly accessible website, in whole or in part.
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How Prices Convey Information – After
the Epizootic
Take Adam Smith’s story a little further and imagine that
an epizootic suddenly cuts the sheep population in half.
Thousands of adjustments ensue, not the least of which is
that the price of woolen coats will increase.
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posted to a publicly accessible website, in whole or in part.
34
How Prices Convey Information –
Dispersed Knowledge and Informative
Prices
Market prices solve the planning problem by
decentralizing decisions into the hands of
people who know only the particulars
of their individual situations. They need not
know about the epizootic at all to respond to
the price changes that result from it.
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posted to a publicly accessible website, in whole or in part.
35
The Present and the Future – Trading
With Yourself
How can an individual best allocate a good between the present
and the future if information about the future is uncertain or
unknown? Because most potatoes are harvested at the end of
the summer, consumers cannot rely on growers to deliver a
steady stream of them to market every week over the year.
Some of the harvest must be stored and decisions made daily
on how much to release from storage for consumption over the
year.
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posted to a publicly accessible website, in whole or in part.
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The Present and the Future – Trading
With Yourself
Buying the stockpile is costly and holding it is risky. If you are
skilled at investing, the potatoes tie up funds that have earning
power in investments elsewhere. If you do not acquire
information about potatoes while you hold them, you might
make mistakes that a potato expert would not. The more
commodities you must treat like potatoes, the more severe
your information problems. Self-sufficiency in potatoes carries
high transaction costs and risks you might rather pay someone
else to bear. Fortunately, intermediaries are available.
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posted to a publicly accessible website, in whole or in part.
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The Present and the Future Speculators
Here is what happens both with and
without speculation. Consider a
commodity whose peak harvest
occurs in October while smaller
amounts come to market in other
months. Without speculation, all of
each month’s production is
immediately sold and consumed.
Speculators will buy
when it is abundant and hold it in
expectation of gains from being able
to resell it later for more money,
which will reduce the price
fluctuations.
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posted to a publicly accessible website, in whole or in part.
38
The Present and the Future Information and Revision of Prices
The market price is affected by information besides that in weather
forecasts. For instance, an expert on grocery markets expects that a
continuing trend for low-carbohydrate diets will decrease the economy’s
demand for wheat. An expert on foreign policy hears from informed
sources that the government will soon initiate policies to raise wheat
exports. Some people believe the information of the grocery researcher or
foreign policy expert will move prices, and so begin to trade accordingly.
Price changes as different people trade on the basis of information that
others do not know and beliefs that others do not hold. There is simply no
imaginable way to centralize all of this knowledge in, say, a government
agency. Yet the market incorporates it into prices through the actions of
dispersed individuals.
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posted to a publicly accessible website, in whole or in part.
39
The Present and the Future Derivatives and Derivatives Markets
Our commodity markets have so far offered their participants a
range of choices that are far smaller than exist in reality. For
example, people might enter into forward contracts that fix the
price today for delivery of a good at some date in the future.
Because its value depends on the price of the underlying
commodity, the forward contract is an example of a derivative or a
derivative asset. A futures contract is a standardized forward
contract, traded on a futures exchange. Like a forward contract, it
sets a price today for future delivery. The contract is valuable to
both producers and large consumers of gas as a hedge that lessens
the risks associated with the highly unstable (“volatile”) spot price.
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posted to a publicly accessible website, in whole or in part.