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MARKET
An arrangement which
allows buyers and sellers to
exchange money and goods.
WHY DO MARKETS EXIST ?
• We are not self-sufficient:
(We specialize in what we do best.)
• We trade what we make for goods or
services we need, or for money to buy
goods and services we need.
Markets facilitate specialization and
exchange.
TWO TYPES OF MARKETS
• INPUT (FACTOR) MARKETS -Firms pay resource owners (i.e., owners of labor,
raw material, land, machinery and buildings) -households-- for the right to use their resources;
firm -- Resource-owner interaction
• OUTPUT (PRODUCT) MARKETS -Consumers --households-- pay firms for consumer
goods;
consumer -- firm interaction
Two of Economy’s
Primary Participants
FIRMS
HOUSEHOLDS
CIRCULAR FLOW OF AN
ECONOMY
Revenue from
Selling Products
PRODUCT MARKET
Products
Supplied
FIRMS
Products
demanded
HOUSEHOLDS
Inputs for
Production
Factor
Costs
Payment for
Products
Inputs
Supplied
FACTOR MARKET
Factor
Payments
What Do Firms Do ?
• Buy factors of production from
households;
• Transform factors of production into
finished products and services;
• Sell finished products and services to
households.
Firms Buy Factors of Production
• LABOR MARKET
-- Hire workers and pay wages and salaries in
exchange for work.
• CAPITAL MARKET
-- Households use savings to provide funds that
firms use to buy machines, buildings and
equipment.
• NATURAL RESOURCES MARKET
-- Households sell land, minerals, oil, etc.... to firms
for use in production.
TYPES OF FIRMS
• Sole Proprietorship
owned by one individual;
individual earns all profits, responsible for all debts;
70% of all U.S. firms; 6% of total U.S. sales by firms.
• Partnership
owned by more than one individual;
division of responsibilities and profits;
each individual fully responsible for all firm’s debts;
8% of all U.S. firms; 4% of total U.S. sales by firms.
• Corporation
legal entity owned by stockholders (i.e., many owners);
owner’s liability for firm’s debt limited to value of stock;
about 20% of all U.S. firms; 90% of all U.S. sales by firms.
Corporation
General Motors
Ford Motor
Exxon
Royal Dutch Shell
Toyota
Hitachi
IBM
Matsushita
General Electric
Daimler-Benz
Mobil
Nissan Motor
British Petroleum
Samsung
Phillip Morris
IRI
Siemans
Volkswagon
Chrysler
Toshiba
Country
USA
USA
USA
The Netherlands
Japan
Japan
USA
Japan
USA
Germany
USA
Japan
United Kingdom
South Korea
USA
Italy
Germany
Germany
USA
Japan
Relative Size
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
CURRENCY MARKETS AND
EXCHANGE RATES
• Foreign Exchange Market -- Entity which
provides for the exchange of one currency
for another;
• Exchange Rate -- Rate at which one
currency can be exchanged for another.
SUPPLY AND DEMAND
•
•
•
Market interaction;
Represents buyers and
sellers in a particular
market;
Predicts equilibrium price
and quantity in a
particular market.
MARKET DEMAND
How much of a particular product
consumers are willing to buy
during a particular time period.
MARKET DEMAND
How much a Consumer Demands of a
Product depends on:
•
•
•
•
Price of the product being demanded;
Consumer income;
Price of related goods;
The number of potential consumers
(population);
• Consumer taste and advertising;
• Consumer expectations about future prices.
THE DEMAND CURVE
• Shows how consumers exchange money
for goods and services;
• Shows relationship between price of a
good and quantity consumers willing to
buy during a specific time period;
• Total amount demanded of a product is
the sum of all consumers’ demand.
THE LAW OF
DEMAND
The lower the price, the
larger the quantity
demanded.
TWO DEMAND EFFECTS
1.
Substitution Effect:
The demand for one good normally purchased will
increase if its price relative to the price of another
good(s) decreases: more of the original good may be
substituted at its new price.
APPLES
BANANAS
Original Price $2/pound
$0.50/pound
sacrifice
4 pounds bananas
1/4pound apples
New Price
$0.50/pound
$0.50/pound
sacrifice
1 pound bananas
1 pound apples
TWO DEMAND EFFECTS
2.
Income Effect A lower price for a product means
that a given amount of money will
buy more of all goods.
Given: $5/week fruit budget; 1pound of apples/week;
APPLES OTHER FRUIT
Original Price
$2/pound
------Original spending
$2
$3
New Price
$0.50/pound
-----New spending
$0.50
$3
$1.50 remains for purchase of any desired product.
Price drop increases real income.
Change in Quantity
Demanded
• A change in the quantity
resulting from a change in the
price of a good;
• Illustrated by movement along a
demand curve.
DEMAND
SCHEDULE
Price / Pound
$$$
$0.80
$0.60
$0.40
Quantity Demanded 14,000 20,000 26,000
(Pounds / Day)
$0.20
32,000
$1.00
Price
per
Pound
of
Apples
$$$
DEMAND
$0.80
$0.60
DEMAND
CURVE
$0.40
$0.20
14
20
26
32
38
Thousands of Pounds of Apples per day
What Causes the Demand Curve
to Shift
(Change in Demand)
A demand curve shifts as the
relationship between product price
and the quantity of the good
demanded changes.
Demand Shift Causes
• Change in income:
--Normal Good: An increase in income
increases demand, shifting demand curve
right;
--Inferior Good: A decrease in income
increases demand, shifting demand curve
right;
DEMAND
$1.00
Price
per
Pound
of
Apples
$$$
$0.80
Rightward Shift
$0.60
$0.40
$0.20
14
20
26
32
38
Thousands of Pounds of Apples per day
Demand Shift Causes
• Change in income:
--Normal Good: A decrease in income
decreases demand, shifting demand curve
left;
--Inferior Good: An increase in income
decreases demand, shifting demand curve
left;
DEMAND
$1.00
Price
per
Pound
of
Apples
$$$
$0.80
Leftward Shift
$0.60
$0.40
$0.20
14
20
26
32
38
Thousands of Pounds of Apples per day
Demand Shift Causes
• Change In Price of Related Good:
-- Substitute Good: As price of one good
increases, demand for other good increases;
-- Complement Good: As price of one
good decreases, demand for other good
increases.
DEMAND
$1.00
Price
per
Pound
of
Apples
$$$
$0.80
Rightward Shift
$0.60
$0.40
$0.20
14
20
26
32
38
Thousands of Pounds of Apples per day
Demand Shift Causes
• Change In Price of Related Good:
-- Substitute Good: As price of one good
decreases, demand for other good
decreases;
-- Complement Good: As price of one
good increases, demand for other good
decreases.
DEMAND
$1.00
Price
per
Pound
of
Apples
$$$
$0.80
Leftward Shift
$0.60
$0.40
$0.20
14
20
26
32
38
Thousands of Pounds of Apples per day
Other Factors Affecting
Demand (Shift)
• Population - An increase in population means
more buyers, an increasing demand, and a
rightward shift in the demand curve;
• Consumer Tastes and Advertising - As
advertising leads to greater consumer preference
for a product, a rightward shift in demand occurs;
• Consumer Expectations of Future Prices - If
consumers expect future prices for a product to be
higher in the future, they will demand more of the
product now.
Individual Demand Curve
Shows the relationship between the price of a
good and the quantity that a single consumer is
willing to buy (quantity demanded) during a
particular time period.
Individual Demand Curve
The result of a rational choice by
the consumer, based on the
associated benefits and costs of
consuming a good.
Individual Demand Curve
• Given a Budget ($30);
• Spend all budget on two goods: Hamburgers and tacos;
• Consumption of Hamburgers depends on:
–
–
–
–
price of burgers;
price of tacos;
income;
underlying tastes or preferences
How Many Burgers Does Bob Buy ?
• at $3 ?
8
• at $2 ?
Price
of
Burgers
Demand Curve
b
$3
c
$2
11
8
Burgers per Month
11
The Principle of Opportunity Cost
The Opportunity Cost:
• Of something is what you sacrifice to get it;
• Of hamburgers is number of tacos given up to get one hamburger.
• Of 1 hamburger is 3 tacos, if hamburgers cost $3 and tacos cost $1.
Consumption of the first through eighth hamburger provides greater pleasure than
consumption of the first taco.
Substitution Effect
Change in consumption resulting from change in price of
one good relative to the prices of other goods.
If price of hamburgers decreases ($2), while price of tacos
remains constant, more hamburgers will be substituted for
tacos. (Opportunity cost of hamburgers, in terms of tacos
decreases).
Income Effect
Change in consumption resulting from an
increase in consumer’s real income.
Real income is measured in terms of the goods
the money can buy.
Income Effect
• At the original price ($3), Bob buys 8 burgers (cost = $24) and 6
tacos (cost = $6), for total cost of $30.
• If the price of burgers drops, Bob’s purchasing power increases.
• Given lower price, Bob can buy more burgers and tacos.
• Since Bob’s $30 can buy more burgers and tacos when the price of
burgers decreases, Bob’s real income increases.
Income Effect
• Normal Goods - Most goods:
New clothing, air transportation,
and
meats are examples.
Consumption of normal goods increases as real
consumer income increases.
Income Effect
• Inferior Goods - Consumption of inferior goods decreases
as real consumer income increases. Examples:
Used clothing, potatoes, inter-city bus transportation.
The Market Demand Curve
• Shows for each price, the quantity of a particular
good demanded by all consumers.
• It is the sum of quantities demanded by each
consumer at a given price.
The Market Demand
Price of
Burgers
$3.50
Bob’s Demand
Ann’s Demand
$3.00
Total Consumer
(Market)
Demand
$2.50
@ $3 market demand = 16
Bob’s 4 + Ann’s 12
@ 50¢ market demand = 28
Bob’s 8 + Ann’s 20
$2.00
$1.50
$1.00
$0.50
4
8 12 16 20 24 28
Burgers per Month
Market Demand Assumptions
• All, except price of the good itself, are held constant:
•Price of other goods,
•Income,
•Tastes,
•Number of consumers.
UTILITY
The benefit generated by consuming a good: the
satisfaction or pleasure the consumer experiences
when he or she consumes the good.
Marginal Utility
The change in utility resulting from one
additional unit of a good.
The Law of Diminishing Marginal
Utility
As consumption of a particular good
increases, marginal utility decreases.
Total
180
Utility
160
( TU )
140
UTILS
120
100
80
60
40
20
Marginal
30
Utility
25
( MU )
20
UTILS
15
10
5
1 2 3 4 5 6 7 8
Burgers / Month
Burgers
MU
TU
1
2
3
4
5
6
7
26
24
22
20
18
16
14
26
50
72
92
110
126
140
8
12
152
1 2 3 4 5 6 7 8 Burgers / Month
The Marginal Principle
Increase the level of an activity if its marginal
benefit exceeds its marginal cost, but reduce the
level if the marginal cost exceeds the marginal
benefit. If possible, pick the level at which the
marginal benefit equals marginal cost.
MARGINAL UTILITY
&
MARGINAL PRINCIPLE
Given: $30 budget; taco price = $1; burger price = $3;
Number of Marginal utility
burgers
burgers ( utils )
Number
of Tacos
Marginal utility
tacos ( utils )
Marginal Cost
Burgers
5
18
15
1
3
6
16
12
2
6
7
14
9
3
9
8
12
6
4
12
9
10
3
5
15
10
8
0
6
18
MARGINAL UTILITY
&
MARGINAL PRINCIPLE
Given: $30 budget; taco price = $1; burger price = $3;
Marginal utility
Number of Marginal utility Number
burgers
burgers ( utils ) of Tacos tacos ( utils )
Marginal Cost
Burgers
5
18
15
1
3
6
16
12
2
6
7
14
9
3
9
8
12
6
4
12
9
10
3
5
15
10
8
0
6
18
The Utility Maximizing Rule
A consumer will maximize his/her utility by picking
the affordable combination of consumer goods that
makes the marginal utility per dollar spent on one
good equal to that of a second good.
The Utility Maximizing Rule
Marginal Utility
of Tacos
Marginal Utility
of burgers
Price of
burgers
=
Price of
Tacos
CONSUMER SURPLUS
The difference between the maximum amount
that a consumer is willing to pay for a good or
service and the price he or she pays for the
product.
Demand Curve and Consumer Surplus
• If Oscar’s demand for CDs is such that at:
Price
Quantity Oscar Will Buy
$24
0
$21
1
$18
2
$15
3
$12
4
$9
5
CONSUMER SURPLUS FOR AN
INDIVIDUAL CONSUMER
PRICE
OF
CD’s
($)
24
t
CDs
u
22
v
20
18
$11
w
16
$8
14
x
$5
12
1
2
3
4
Willing to
Pay
$21
$18
$15
$12
Total
$2
10
y
Consumer
Surplus
$11
$8
$5
$2
$26
Price = $10
Individual Demand
Curve
1
2
3
4
5
NUMBER OF CD’s PER MONTH