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“The Economic Way of Thinking” 10th Edition by Paul Heyne, Peter Boettke, and David Prychitko “Supply and Demand: A Process of Cooperation” PowerPoint Slides prepared by Assistant Professor Paul Harris Camden County College 1 The Economic Way of Thinking 10e ©Prentice Hall 2003 Chapter Outline I. II. Introduction The Market is a Process of Competing Bids and Offers III. Transaction Cost IV. Property Rights and Institutions V. The Coordinating Role of Money Prices VI. The Basic Process 2 The Economic Way of Thinking 10e ©Prentice Hall 2003 Chapter Outline VII. Competition, Cooperation, and Market Clearing. VIII. Changing Market Conditions IX. The Urge to Fix Prices X. Competition When Prices are Fixed XI. Appropriate and Inappropriate Signals XII. Competition Results From Scarcity XIII. Once Over Lightly 3 The Economic Way of Thinking 10e ©Prentice Hall 2003 Introduction • Specialization is what distinguishes every wealthy society the world has ever known. Adam Smith observed…….. “It is the great multiplication of the productions of all the different arts, “in consequence of the division of labour” which occasions, in well governed society, that universal opulence which extends itself to the lowest ranks of the people. 4 The Economic Way of Thinking 10e ©Prentice Hall 2003 Introduction How do wealthy highly specialized commercial societies know to take the actions necessary wind up producing the myriad of goods and services they enjoy? Answer… Massive ignorance, since specialist by their very nature don’t know how to do everything. The miracle of the market is that millions of people globally, manage to cooperate together to produce the goods and services that we enjoy. 5 The Economic Way of Thinking 10e ©Prentice Hall 2003 Introduction • The role of government in these societies is to … Monitor property rights. Enforce contracts Enforce property rights. 6 The Economic Way of Thinking 10e ©Prentice Hall 2003 The Market – Competing Bids and Offers Markets are not necessarily physical places. They are mechanisms which brings together buyers and sellers, demanders and suppliers. A market can be formal, but many markets are informal. A market is not a person place or thing. It is a process of competing bids and offers. 7 The Economic Way of Thinking 10e ©Prentice Hall 2003 Transaction Cost Transaction costs are the costs of arranging contracts or transaction agreements between demanders and suppliers. It isn’t enough that demanders are willing to what suppliers would require. Someone needs to arrange the the actual transaction. 8 The Economic Way of Thinking 10e ©Prentice Hall 2003 Transaction Cost Questions…… Why does broken glass stay on a bicycle trail even if each bicyclist would pay someone to clean it up? Why don’t commuters in no hurry clear the way for those who are? Why does even the most environmentally aware person contribute to its degradation? Why did food rot in the fields in the U.S.S.R. when people were starving? 9 The Economic Way of Thinking 10e ©Prentice Hall 2003 Transaction Cost Questions…… • Why does broken glass stay on a bicycle trail Answer: even if eachWhen bicyclist wouldcosts payare someone to transaction clean it up? too high, the result will • Why don’t be commuters no hurry clear the a failure of in cooperation. way for thoseAll who are? questions of these illustrate a failure of • Why does even the most environmentally cooperation because thedegradation? cost aware person contribute to its of arranging the transaction • Why did food rotare in too thehigh. fields in the U.S.S.R. when people were starving? 10 The Economic Way of Thinking 10e ©Prentice Hall 2003 Property Rights and Institutions Private Ownership People have the incentive to take control of resources. Resources will quickly and cheaply come together. Low Transaction Costs Allow negotiations necessary to produce goods and services to succeed 11 The Economic Way of Thinking 10e ©Prentice Hall 2003 Property Rights and Institutions Questions… Why are the countries that are attempting to move to a market system facing high transaction costs? Can they design an efficient system? Can they do it quickly? 12 The Economic Way of Thinking 10e ©Prentice Hall 2003 Property Rights and Institutions Questions… Why are the countries that are attempting to move to a market system facing high transaction costs? Can they design an efficient system? Can they do it quickly? 13 The Economic Way of Thinking 10e ©Prentice Hall 2003 Property Rights and Institutions Questions… Answer….. The success ofthat market Why are the countries are attempting to many high move to areform marketprojects systeminfacing nations depends transaction costs? on overcoming the Can they design an efficient problem of high system? Can they do ittransaction quickly? cost rapidly. 14 The Economic Way of Thinking 10e ©Prentice Hall 2003 The Coordinating Role of Money Prices • Question………. – Why is money used in exchanges instead of barter? • Answer……… – Money is a general medium of exchange. 15 The Economic Way of Thinking 10e ©Prentice Hall 2003 The Coordinating Role of Money Prices Money’s Advantages Lowers transaction costs Acceptability Provides signals quickly 16 The Economic Way of Thinking 10e ©Prentice Hall 2003 The Basic Process Supply and Demand in the Acoustic Guitar Market S $700 $500 $300 D 800 1000 1,200 Quantity of Acoustic Guitars The Economic Way of Thinking 10e ©Prentice Hall 2003 17 The Basic Process Supply and Demand in the Acoustic Guitar Market S $700 The Market clears at $500 $500 $300 D 800 1000 1,200 Quantity of Acoustic Guitars The Economic Way of Thinking 10e ©Prentice Hall 2003 18 The Basic Process Supply and Demand in the Acoustic Guitar Market S $700 $500 $300 A shortage of 400 guitars At $300 800 1000 D 1,200 Quantity of Acoustic Guitars The Economic Way of Thinking 10e ©Prentice Hall 2003 19 The Basic Process Supply and Demand in the Acoustic Guitar Market $700 A surplus of 400 guitars at $700 S $500 $300 D 800 1000 1,200 Quantity of Acoustic Guitars The Economic Way of Thinking 10e ©Prentice Hall 2003 20 Competition, Cooperation, and Market Clearing • Competition, like cooperation, is rampant throughout the market process. • Rather than competition between buyer and seller; – Buyers tend to compete with other buyers. – Sellers tend to compete with other sellers. The Economic Way of Thinking 10e ©Prentice Hall 2003 21 Competition, Cooperation, and Market Clearing In the case of a shortage, buyers compete with one another by offering higher prices, and the bidding process eliminates the shortage. In the case of a surplus sellers compete amongst themselves by trying to attract customers and move excess inventories. Each seller would compete with lower prices until the surplus disappears. 22 The Economic Way of Thinking 10e ©Prentice Hall 2003 Competition, Cooperation, and Market Clearing • In the case of a shortage, buyers compete with one another by offering With individual buyers bidding up process higher prices, and the bidding prices when there are shortages, eliminates the shortage. and sellers reducing prices when • In thethere caseare ofsurpluses, a surplus the sellers market compete amongst themselves trying system, through theby forces of to attract supplyand and demand a customers move settles excessoninventories. market clearing price. The clearing – Each seller would compete with lower price is the equilibrium quantity, prices until the surplus disappears. and price 23 The Economic Way of Thinking 10e ©Prentice Hall 2003 Competition When Prices Are Fixed • Question… – What happens if the price of a good is not allowed to rise when it becomes more scarce? • Answer…. – Government imposed price ceilings cause shortages, and make it necessary for the government to ration the product. The Economic Way of Thinking 10e ©Prentice Hall 2003 24 Competition When Prices Are Fixed P D S Nonmonetary costs Legal ceiling price Money costs shortage Q 25 The Economic Way of Thinking 10e ©Prentice Hall 2003 Competition When Prices Are Fixed • Question…… – What are the non-monetary costs? • Answer……. – Waiting lines – Restraining activity – Striking deals 26 The Economic Way of Thinking 10e ©Prentice Hall 2003 Appropriate and Inappropriate Signals Question…. What will suppliers do if a law prevents them from raising their prices when a shortage exists? Answer… Prices provide signals. Price Ceilings Suppliers and demanders receive incorrect signals Effective accommodation does not occur 27 The Economic Way of Thinking 10e ©Prentice Hall 2003 Competition Results from Scarcity Scarce Goods When people cannot obtain as much of a good as they would like without being required to sacrifice something else of value. Rationing Prices ration scarce goods Competition A result of scarcity Occurs when people strive to meet the criteria that is being used to ration scarce goods 28 The Economic Way of Thinking 10e ©Prentice Hall 2003 From Scarcity to Competition P S Scarce good D Q 29 The Economic Way of Thinking 10e ©Prentice Hall 2003 From Scarcity to Competition P D S A nonscarce good Q 30 The Economic Way of Thinking 10e ©Prentice Hall 2003 Surpluses and Scarcity Surplus Occurs when quantity supplied exceeds quantity demanded Surplus of Teachers Decreasing wages motivates people to look at different careers. Question How would school systems respond if they were not allowed to reduce wages? 31 The Economic Way of Thinking 10e ©Prentice Hall 2003 Surpluses and Scarcity • Surplus of Doctors – Number “needed” is quantity demanded at the current price. • Question – What would this surplus do to wages and prices? 32 The Economic Way of Thinking 10e ©Prentice Hall 2003 Market Processes Versus Central Planning A socialist economy would be run like one huge non-profit organization. They utilize a system of central planners, to perform the functions that we take for granted, and which occur automatically in a market system. There is no efficient way to effectively and efficiently produce and distribute the massive array of goods and services desired by millions of citizens. 33 The Economic Way of Thinking 10e ©Prentice Hall 2003 Once Over Lightly Society is characterized by extensive division of labor. The market is a process of competing bids and offers. Intermediaries facilitate exchange and reduce transaction cost. Transaction cost is the cost of arranging contracts or or transaction agreements between suppliers and demanders. Money is used as a medium to facilitate exchange. 34 The Economic Way of Thinking 10e ©Prentice Hall 2003 Once Over Lightly The market clears when quantity demanded equals quantity supplied. Exchange is a cooperative activity. Scarce goods must be rationed in some fashion. Surpluses and shortages arise when the market price is above or below the equilibrium price. 35 The Economic Way of Thinking 10e ©Prentice Hall 2003 Next Chapter 6 Supply and Demand: Issues and Applications End of Chapter 5