Download Decision Making and Demand and Supply

Decision-making and Demand
and Supply Analysis
Thinking Economically: Marginal Analysis
• Optimization Assumption: an assumption that
suggests that the person in question is trying to
maximize some objective
• Marginal Benefit: the increase in the benefit that
results from an action
• Marginal Cost: the increase in the cost that results
from an action
• Total Net Benefits: the difference between all benefits
and all costs
Maximizing Total Net Benefits
• Total Way – select the level of the activity that
maximizes the difference between total benefits
and total costs
• Marginal Way – set the marginal benefit of to the
marginal cost of an extra unit
• Economist prefer the later because many decisions
are not all or nothing. Most times people are
deciding to increase or decrease the amount of
something that they are doing.
Marginal Way in Action
• The example of the boxes
• If the marginal benefit of an extra unity of the
activity is greater than its marginal cost, increasing
the activity will increase total net benefits.
• If the marginal cost of an extra unit of the activity
is greater than its marginal cost, increasing the
activity will decrease total net benefits.
• Therefore, to maximize total net benefits the level
of an activity that maximizes total net benefits is
where the marginal benefit equals the marginal
cost of an extra unit of the activity.
Boxes
• If an extra unit of the activity (trades) results in
getting more boxes (MB) than are being given up
(MC) the stack of boxes grows (TNB).
• If an extra unit of the activity (trades) results in
getting less boxes (MB) than are being given up
(MC) the stack of boxes shrinks (TNB).
• If an extra unit of the activity (trades) results in
getting the same amount of boxes (MB) that are
being given up (MC) the stack of boxes is at its
tallest ( maximum TNB).
Activity
1
2
3
4
5
MB
MC
5
4
3
2
1
TB
1
2
3
4
5
TC
5
9
12
14
15
TNB
1
3
6
10
15
4
6
6
4
0
Markets: The power of Demand
and Supply
• Competitive Markets
–
–
–
–
identical or homogeneous goods
many sellers and buyers
perfect Information
free entry and exit
• Non-Competitive Markets
– Monopoly – one seller
– Oligopoly – few sellers
– Monopolistically Competitive – differentiated products
Demand
• The demand curve
– Price and the quantity demanded
• Rational behavior
– Utility maximization (MB=MC all over again)
• Law of diminishing marginal utility
– Jelly bean example
– MB fall as activity level increases
• Income and substitution effects
– Demand schedule
– Individual demand curve
– Market demand curve
Catherine’s Demand Schedule
Figure 1 Catherine’s Demand Schedule and Demand
Curve
Price of
Ice-Cream Cone
$3.00
2.50
1. A decrease
in price ...
2.00
1.50
1.00
0.50
0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity
of cones demanded.
Copyright © 2004 South-Western
• The demand function
– Income
– Price of related goods
• Complements
• Substitutes
– Tastes
– Expectations
– Number of Buyers
• Movement along and shifts of the demand
curve
– Curve versus function
– Schedules
– Graphs
Figure 3 Shifts in the Demand Curve
Price of
Ice-Cream
Cone
Increase
in demand
Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Supply
• Price and the quantity supplied
– Rational behavior an the profit motive
– Law of diminishing returns
• The production example
• MC rise as production increases in the short-run
• Supply schedule
• Individual supply curve
• Market supply curve
Ben’s Supply Schedule
Figure 5 Ben’s Supply Schedule and Supply Curve
Price of
Ice-Cream
Cone
$3.00
1. An
increase
in price ...
2.50
2.00
1.50
1.00
0.50
0
1 2
3
4
5
6
7
8
9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity of cones supplied.
Copyright©2003 Southwestern/Thomson Learning
• The supply function
–
–
–
–
Input prices
technology
expectations
number of sellers
Figure 7 Shifts in the Supply Curve
Price of
Ice-Cream
Cone
Supply curve, S3
Decrease
in supply
Supply
curve, S1
Supply
curve, S2
Increase
in supply
0
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Market Equilibrium
• Equilibrium price and quantity = market clearing
price and quantity
• Disequilibrium prices and quantities
– Shortage – Excess Demand
– Surplus – Excess Supply
• Comparative static analysis: changes in
equilibrium prices and quantities
• Shifts in curves versus movement along revisited
• Changes in demand and supply
Figure 8 The Equilibrium of Supply and Demand
Price of
Ice-Cream
Cone
Supply
Equilibrium
Equilibrium price
$2.00
Equilibrium
quantity
0
1
2
3
4
5
6
7
8
Demand
9 10 11 12 13
Quantity of Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Figure 9 Markets Not in Equilibrium
(a) Excess Supply
Price of
Ice-Cream
Cone
Supply
Surplus
$2.50
2.00
Demand
0
4
Quantity
demanded
7
10
Quantity
supplied
Quantity of
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning
Figure 8 The Equilibrium of Supply and Demand
Price of
Ice-Cream
Cone
Supply
Equilibrium
Equilibrium price
$2.00
Equilibrium
quantity
0
1
2
3
4
5
6
7
8
Demand
9 10 11 12 13
Quantity of Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Figure 9 Markets Not in Equilibrium
(a) Excess Supply
Price of
Ice-Cream
Cone
Supply
Surplus
$2.50
2.00
Demand
0
4
Quantity
demanded
7
10
Quantity
supplied
Quantity of
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning
Figure 9 Markets Not in Equilibrium
(b) Excess Demand
Price of
Ice-Cream
Cone
Supply
$2.00
1.50
Shortage
Demand
0
4
Quantity
supplied
7
10
Quantity of
Quantity
Ice-Cream
demanded
Cones
Copyright©2003 Southwestern/Thomson Learning
Figure 10 How an Increase in Demand Affects the
Equilibrium
Price of
Ice-Cream
Cone
1. Hot weather increases
the demand for ice cream . . .
Supply
New equilibrium
$2.50
2.00
2. . . . resulting
in a higher
price . . .
Initial
equilibrium
D
D
0
7
3. . . . and a higher
quantity sold.
10
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Figure 11 How a Decrease in Supply Affects the
Equilibrium
Price of
Ice-Cream
Cone
S2
1. An increase in the
price of sugar reduces
the supply of ice cream. . .
S1
New
equilibrium
$2.50
Initial equilibrium
2.00
2. . . . resulting
in a higher
price of ice
cream . . .
Demand
0
4
7
3. . . . and a lower
quantity sold.
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
The Invisible Hand
• Economic Agents are motivated by self-interest
– consumers by utility maximization
– Producers by profit maximization
• Market prices as signals for resource allocation
and coordinate consumer and producer behavior
• Market or the Price System and Efficiency