11

Why are markets Why are markets important?important? In order to reap the benefits In order to reap the benefits

from specialization, trade from specialization, trade must be organized and easy must be organized and easy to conduct.to conduct.

Markets which are part of a Markets which are part of a “market system” facilitate “market system” facilitate trade.trade.

22

Market System: Market System: CharacteristicsCharacteristics

Market: any arrangement that Market: any arrangement that enables buyers and sellers to get enables buyers and sellers to get information and do business (trade) information and do business (trade) with each other. with each other.

Markets pool information about Markets pool information about buyers’buyers’ and and sellers’sellers’ plans and then plans and then summarize this information in one summarize this information in one

number: number: the pricethe price

1.) Markets

33

1.) Markets1.) Markets Prices:Prices:

– Move in response to decisions of Move in response to decisions of buyers buyers and and sellerssellers..

– Send signals to Send signals to buyersbuyers & & sellerssellers i.e., i.e., provide information and incentives to provide information and incentives to buyersbuyers and and sellerssellers.. Function as the rationing device Function as the rationing device

– Money serves as a medium of Money serves as a medium of exchange, eliminating the need for exchange, eliminating the need for barterbarter

44

1.) Markets1.) Markets Invisible HandInvisible Hand

– In markets, buyers & sellers act in In markets, buyers & sellers act in their own self interest responding to their own self interest responding to the incentives provided by changing the incentives provided by changing prices. prices.

– Self interested behaviour becomes Self interested behaviour becomes cooperative action resulting in good cooperative action resulting in good solutions for individuals & for society solutions for individuals & for society as a whole to the what, how, for as a whole to the what, how, for whom questionswhom questions

55

Market System: Circular Market System: Circular FlowFlow

Decision Makers:Decision Makers:– Buyers & SellersBuyers & Sellers//Households & FirmsHouseholds & Firms

key players in the market system.key players in the market system.– Govt. is also an important decision Govt. is also an important decision

maker-to be added latermaker-to be added later

Markets:Markets: – Two kinds of marketsTwo kinds of markets make up the make up the

“market system”: “market system”: – Goods Markets & Goods Markets & – Resource MarketsResource Markets

66

Factor MarketFactor MarketHH SellHH Sell

Firms BuyFirms Buy

Goods MarketGoods MarketFirms SellFirms Sell

HH BuyHH Buy

FirmsFirmsmake & sell make & sell

goods & servicesgoods & serviceshire factors ofhire factors of

productionproduction

HouseholdsHouseholdsbuy & consume buy & consume

goods & servicesgoods & servicessell factors ofsell factors of

productionproduction

SpendingSpending

IncomeIncome

Land, LabourLand, Labourand Capitaland Capital

Goods & Goods & services services boughtbought

RevenueRevenue

Goods & Goods & services services soldsold

Wages, Profits,Wages, Profits,and rentand rent

ProductionProductionInputsInputs

77

Market System: Market System: Decision Decision Makers:Makers:

1.) Households1.) Households– BuyersBuyers – consumers/demanders of final – consumers/demanders of final

goods & servicesgoods & services– SellersSellers – owners/suppliers of scarce – owners/suppliers of scarce

resources (factors of production)resources (factors of production)

Rational decision makers inRational decision makers in– 1. spending income (buying) &1. spending income (buying) &– 2. allocating/supplying their resources 2. allocating/supplying their resources

(selling)(selling)

88

2.) Firms/Producers2.) Firms/Producers– Sellers/suppliersSellers/suppliers of goods and services of goods and services – Buyers/demandersBuyers/demanders of resourcesof resources

Rational decision makers inRational decision makers in– 1. Production/selling decisions1. Production/selling decisions– 2. Hiring/buying resources2. Hiring/buying resources

Market System: Market System: Decision Decision Makers:Makers:

99

Market SystemMarket System: : MarketsMarkets

The 2 kinds of marketsThe 2 kinds of markets in which households in which households & firms meet are:& firms meet are:– 1. 1. Markets for Goods & ServicesMarkets for Goods & Services

households demand/households demand/buybuy firms supply/firms supply/sellsell

– 2. 2. Markets for Factors of Production Markets for Factors of Production (resources/inputs)(resources/inputs) households supply/households supply/sellsell firms demand/firms demand/buybuy

Three Basic Economic QuestionsThree Basic Economic Questions

1)1) WHAT and how much will be WHAT and how much will be produced?produced?

2)2) HOW will it be produced?HOW will it be produced?

3)3) For WHOM will it be produced?For WHOM will it be produced?

Pure Command EconomyPure Command Economy

An economic system characterized An economic system characterized by public ownership of all by public ownership of all property resourcesproperty resources

3 economic questions answered by 3 economic questions answered by a central governmenta central government

Pure Capitalist EconomyPure Capitalist Economy

An economic system characterized An economic system characterized by private ownership of all by private ownership of all property resourcesproperty resources

3 economic questions answered by 3 economic questions answered by household and firm interactionhousehold and firm interaction

Canada – A Mixed EconomyCanada – A Mixed Economy

Property resources are owned Property resources are owned privately and publiclyprivately and publicly

Decisions are made by the private Decisions are made by the private sector and the governmentsector and the government

Ie) Cost of a pizza – private Ie) Cost of a pizza – private decisiondecision

Ie) Taxes and social assistance – Ie) Taxes and social assistance – government decisiongovernment decision

Ie) Tuition – mixed decisionIe) Tuition – mixed decision

1414

Demand & Demand & SupplySupply Markets for Goods & ServicesMarkets for Goods & Services

– All the important factors affecting All the important factors affecting market exchange & therefore market market exchange & therefore market price, can be divided into price, can be divided into 22 categories: categories:those affecting those affecting demanddemand and andthose affectingthose affecting supply.supply.

1515

Demand: DefinitionDemand: Definition

A schedule showing amounts A schedule showing amounts of a product that consumers of a product that consumers are willing and able to are willing and able to purchase at each specific purchase at each specific price during some specified price during some specified time period: everything else time period: everything else held constant.held constant.

1616

The Law of DemandThe Law of Demand There is an inverse relationship There is an inverse relationship

between the quantity of anything that between the quantity of anything that people will want to purchase and the people will want to purchase and the price they must pay to obtain it:price they must pay to obtain it:

ceteris paribusceteris paribus

This causes demand curves to be This causes demand curves to be downward slopingdownward sloping

When prices increase, people buy When prices increase, people buy lessless

When prices decrease, people buy When prices decrease, people buy moremore

1717

Price/Unit

$

Qn/yr

A B C D E

5.00 4.00 3.00 2.00 1.00

20 30 40 60 50

The Individual’s Demand Schedule

Number of CD-R’s per Year

Pric

e of

CD

-R (

$)

1

2

3

4

5

10 20 30 40 500

A

B

C

D

E

Change in PriceMovement alongthe Demand

1818

Movement Along Movement Along Demand/Demand/ Changes in Quantity DemandedChanges in Quantity Demanded

A A change in a good’s own pricechange in a good’s own price

– results in a results in a change in quantity change in quantity demandeddemanded

– the same thing as a the same thing as a movement movement alongalong the same demand curve. the same demand curve.

1919

A Shift in the Demand A Shift in the Demand CurveCurve

Quantity of CD-R’s Demanded(millions of constant-quality units per year)

Pric

e of

CD

-R’s

($)

1

2

3

4

5

20 40 60 80 1000 140120

D1D3

Decrease in Demand

Suppose universitiesoutlaw the use of personal computers

D2

Increase in Demand

Suppose the federalgovernment givesevery student a personalcomputer.

2020

Shifts/Changes in Shifts/Changes in Demand*Demand*

AA change inchange in one or more of theone or more of the non-price determinantsnon-price determinants of of demand (income, tastes, etc)demand (income, tastes, etc)– results in aresults in a change inchange in demanddemand * *

– also called aalso called a shift in demand*shift in demand*

*The whole demand schedule

2121

““Everything Else” : Everything Else” : The “Determinants”/ The “Determinants”/ “Shifters” “Shifters” of “Demand”of “Demand” Factors other than Factors other than Price which affect Price which affect “Demand” : “Demand” :

1) Income, wealth1) Income, wealth 2) Tastes and 2) Tastes and

preferencespreferences 3) The price of 3) The price of

related goodsrelated goods– ComplementsComplements– SubstitutesSubstitutes

4) Expectations4) Expectations– Future pricesFuture prices– IncomeIncome– Product availabilityProduct availability

5) Population (market 5) Population (market size)size)

What movement would these What movement would these factors cause?factors cause?

2222

Compliments and Compliments and SubstitutesSubstitutes ComplimentCompliment: a good that is : a good that is

consumed WITH another goodconsumed WITH another good– Ie: Ketchup and hot dogsIe: Ketchup and hot dogs– Demand for good A DECREASES when Demand for good A DECREASES when

the price of a compliment increasesthe price of a compliment increases SubstituteSubstitute: a good that is consumed : a good that is consumed

IN PLACE OF another goodIN PLACE OF another good– Ie: Hamburgers and hot dogsIe: Hamburgers and hot dogs– Demand for good A INCREASES when Demand for good A INCREASES when

the price of a substitute increasesthe price of a substitute increases

2323

Review of Demand Review of Demand TerminologyTerminology DemandDemand: a schedule of quantities : a schedule of quantities

that will be bought/unit of time, at that will be bought/unit of time, at various prices, ceteris paribus.various prices, ceteris paribus.

Quantity DemandedQuantity Demanded:: a specific a specific amount that will be demanded /unit of amount that will be demanded /unit of time at a specific price, ceteris time at a specific price, ceteris paribus. paribus.

Distinguish between a Distinguish between a change in the change in the Quantity DemandedQuantity Demanded and a and a shift in shift in Demand.Demand.

2424

Shift vrs. MovementShift vrs. Movement

Pric

e of

Cig

aret

tes,

per

pac

k

Number of Cigarettes smoked per day

10 20

$2

$4

A tax raises the price of cigarettes, resulting in amovement along the demand curve

A policy to discouragesmoking (no smoking inpublic buildings) shiftsthe demand curve left

Pric

e of

Cig

aret

tes,

per

pac

k

Number of Cigarettes smoked per day

10 20

$2

DD’ D

2525

Normal vrs. Inferior GoodsNormal vrs. Inferior GoodsFor normal goods, Demand decreasesWith income

Pric

e of

Chi

cken

Chicken eaten in a month10 20

$2

DD’

Pric

e of

Kra

ft D

inne

r

Kraft Dinner eaten in a month

10 20

$2

D

For inferior goods, Demand increasesWhen income decrease

D’

30

2626

Supply: ProfitSupply: Profit

The The CostCost side of the profitside of the profit equation depends on theequation depends on the Costs Costs of Productionof Production which depend onwhich depend on

the kinds of inputs usedthe kinds of inputs usedthe amount of each input the amount of each input usedused

prices of inputs usedprices of inputs usedtechnologytechnology

2727

Supply: DefinitionSupply: Definition A schedule that shows how much A schedule that shows how much

of a product a firm will supply at of a product a firm will supply at alternative prices for a given time alternative prices for a given time period “ceteris paribus”.period “ceteris paribus”.

2828

The Law of SupplyThe Law of Supply• The price of a product or service and The price of a product or service and

the quantity supplied are directly the quantity supplied are directly related: “ceteris paribus”related: “ceteris paribus”

• Causes an upward sloping supply curveCauses an upward sloping supply curve

• The higher the price of a good, the more The higher the price of a good, the more sellers will make availablesellers will make available

• The lower the price of a good, the fewer The lower the price of a good, the fewer sellers will make availablesellers will make available

• All else being equalAll else being equal

2929

The Individual Producer’s Supply The Individual Producer’s Supply ScheduleSchedule

Qnty of CD-R Supplied Price / (thousands / CD-R year)

F $5 550

G 4 400

H 3 350

I 2 250

J 1 200Quantity of CD-R Supplied

(thousands of constant-quality units per year)

Pric

e of

CD

-R (

$)1

2

3

4

5

100 2003004005000

J

I

H

G

F

600

Change in PriceMovement alongThe Supply

3030

Movement Along Movement Along Supply/Supply/

Changes in Quantity SuppliedChanges in Quantity Supplied

– A change in a good’s own price A change in a good’s own price leads to aleads to a change inchange in quantity quantity supplied.supplied.

that is, athat is, a movement alongmovement along the supply the supply curve.curve.

3131

S1S2

a

c

A Shift in the Supply CurveA Shift in the Supply Curve

Quantity of CD-R Supplied(millions of constant-quality units per year)

Pric

e of

CD

-R (

$)

1

2

3

4

5

20 40 60 80 1000 140120

When supply decreasesthe quantity suppliedwill be less at each price: eg, employees form a union and successfully negotiate higher wages.

b

d

S2

When supply increasesthe quantity suppliedwill be greater at each price: eg, producer finds that she can use some cheaper materials due to a technology change.

b

d

3232

Shifts/Changes in Shifts/Changes in SupplySupply

A change in one or more of A change in one or more of the non-price determinants the non-price determinants of supply leads to aof supply leads to a– change inchange in supplysupply which iswhich is

the same thing asthe same thing as a a

– shiftshift of the supply curve.of the supply curve.

3333

Factors other than Price that Factors other than Price that affect Supplyaffect Supply – 1) 1) Cost of inputs Cost of inputs (price in factor markets)(price in factor markets)

– 2) Technology and Productivity2) Technology and Productivity– 3) Taxes and Subsidies3) Taxes and Subsidies– 4) Price Expectations 4) Price Expectations (in the product (in the product

market)market)

– 5) Number of firms in the industry5) Number of firms in the industry

““Everything Else” : The Everything Else” : The “Determinants”/“Shifters” of “Determinants”/“Shifters” of SupplySupply

How will these shift How will these shift supply?supply?

3434

Market Equilibrium Price & QuantityMarket Equilibrium Price & Quantity

MarketMarket: where prices tend toward : where prices tend toward equality through the continuous equality through the continuous interaction of buyers and sellers: interaction of buyers and sellers: the market forces of demand and the market forces of demand and supplysupply

3535

Market Equilibrium Price & QuantityMarket Equilibrium Price & Quantity

Perfectly Competitive MarketPerfectly Competitive Market Buyers & sellers numerous enough that Buyers & sellers numerous enough that

no single buyer/seller can influence the no single buyer/seller can influence the priceprice

Buyers & sellers are free to enter or exit Buyers & sellers are free to enter or exit the market at any timethe market at any time

Each party to the market exchange has Each party to the market exchange has full informationfull informationSingle Equilibrium

Price

3636

Putting Demand and Supply Putting Demand and Supply Together: Finding Market Together: Finding Market EquilibriumEquilibrium

(1) (2) (3) (4) (5)Difference

Price per Quantity Supplied Quantity Demanded (2) - (3)Constant-Quality (CD-R (CD-R (CD-R

CD-R per year) per year) per year) Condition

$5 100 million 20 million 80 million

4 80 million 40 million 40 million

3 60 million 60 million 0

2 40 million 80 million -40 million

1 20 million 100 million -80 million

Excess quantitysupplied (surplus)

Excess quantitysupplied (surplus)

Excess quantitydemanded (shortage)

Excess quantitydemanded (shortage)

3737

S

D

Market Equilibrium: Market Equilibrium: DefinitionDefinition

Quantity of CD-R(millions of constant-quality units per year)

Pric

e pe

r C

D-R

($)

1

2

3

4

5

20 40 60 80 1000

Excess quantity supplied at price $5

Excess quantity demanded at price $1

A B

Market clearing, orequilibrium, price

E QD= QS

The condition in a market when quantity supplied equals quantity demanded at a particular price; a point from where there tends to be no movement

3838

The Law of Supply & The Law of Supply & DemandDemand

The expression used to describe the The expression used to describe the fact that the price of any good will fact that the price of any good will adjust until the price is such that the adjust until the price is such that the quantity demanded is equal to the quantity demanded is equal to the quantity supplied, and quantity supplied, and

the market clears resulting in a the market clears resulting in a single market clearing or equilibrium single market clearing or equilibrium priceprice..

3939

Adjustment Example: Adjustment Example: Gas PricesGas Prices

Summer: Gas prices at equilibrium at Summer: Gas prices at equilibrium at $1.07 per liter$1.07 per liter

Winter arrives and certain drivers Winter arrives and certain drivers limit or end their driving for the limit or end their driving for the season (shift in demand)season (shift in demand)

The new market equilibrium is $0.70 The new market equilibrium is $0.70 per literper liter

4040

The Price System/Market The Price System/Market SystemSystem The equilibrium price rations the The equilibrium price rations the

limited amount of a good produced by limited amount of a good produced by the most willing and able suppliers, or the most willing and able suppliers, or sellers, to the most willing and able sellers, to the most willing and able demanders or buyers.demanders or buyers.– Prices signal what is relatively scarce and Prices signal what is relatively scarce and

relatively abundantrelatively abundant– Prices provide information and incentivesPrices provide information and incentives

– Prices rationPrices ration

4141

Changes in Market Equilibrium: Changes in Market Equilibrium: Shifts in Demand &/or SupplyShifts in Demand &/or Supply

– 1.) Decide whether Demand &/or 1.) Decide whether Demand &/or Supply is affected.Supply is affected.

– 2.) Decide in which direction the 2.) Decide in which direction the affected Demand &/or Supply will affected Demand &/or Supply will move.move.

– 3.) Use a Demand and Supply diagram 3.) Use a Demand and Supply diagram to determine the new equilibrium.to determine the new equilibrium.

•Suppose something in the demand &/or the supply ceteris paribus envelope(s) changes.

•How is the MARKET affected?