Economics 310Economics 310

First Homework-Answer.

Department of Economics

College of Business and Economics

California State University-Northridge

Professor Kenneth Ng

Four Economics Principles.

Comparative Advantage. Specialization and Exchange. Do Nothing. More Different.

How do these apply to supply and demand analysis?

Demand Schedule

A demand schedule shows how much of a good will be purchased at any given price.

Can represent the demand of an individual or group of individuals.

Price Quantity10 19 28 37 46 55 64 73 82 91 10

Graphing the demand schedule produces the demand curve.

Interpreting the demand curve. The height of the demand curve

at a given quantity represents marginal value.

Marginal value is the most an individual will pay for an additional unit of the good given the amount of the good he already has.

The marginal value of a unit of a good is analogous to opportunity cost in the carpenter and electrician example.

The marginal value to a demander can be thought of as what it would cost the demander to produce a certain unit of the good themselves.

Given the opportunity cost, the demander could make himself better off if he could buy the good for less in the marketplace that he could produce the good himself.

Interpreting the demand curve (2)

The area under the demand curve out to a given quantity represents the total willingness to pay.

Total willingness to pay is the most money an individual will voluntarily give up to acquire a given quantity of a good.

The total willingness to pay measures the potential benefit from exchange.

What is the TWP for 6 units?

Price Quantity10 19 28 37 46 55 64 73 82 91 10

What is the TWP for 6 units?

Price Quantity10 19 28 37 46 55 64 73 82 91 10

Supply Schedule.

A supply schedule shows how much a person or group or people would be willing to sell at any given price.

The supply schedule can be graphed to yield a supply curve.

Price Quantity10 119 108 97 86 75 64 53 42 31 2

Supply Curve.

Interpreting the Supply Curve• Height of supply curve

represents the sellers marginal value.

• Marginal value for seller is the minimum the seller would accept to sell a particular unit of the good.

• The marginal value of a unit of a good is analogous to opportunity cost in the carpenter and electrician example.

The marginal value to a supplier can be thought of as the cost of producing the good.The supplier would be better off if he could sell the good for more than it costs him to produce it.

Interpreting the Supply Curve

• Area under the supply curve represents the minimum willingness to sell.

• Minimum willingness to sell is the least the seller would accept in voluntary exchange for a given amount of the good.

• Minimum willingness to sell 6 units is 2+2+3+4+5=16.

Equilibrium

Supply and demand curves can be used to generate positive statements about human behavior.

Given the supply and demand curves for a good , …. will happen. – Supply will equal demand.– The market will equilibrate.– a certain amount of the good will be exchanged at a

particular price. If the demand or supply of a good changes, then …. If income, price of other goods, or tastes and preferences

change then the demand for a good will change and ….

Equilibrium: Supply equals Demand

Price Quantity10 19 28 37 46 55 64 73 82 91 10

Price Quantity10 119 108 97 86 75 64 53 42 31 2

Demand

Supply

Why Equilibrium?Price Quantity

10 19 28 37 46 55 64 73 82 91 10

Price Quantity10 119 108 97 86 75 64 53 42 31 2

Demand

Supply

•Is there an opportunity for mutually beneficial voluntary exchange if no units of the good have been exchanged?

•The MV to seller of first two units of good is $1, i.e. will sell for any price greater than $1.

• The MV to demander of the first two units of good is $10 and $9, i.e. will pay any amount less than $19 for 2 units of the good.

•Demander and supplier would voluntarily exchange at a price of $5.

The movement to equilibrium illustrates several effects of the operation of markets.

Moving to equilibrium – Produces collective and individual enrichment.

• In this case, because marginal values differ between buyer and seller there is an opportunity for wealth creation.

• Corollary to Law of Comparative Advantage. • How much better off are demander and seller after

exchanging 2 units of good?• Role of price?

– Occurs as a result of individuals pursuing their own self interest (corollary of the Do Nothing Policy).

Properties of Equilibrium (1) Moving to an equilibrium divides

the potential gain from trade between buyers and sellers.

The price determines how the gain from trade is divided between buyer and seller.

– For 6 units of the good, the buyer has a TWP of $45.

– For 6 units, the seller has a minimum willingness to sell of $16.

– The potential gain from trade is $45-$16 or $29

– At a price of $5 the buyer pays $30 and the seller gets $30. Therefore the buyer has gained $15 from trade and the seller has gained $14 from trade.