What sets the Price

In The ChipsP Qd Qs

3.50 35 43.70 33 113.90 31 184.10 29 234.30 27 274.50 23 294.70 18 314.90 11 335.10 4 35

IN THE CHIPS: S & D

3.30

3.50

3.70

3.90

4.10

4.30

4.50

4.70

4.90

5.10

5.30

0 4 8 12 16 20 24 28 32 36

Quantity

Pri

ce

Qd

Qs

So how does this crazy stuff work

• Consumers in the Market– DEMAND =

• CONSUMERS DESIRES + ABILITY TO PAY

• Also known as the law of Demand: as price(P) rises the quantity demanded (Qd) decreases – P Qd

What causes this graph to move

2 4 6 8 10 12 14 16 18 20$3.00

$3.50

$4.00

$4.50

$5.00

$5.50

$6.00

Demand Demand 2

Income

Substitutes

Complements

Tastes and Preferences

Advertising

It can go the other way too

2 4 6 8 10 12 14 16 18 20$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

$5.50

DemandDemand 2

But that only covers the Buyers

• Where do the Sellers come in?

The Seller side

2 4 6 8 10 12 14 16 18 20$3.00$3.20$3.40$3.60$3.80$4.00$4.20$4.40$4.60$4.80$5.00

Supply

Supply

Supply can move too

2 4 6 8 10 12 14 16 18 20$3.00

$3.20

$3.40

$3.60

$3.80

$4.00

$4.20

$4.40

$4.60

$4.80

$5.00

SupplySupply 2

Subsidy

Input Costs

Taxes

Government Regulation

Number of suppliers

Future Expectations

Buyers SellersEquilibrium

What If Something Changes?

• price

• income, price of other goods, tastes & preferences

• Recall the market for ice cream.

• Suppose the weather gets hotter.

• What would you expect to happen?

Buyers

• ↑ T&P

• D shifts right

• shortage at P1

Price ofIce-Cream

Cone

Quantity of Ice-Cream Cones

SupplySupply

Initialequilibrium

Initialequilibrium

DD

DD

3. . . . and a higherquantity sold.3. . . . and a higherquantity sold.

2. . . . resultingin a higherprice . . .

2. . . . resultingin a higherprice . . .

2. . . . resultingin a higherprice . . .

1. Hot weather increasesthe demand for ice cream . . .1. Hot weather increasesthe demand for ice cream . . .

2.00

7

2.00

7

New equilibrium$2.50

10

New equilibrium$2.50

10

$2.50

10

P ↑ to restore equilibrium (sellers respond, Qs ↑)new equilibrium: higher P & higher Q

Δ DDisequilibriumP adjustsQs respondsLaw of S

What If Something Changes?

• price

• price of inputs, technology, weather

• Recall the market for ice cream.

• Suppose the price of sugar increases.

• What would you expect to happen?

Sellers

• ↑ P input

• S shifts left

• shortage at P1

P ↑ to restore equilibrium (buyers respond, Qd ↓)new equilibrium: higher P & lower Q

Δ SDisequilibriumP adjustsQd respondsLaw of D

Price ofIce-Cream

Cone

Quantity of Ice-Cream Cones

DemandDemand

Newequilibrium

Newequilibrium

Initial equilibrium

S1S1

S2S2

2. . . . resultingin a higherprice of icecream . . .

2. . . . resultingin a higherprice of icecream . . .

2. . . . resultingin a higherprice of icecream . . .

2. . . . resultingin a higherprice of icecream . . .

1. An increase in theprice of sugar reducesthe supply of ice cream. . .

1. An increase in theprice of sugar reducesthe supply of ice cream. . .

3. . . . and a lowerquantity sold.3. . . . and a lowerquantity sold.

2.00

7

2.00

7

$2.50

4

$2.50

4

apples

beachfront cottages

identify period of highest buying/selling.

will price be high or low compared to normal?

relative scarcity is the key.

How Markets Work…

two markets with seasonal variation

Seasonal Variation: Apples

Seasonal Variation: Beachfront Cottages

• Your team will start with $60 to play.• There are four questions.• Each question is worth $10 or $20.

• If you answer the question correctly, you keep $$.• If your answer is incorrect, you give up $$.

• Answers must be written and complete in time.

• Decisions of the judges are final.• Each team must play every round ($0-120 possible).

Markets In Action

Cranberries, the Ruby Slipper & Your Health

The First Three Questions

1. What would you expect to happen if a new machine called the Ruby Slipper is introduced that dramatically improves the cranberry harvesting process?

A. The demand for cranberries would increase because more cranberries will be produced.

B. The supply of cranberries will increase as the marginal cost of production for farmers falls.

C. The quantity of cranberries purchased will increase as the price falls.

D. Both A and B are correct.E. Both B and C are correct.

1. What would you expect to happen if a new machine called the Ruby Slipper is introduced that dramatically improves the cranberry harvesting process?

A. The demand for cranberries would increase because more cranberries will be produced.

B. The supply of cranberries will increase as the marginal cost of production for farmers falls.

C. The quantity of cranberries purchased will increase as the price falls.

D. Both A and B are correct.E. Both B and C are correct.

2. Suppose that newly released medical research reveals significant health benefits associated with increased cranberry consumption?

A. The demand for cranberries will increase as people seek the added health benefits of cranberries.

B. The supply of cranberries will increase as more people want to eat cranberries.

C. The quantity of cranberries produced will increase as the price rises.

D. Both A and B are correct.E. Both A and C are correct.

2. Suppose that newly released medical research reveals significant health benefits associated with increased cranberry consumption?

A. The demand for cranberries will increase as people seek the added health benefits of cranberries.

B. The supply of cranberries will increase as more people want to eat cranberries.

C. The quantity of cranberries produced will increase as the price rises.

D. Both A and B are correct.E. Both A and C are correct.

3. Suppose that both the introduction of the new harvesting machine and the announced health benefits happened simultaneously.

What would you expect would happen to both the price of cranberries and the quantity of cranberries produced?

3. Suppose that both the introduction of the new harvesting machine and the announced health benefits happened simultaneously.

What would you expect would happen to both the price of cranberries and the quantity of cranberries produced?

↑ S: P ↓ Q ↑

↑ D: P ↑ Q ↑

Q ↑ for sure!

P ↓ if ↑ S > ↑ D

P ↑ if ↑ D > ↑ S

When big (flat) screen TVs were first introduced in the 1990s they were very expensive and very few households owned one.

Over time there was increased competition among producers as well as technological advancements in the production process. Over the same period average household incomes also rose significantly.

The Final Question

4. What effect would these changes have on the supply and/or demand in the market for big (flat) screen TVs?

Consumers have more income

Competition and advancing technology among sellers

4. What effect would these changes have on the supply and/or demand in the market for big (flat) screen TVs?

Consumers have more income

↑ S: P ↓ Q ↑↑ D: P ↑ Q ↑

Q ↑ for sure!

P ↓ if ↑ S > ↑ D

P ↑ if ↑ D > ↑ S

Competition and advancing technology among sellers

1. How do consumers respond to price changes for the following goods/services?

salt, public transportation, gasoline, automobiles

3. What if you wanted to help low skilled workers?

5. What if you wanted less pollution?

4. What if you wanted to reduce congestion on city streets?

2. What if you wanted to help poor people afford housing?

More In The ChipsP Qd Qs

3.50 35 43.70 33 113.90 31 184.10 29 234.30 27 274.50 23 294.70 18 314.90 11 335.10 4 35

IN THE CHIPS: S & D

3.30

3.50

3.70

3.90

4.10

4.30

4.50

4.70

4.90

5.10

5.30

0 4 8 12 16 20 24 28 32 36

Quantity

Pri

ce

Qd

Qs

• What would happen if we…

• limit the price transactions take place

– Not above $3.80 (price ceiling)

– Not below $4.80 (price floor)

• restricted # of sellers to 2 (same # buyers)

More In The Chips

• Restrict rent below some level• Affordable housing for low income

• How will buyers respond?

– Law of demand

• How will sellers respond? – Law of supply

• Short run, Long run

Rent Control

• Restrict wage above some level• Living wage for low skill workers

• How will buyers respond?

– Law of demand

• How will sellers respond? – Law of supply

• Short run, Long run

Minimum Wage

Big Ideas• Scarcity forces us to choose and every choice has an

opportunity cost.

• Open markets are a key institution for fostering economic growth and improving standards of living.

• Property rights, information, interaction and competition.

• Voluntary transactions create well-being.

• Prices reflect relative scarcity.• Prices represent opportunity cost.• Price is a powerful incentive.

• Buyers’ and sellers’ decisions about quantity demanded and quantity supplied are influenced by changing opportunity costs.

• The law of supply and the law of demand describe producers’ and consumers’ predictable reactions to changes in price.

Big Ideas

Big Ideas

People do things that make them better off.

Voluntary trade creates well-being.

Markets do a good job of allocating scarce resources to meet society’s desires.

Government can sometimes help, be careful.