“Making a speech on economics is a lot like pissing down your leg. It seems hot to you, but it never does to anyone else

1. “Making a speech on economics is a lot like pissing down your leg. It seems hot to you, but it never does to anyone else”. Lyndon B. Johnson

2. Median annual earnings for child day care workers (2008): $17,440 NBA Average Salary: $5,000,000

3. Do prices reflect the value we place on a commodity? Is a game more valuable than caring for our children?

4. Do prices reflect how necessary a commodity is?

5. Price of a gallon of Perfume (Channel No.5) is $25,600 Price of a gallon of gasoline is $3 Price of a gallon of tap water is ~$0 • Is perfume more necessary than water?

6. Do prices reflect how scarce a commodity is?

7. Scarcity? Necessity? Value? We want to know What determines prices?

8. Retail Price Gasoline Is $4.60/gallon too high? Is $2.78/gallon the correct price?

10. We want to know What is the correct price?

11. Soaring gas prices turned into massive profits for big oil In the middle of the worst recession in decades • British Petroleum reported a staggering 63%increase in first quarter net profit to $7.6 billion • Royal Dutch Shell posted a 25% increase to $9.1 billion. • Conoco Phillips reported a 16% rise in net income to $4.1 billion.

12. With unemployment around 10% is it fair to allow oil companies to rake in the profit? Should the government do something about it?

13. Prices are determined in two ways • By buyers and sellers in a market free of any type of interference: • Perfectly Competitive Markets (Chapter 11) • By producers when they have the power to do so: • Monopolies (Chapter 12) • Monopolistically Competitive Firms (Chapter 13) • Oligopolies (Chapter 13)

14. The Correct Price is the one set by Perfectly Competitive Markets Prices are determined by supply and demand

15. The Role of the Government • Improve upon the Free Market solution: • Price ceilings and floors • Regulate prices set by producers: • Antitrust legislation • Discourage undesirable behavior • Tax vices

16. Perfect Competition • There are so many firms that no single firm can affect the price: firms are price takers. • There are so many buyers that no single buyer can affect the price: buyers are price takers. • All firms sell identical products. • Established firms have no advantages over new firms: • If a firm experiences a technological breakthrough other firms will copy immediately. • Sellers and buyers have all necessary information about prices. • There are no costs to enter or exit the industry.

17. To explain how prices are determined in Perfectly Competitive Markets we use the Supply and demand model

18. What is a market? Examples: commodities market, stock market, classified advertising section of the newspaper, e-bay, market for cocaine... Any environment in which buyers and sellers communicate to exchange goods or services.

19. Quantity Demanded The number of units an individual is willing and able to purchase at each price holding constant all other factors that may influence his/her decision.

20. Demand CurvesSlope DOWN to the right. PRICE $2.5 $2.50 for a cup of coffee? Forget it! $2 Because the more units you have the lower the value to you of getting an additional unit $1.5 $1 $0.5 $0 1 2 3 4 ? 0 QUANTITY

21. $2 $1.5 The less expensive an item is… $1 1 2 3 4 $0.5 The more units we buy The Law of Demand Demand Curves Slope DOWN to the right. Implies that

22. Application • Use the law of demand to predict how buyers will react to a decrease in the price of cars. • Quantity Demanded increases: IF and only IF nothing but the price changes. • What if at the same time that car prices drop, the economy enters into a recession, jobs are lost and incomes drop? • We can not know what will happen. Two variables changed (income and prices). The drop in incomes will lower sales, the drop in prices would increase sales. We cannot tell which effect will dominate.

23. $2 $1.5 The less expensive an item is… $1 1 2 3 4 $0.5 The more units we buy ONLY the price changes The Law of Demand Demand Curves Slope DOWN to the right. Implies that Income remain the same

24. You buy status –not just jeans- when you buy these Application • Use the law of demand to predict how buyers will react to a decrease in the price of jeans. • Quantity Demanded increases: IF and only IF nothing but the price changes. • Suppose that Bluefly jeans were $240 at Nordstrom and now they are available at Costco for $19.99! • We can not know what will happen. Two variables changed (tastes and prices). The drop in price should increase sales, but at such low price they lost most of their appeal.

25. $2 $1.5 The less expensive an item is… $1 1 2 3 4 $0.5 The more units we buy ONLY the price changes The Law of Demand Demand Curves Slope DOWN to the right. Implies that Consumer Tastes remain the same

26. Application • Use the law of demand to predict how buyers will react to a decrease in the price of wines made in California. • Quantity Demanded increases: IF and only IF nothing but the price changes. • What if at the same time the price of French wines also drop? • We can not know what will happen. Two variables changed (price of domestic wines and price of French wine). The drop in price of French wine would lower sales of domestic brands, the drop in price of domestic brands should increase sales…

27. $2 $1.5 The less expensive an item is… $1 1 2 3 4 $0.5 The more units we buy ONLY the price changes The Law of Demand Demand Curves Slope DOWN to the right. Implies that Prices of related goods remain the same

28. Application • Use the law of demand to predict how buyers will react to a decrease in the price of Dell Laptops • Quantity Demanded increases: IF and only IF nothing but the price changes. • What if you just got notice that your company may cut your work hours starting next week? • We can not answer this question, because there are two variables (price and expectations) changing. Fear of losing income would lower sales, the drop in prices would increase sales. Put together we cannot tell which effect will dominate.

29. $2 $1.5 The less expensive an item is… $1 1 2 3 4 $0.5 The more units we buy ONLY the price changes The Law of Demand Demand Curves Slope DOWN to the right. Implies that Consumer Expectations remain the same

30. Demand Curves Slope DOWN to the right. Impliesthat $5 $4 The less expensive an item is… $3 2 4 6 8 $2 The more units we buy What if at the same time the price drops, you lose your job? The Law of Demand What if because the price dropped, you no longer like this good? What if at the same time the price drops, prices of similar goods also drop? What if the price drops because a new version is coming into the market soon?

31. The Ceteris Paribus Assumption “Other things constant” means that all other factors –different from the price- that affect your decision are assumed to remain constant, whether they actually remain constant or not.

32. When the price dropsceteris paribus the quantity demanded increases and vice versa. The Law of Demand and everything else remains the same

33. Price Changes are represented by aMovement Along the Demand Curve 150 A drop in price from $100 to $ 50 120 A movement Along 100 Cause a change in quantity demanded from 10 to 20 50 30 D 0 10 20 0 6 24 30

34. Prices ONLY! Changes in price cause changes in quantity demanded A movement along the demand curve. Determinants of Quantity Demanded

35. Anna’s Demand Schedule 150 120 100 50 D 30 0 0 6 10 20 24 30

36. When Income Increases… At each price now she can afford to buy more units The entire line shifts! 150 A shift in Demand 120 100 50 30 0 6 10 20 24 30 0 41 Instead of zero units Instead of 6 Instead of 24 11 17 21 31 35 Instead of 10 Instead of 20 Instead of 30

37. Changes inQuantity Demanded vs. Changes in Demand: Important Distinction! Changes in quantity demandedare the result of price changes. Moving Along a Demand Curve Changes in demand are the result of changes in all other determinants of demand (Prices of other goods, incomes, expectations, tastes and preferences) Shift the Demand Curve

38. When other things do NOT remain constant A household’s decision about how many units of a product to demand is also affected by: • Prices of Other Goods (P) • INCOME available (I) • TASTES AND PREFERENCES (T) • EXPECTATIONS with respect to future income, wealth, and prices (E) Demand Line Shifts

39. Health Care Services Homes Restaurant Meals Normal Goods • Goods that people buy more when their income increases • Goods that people buy less when their income decreases • Most goods we buy are Normal Goods Demand for Normal Goods changes in the same direction as income changes

40. Demand for Normal Goods Increases when Income Increases Price Demand shifts to the right. D2 D1 0 Quantity demanded Normal Good

41. Demand for Normal Goods Decrease when Income Decrease Price Demand shifts to the left. D1 D2 0 Quantity demanded

42. Bus Rides Store Brand Products Ralph's Ice Cream No Brand Shampoo Generic Products Inferior Goods • Goods that people are forced into buying when incomes drop. • Goods that people buy less or stop buying when income increases. • Inferior goods are bought only out of necessity… Store Brand Products Demand for Inferior Goods changes in the opposite direction as income changes Generic Products

43. Demand for Inferior Goods Decrease when Income Increase Price Demand shifts to the left. D1 D2 0 Quantity demanded Inferior good

44. Demand for Inferior Goods Increases when Income Decreases Price Demand shifts to the right. D2 D1 0 Quantity demanded Normal Good

45. Price D 0 Quantity demanded Gasoline pricesrise What will happen to the demand for gasoline?

46. Consumer incomesrise. Price D 0 Quantity demanded What will happen to the demand for gasoline? What will happen to the demand for cars? What will happen to the demand for public transportation?

47. If the price of a substitute of good of good X increases, Demand for X increases: a shift to the right. Determinants of Demand • Prices of Related goods. Substitute Goods: • Goods that can serve as replacements for one another • When one of the goods becomes more expensive, demand for the other good increases. • Perfect substitutes are identical products from the point of view of the buyer.

48. Substitute Goods • Fuel oil, natural gas (used for heating or electricity), coal, nuclear fuels, windmills, etc • Butter and margarine • Wood and bricks • Cellular phones and public pay phones • Compact discs and cassettes • Zip disks, memory sticks, CDs. • Different brands of the same product.

49. Practice • Price of a Sony cell phone increase. What happens to the demand iPhones? • Price of a Sony cell phone increase. What happens to the demand Sonycell phones? • Price of a Sony cell phone increase. What happens to the quantity demanded of Sonycell phones?

50. Determinants of Demand • Prices of Other Goods. Complements: • Goods that are used together • When one becomes more expensive, we buy fewer units of both goods. • When the price of one increases, demand for the other decreases. If the price of a complement of good X increases, Demand for X will decrease: the demand curve for X shifts to the left.