Dr. Duffy Microeconomics

1. Dr. Duffy Microeconomics The end of CHAPTER 3 Frank and Bernanke With supplemental material

2. Market Equilibrium A market equilibrium comes at the place where quantity demanded equals quantity supplied. Equilibrium takes place at the intersection of the supply and demand curves.

3. Market Equilibrium • Equilibrium • A system is in equilibrium when there is no tendency for it to change • Market Equilibrium • Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price

4. Market Equilibrium • What Do You Think? • Is the market equilibrium always an ideal outcome for all market participants? • Would buyers prefer a lower price than the equilibrium price? • Would sellers prefer a higher price than the equilibrium price?

5. Movements of Curves • An increase moves demand (or supply) to the right. • A decrease moves demand (or supply) to the left. • Think in terms of right and left, not up and down, when shifting curves.

6. Predicting and Explaining Changes In Prices and Quantities • Distinguishing Between: • A change in the quantity demanded • A movement along the demand curve that occurs in response to a change in price • A change in demand • A shift of the entire demand curve

7. Increase in quantity demanded D An Increase In Quantity Demanded vs. An Increase In Demand Price ($/can) 6 5 4 3 2 1 Quantity (1000s of cans/day) 0 2 4 6 8 10 12

8. An Increase In Quantity Demanded vs. An Increase In Demand Price ($/can) D’ D 6 5 4 Increase in demand 3 2 D’ 1 D Quantity (1000s of cans/day) 0 12

9. Predicting and Explaining Changes In Prices and Quantities • Change in the quantity supplied • A movement along the supply curve that occurs in response to a change in price • Change in supply • A shift of the entire supply curve

10. S Increase in quantity supplied S An Increase In Quantity Supplied vs. An Increase In Supply Price ($/can) 6 5 4 3 2 1 Quantity (1000s of cans/day) 0 2 4 6 8 10

11. An Increase In Quantity Supplied vs. An Increase In Supply Price ($/can) 6 S S’ 5 4 3 Increase in supply 2 1 S S’ Quantity (1000s of cans/day) 0 2 4 6 8 10

12. Predicting and Explaining Changes In Prices and Quantities • Economic Naturalist • When the Federal Government implements a large pay increase for its employees, why do rents for apartments near Washington Metro stations go up relative to rents for apartments located far away from Metro stations?

13. S P’ P D’ D Q Q’ The Effect of a Federal Pay Raise on the Rent for Conveniently Located Apartments in Washington D.C. Rent (dollars per month) Conveniently located apartments (units per month)

14. Economic Puzzler • Economic Naturalist • Why do the prices of some goods, like airline tickets to Europe, go up during the months of heaviest consumption, while others, like sweet corn, go down? • Hint, figure out which curve is shifting! A quantity increase can occur from either a demand increase or a supply increase.

15. High Consumption and Prices Due to High Demand Price ($/ticket) S PS PW DS DW 1000s of tickets QW QS Seasonal Variation in Air Travel

16. High Consumption and Low Prices due to High Supply Price ($/bushel) SW SS PS PW D Millions of bushels QW QS Seasonal Variation in Corn Markets

17. S S’ S’ after reduction in price of corn harvesting equipment P D’ after discovery that oils are harmful to people’s health P’ D D’ Q’ Q The Effects Of Simultaneous Shifts In Supply And Demand The Market for Corn Tortilla Chips Price ($/bag) Millions of bags per month

18. S’ after reduction in price of corn harvesting equipment S’ D’ after discovery that oils are harmful to people’s health P’ D’ Q’ The Effects Of Simultaneous Shifts In Supply And Demand The Market for Corn Tortilla Chips Price ($/bag) S P D Millions of bags per month Q

19. Simultaneous Shifts, part 1 • If supply increases and demand increases, quantity will increase (we can’t say what happens to price without more information). • If supply decreases and demand decreases, quantity will decrease (we can’t say what happens to price without more information.)

20. Simultaneous Shifts, part 2 • If demand increases and supply decreases, price will rise (we can’t say what happens to quantity without more information). • If demand decreases and supply increases, price will fall (we can’t say what happens to quantity without more information.)

21. Predicting and Explaining Changes In Prices and Demand • Assume • A vitamin found in corn chips helps protect against cancer and heart diseases • Swarm of locusts destroys part of the corn crop • What Do You Think? • What will happen to the equilibrium price and quantity of corn chips?

22. Markets And Social Welfare • What Do You Think? • When are the prices and quantities determined in market equilibrium socially optimal, in the sense of maximizing total economic surplus?

23. Markets And Social Welfare • Cash On The Table • Assume: • All exchange is purely voluntary • If so: • The buyer’s reservation price exceeds the seller’s reservation price and both the buyer and seller receive an economic surplus

24. Markets And Social Welfare • Cash On The Table • Buyer’s surplus • The difference between the buyer’s reservation price and the price he or she actually pays

25. Markets And Social Welfare • Cash On The Table • Seller’s surplus • The difference between the price received by the seller and his or her reservation price

26. Markets And Social Welfare • Cash On The Table • Total surplus • The difference between the buyer’s reservation price and the seller’s reservation price

27. Markets And Social Welfare • Cash On The Table • Economic metaphor for unexploited gains from exchange

28. Socially “optimal” quantity • The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good • The socially optimal quantity occurs when • MC = MB

29. Economic Efficiency Economic efficiency occurs when all goods and services are produced and consumed at their respective socially optimal levels

30. The Efficiency Principle • Maximize the economic surplus • Increase the economic pie

31. Market Equilibrium And Social Welfare • When is the market equilibrium efficient? • When all cost of producing the good or service are borne directly by the seller • When all benefits from the good or service accrue directly to buyers Can you think of situations where costs or benefits accrue to people who do not buy or sell the good?

32. Inefficient Market Equilibrium An inefficient market equilibrium occurs when some costs of production fall on people other than those who sell the good or service OR When some benefits of consumption fall on those who do not buy the good or service.

33. Externalities • Externalities is the name given to a cost or benefit that accrues to people outside a market. • Pollution is one type of externality. • But externalities can also be beneficial, such as the benefit to existing gas stations of having a shopping mall move to a location. • Negative externalities are more likely to draw attention than positive ones.

34. Markets And Social Welfare • Example: Pollution (cost example) • The market is in equilibrium for all buyers and sellers so that for them MC = MB • MC in the market, however, underestimates the cost to society of producing the good • Therefore, the market produces more than the efficient amount and there is no incentive for producers and consumers to alter their behavior

35. Markets And Social Welfare • Example: Vaccinations (benefit example) • The market is in equilibrium for all who buy or sell in the market so that: MC = MB • MB underestimates the benefits to society of consuming the vaccinations • The market produces less than the efficient amount of vaccinations and there is no incentive for producers and consumers to alter their behavior

36. Markets And Social Welfare • Smart For One, Dumb For All • In these markets • Buyers and sellers are behaving rationally • Market equilibrium exists • There are no unexploited opportunities for individuals • Economic surplus is not maximized

37. Markets And Social Welfare • The Equilibrium Principle • A market in equilibrium leaves no unexploited opportunities for individuals, but may not exploit all gains achievable through collective action.

38. Public good • A public good is a good that is not “used up” by its consumers. It has positive externalities. • Education is one example. The people getting the education benefit, but so do others in society because educated people are likely to increase the society’s PPF. • A park or road is another type of public good. I can use it and still leave it for others to use.

39. Public goods and public “bads” • If outcomes are left entirely to the market, society will tend to overproduce good with negative externalities and underproduce those with positive externalities. • Why?

40. Externalities and markets • For goods with negative externalities, costs are borne by those outside the market so the price of the item does not reflect its full MC to society. • For goods with positive externalities, producers find it impossible to collect fees from all who benefit. Hence price of the item will not reflect its MB to society.

41. Calculating price and quantity at market equilibrium • Demand Equation • Quantity Demanded = 200 – 5p • Supply Equation • Quantity Supplied = 50 + 10P • At equilibrium Qd=Qs

42. Solving the Equations Set Qd=Qs and solve 200 – 5p = 50 + 10P 150 = 15p P= 10 Qd = 150 Qs = 150 Check!

43. End of Chapter