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Mpp#010+more.on.markets.(36)

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Mpp#010+more.on.markets.(36)

  1. 1. More on MarketsConsidering Equilibrium andEquilibrium’s Interactions with DEMAND & SUPPLY 1
  2. 2. Relative Scarcity How scarce is one good or service compared to all other goods and services? Relative scarcity is the relationship between SUPPLY and DEMAND. Price represents the measurement of relative scarcity. What determines the price of a work of art, or an antique, or an old stamp or coin? 2
  3. 3. What is an Equilibrium Price? The measure of relative scarcity. Relative scarcity is the relation between SUPPLY and DEMAND. How scarce is one product compared to all others? The unit of measurement is the price in the domestic currency. (e.g. $43.37) 3
  4. 4. Relative Prices: the Why? Diamond $50,000Insulin $5 4
  5. 5. Price: as the Indicator of Relative Scarcity $ $ $how many units on the Scarcometer? 5
  6. 6. Order these Products on the basis of Relative Scarcity yacht candy bar nice dinner for two in San Francisco mini truck laptop computer 6
  7. 7. Order these Products on the basis of Relative Scarcity1 yacht5 candy bar4 nice dinner for two in San Francisco2 mini truck3 laptop computer 7
  8. 8. the Equilibrium Price asthe Measure of Relative Scarcity Feet and inches measure distance. Pounds and ounces measure weight. Degrees Fahrenheit measure heat. Cups and pints and quarts measure volume. Dollars and cents measure relative scarcity in the U.S. economy. 8
  9. 9. Relative Scarcity is NOT the same as rare  Rare tropical disease is not scarce (no DEMAND ).  Gold is more scarce than water even though water is essential for life. (the SUPPLY of water is greater than the SUPPLY of gold.)  Some collectors’ items are more scarce than others depending upon SUPPLY & DEMAND . Their prices go up or down depending upon changes in SUPPLY & DEMAND . 9
  10. 10. Relative Scarcity Relative scarcity is not a subjective evaluation of worth or value or social contribution although some of those considerations may be included in the DEMAND function. To the extent someone can manipulate SUPPLY or DEMAND they may be able to influence relative scarcity and thus the price ~ but price remains the ultimate measurement of relative scarcity.  OPEC  Advertising In a market with CIIP, price is the accurate measure of the relative scarcity of a good or service. 10
  11. 11. Relative Scarcity is the relationship existing between SUPPLY and DEMAND. is measured by the Equilibrium Price is not the same as rare is not a matter of SUPPLY alone Is neither “fair” nor “unfair” 11
  12. 12. The Law of Supply Once all “other factors” have been considered, the quantity supplied of a good or service varies directly with the price of the good or service; so if price goes up then quantity supplied goes up. The influence of price on quantity supplied is a short run phenomenon and assumes no change in “other factors”. The Principle of Exchange – if the price received by the supplier is greater than all production costs the supplier will SUPPLY the product. Price is an incentive to suppliers 12
  13. 13. Diminishing Marginal Returns Given some fixed inputs, additions of the variable inputs will yield lower additional products. Since each of the variable inputs are paid the same, marginal costs increase as production increases. Marginal resource costs rise as production increases. Therefore, suppliers must receive a higher price to supply a greater quantity, assuming no change in “other factors”. 13
  14. 14. Price Elasticity of SUPPLY Measures the strength of sellers’ reactions to a price change. How much will quantity supplied change as a result of a price change? Depends upon suppliers’ ability to increase or decrease production in the short run. How flexible are the resources used in production? 14
  15. 15. The Law of Demand Once all other factors have been considered, the quantity demanded of a good or service varies inversely with the price of the good or service. Price rises, quantity demanded falls; price falls, quantity demanded rises. The Principle of Exchange – if the price asked is greater than the expected benefit, the demander will not buy the product; if the price asked is less than the expected benefit, the demander will buy the product. Price is a disincentive to buyers. Higher prices send buyers in search of substitutes. 15
  16. 16. Diminishing Marginal Utility and DEMAND Utility is the benefit consumers get from consuming goods and services As consumers consume more of a product, the additional utility from additional units of the product decreases – the Law of Diminishing Marginal Utility To entice buyers to buy more as their marginal utility falls the price must also fall thereby making the price lower than the expected benefit. (the Principle of Exchange ) 16
  17. 17. Price Elasticity of DEMAND Measures the strength of buyers’ reactions to a price change. How much will quantity demanded change as a result of a price change? Depends upon  availability of substitutes  Percentage of total expenditures  time 17
  18. 18. Allocative Efficiency At the equilibrium price the marginal utility of consuming the product is equal to the marginal resource cost of producing the product. From society’s perspective this is the optimal resource allocation to this particular activity Attempts to change the price of a product through regulation will distort incentives and cause some amount of resource misallocation. 18
  19. 19. @ a Price Above Equilibrium If a price is set above equilibrium, a surplus exists. (wherein the quantity supplied is greater than the quantity demanded at the higher price.) Without artificial barriers to restrain “adjustment” the price will begin to fall towards equilibrium As price falls the quantity supplied will decrease and quantity demanded will increase. Eventually the price will fall to the equilibrium price where quantity supplied is equal to quantity demanded and the quantity exchanged. 19
  20. 20. @ a Price Below Equilibrium If a price is set below equilibrium, a shortage exists. (wherein the quantity demanded is greater than the quantity supplied at the lower price.) Without artificial barriers to restrain “adjustment” the price will begin to rise towards equilibrium As price rises the quantity demanded will decrease and quantity supplied will increase. Eventually the price will rise to the equilibrium price where quantity demanded is equal to quantity supplied and the quantity exchanged. 20
  21. 21. Surplus versus Shortage Surplus: at a price set above equilibrium the quantity supplied is greater than the quantity demanded. Shortage: at a price set below equilibrium the quantity demanded is greater than the quantity supplied. Surpluses and shortages are always in reference to specific non-equilibrium prices. They will be automatically eliminated by price changes if there are no barriers to price movements. 21
  22. 22. Price Floors & Price Ceilings A legislated price  A price floor is a minimum price. Prices can be higher but not lower than a floor (minimum “rent”). If the floor is set above the equilibrium a surplus is created.  A price ceiling is a maximum price. Prices can be lower but not higher than a ceiling (re: rent controls). If the ceiling is set below the equilibrium a shortage is created. 22
  23. 23. Price Floors & Price CeilingsPrice cannot fall below a floorPrice cannot rise above a ceiling 23
  24. 24.  Who gains?  Politicians  Those who get the goods and services  Those who police the ceiling Who loses?  Those who supply the good or service  Those who can’t get the good or service  Taxpayers a Price Ceiling = shortage 24
  25. 25. a Price Floor = surplus Who gains?  Politicians  Those who supply the goods and services  Those who police the floor  Those who store the surplus Who loses?  Those who demand the good or service  Taxpayers 25
  26. 26. Price Controls - the Message Price Controls distort market incentives Price Controls can not change the relative scarcity of the product Price Controls cause over allocation or under allocation of resources Price Controls cause arbitrary distributive effects …..But they are great politics! 26
  27. 27. the Markets during Disasters What happens to the markets for wood, tools and even water during a disaster?  Can’t get products in as SUPPLY decreases.  More people want these products as DEMAND increases.  the Product becomes relatively more scarce. 27
  28. 28. the Markets during Disasters What happens to the markets for wood, tools and even water during a disaster?  What incentive would cause suppliers to SUPPLY more of the product?  A price ceiling prevents the price from rising.  The shortage worsens. 28
  29. 29. Disasters usually causeshortages and Price Ceilings make the shortages worse. the Government’s Price Controls can’t change relative scarcity but they do distort incentives 29
  30. 30. the Market in Disasters Considering what happens to markets for products like wood, tools and even water during a disaster?  Trucks can’t bring products in thereby decreasing SUPPLY  More people need these products than under “normal” thereby increasing DEMAND  So why do people cry price gouging? 30
  31. 31. Price Gouging??? As economists we know if the government felt sorry for these people and imposed a price floor on certain products there will be a shortage. Other people feel the prices are “made artificially high” to take advantage of the affected “victims”. This is an untrue statement. 31
  32. 32. PRICE CONTROLSDISTORT MARKET INCENTIVES AND CAUSE THE MISALLOCATION OF RESOURCES 32
  33. 33. Main Points [continued (a)] Relative scarcity for a particular product is the defined by relationship between SUPPLY & DEMAND Consistent with CIIP, SUPPLY & DEMAND determine the relative scarcity of a product. The relative scarcity is accurately measured by the price of the product. The Law of SUPPLY states price and quantity move in the same direction. Price Elasticity of SUPPLY measures the strength of a suppliers’ response to price changes. 33
  34. 34. Main Points [continued (b)] the Law of DEMAND states the price and the quantity demanded move in the opposite direction. the Price Elasticity of DEMAND measures the strength of the buyers’ reactions to price changes. 34
  35. 35. Main Points [continued (c)] Supply represents the marginal opportunity cost of producing different quantities of a product. Demand represents the marginal utility of consuming different quantities of a product. Allocative efficiency occurs at the equilibrium where the marginal opportunity cost of producing a quantity is just equal to the marginal utility of consuming that quantity. 35
  36. 36. Main Points a surplus exists at a price above the equilibrium point where the quantity supplied is greater than the quantity demanded a shortage occurs at a price below the equilibrium point where the quantity demanded is greater than the quantity supplied if there is no price floor a surplus will correct itself as the price falls if there is no price ceiling a shortage will correct itself as the price rises 36

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