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- 1. Prof. dr. Maarten Pieter Schinkel Principles of Economics & Business Monday Lecture 2 September 12th 2022 ‘Choices’ – with Willemijn van Dolen
- 2. 1
- 3. 2 “The master-economist must possess a rare combination of gifts .... He must be mathematician, historian, statesman, philosopher—in some degree. He must understand symbols and speak in words. He must contemplate the particular, in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the present in the light of the past for the purposes of the future. No part of man's nature or his institutions must be entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood, as aloof and incorruptible as an artist, yet sometimes as near to earth as a politician.” John Maynard Keynes (1924)
- 4. 3 Agenda • Demand and Consumer Surplus • What can shift a Demand Curve? • Supply and Producer Surplus • What can shift a Supply Curve? • Market Equilibrium and how it comes about • Free market maximizes the gains from trade
- 5. 4 Demand Curve: A function that shows the quantity demanded at different prices. Quantity Demanded: The quantity that buyers are willing and able to buy at a particular price.
- 6. 5 Demand for Crude Oil
- 7. 6 ‘The Law of Demand’ • A demand curve is (typically) negatively sloped: The lower the price, the greater the quantity demanded • Demand summarizes how consumers choose to use a good, given their preferences and the possibilities for substitution
- 8. 7 Demand reflects value in different uses
- 9. 8 Consumer Surplus: The consumer’s gain from exchange, or the difference between the maximum price a consumer is willing to pay for a certain quantity and the market price. Total Consumer Surplus: The area beneath the demand curve and above the price.
- 11. 10 Shifts in the Demand Curve
- 12. 11 Demand Shifters • Tastes • Income • Population • Price of substitutes • Price of complements • Expectations
- 13. 12 Tastes • What people like underlies their demand • Changes in tastes caused by fads, fashions, and advertising can all increase or decrease demand – important role of marketing
- 14. 13 Income • When people get richer, they buy more stuff • When an increase in income increases the demand for a good, it is a normal good • Most goods are normal goods • When an increase in income decreases the demand for a good, it is an inferior good
- 15. 14 Population • An increase in population will increase demand generally • A shift in subpopulations will change the demand for specific goods and services – e.g. an aging population
- 16. 15 Price of Substitutes • A substitute is a good that can be consumed instead of another good • A decrease in the price of a substitute will decrease demand for the other good • New substitutes becoming available decrease demand
- 17. 16 Prices of Complements • Complements are things that go well together • A drop in the price of a complement increases demand for the complementary good • New complements becoming available increase demand
- 18. 17 Expectations • New expectations of a reduction in future supply increases the demand today • Changed expectations of future demand can in- or decreases demand today
- 19. 18 Supply Curve: A function that shows the quantity supplied at different prices. Quantity Supplied: The quantity that sellers are willing and able to sell at a particular price.
- 20. 19 Supply of Crude Oil
- 21. 20 ‘The Law of Supply’ • A supply curve is (typically) positively sloped: The higher the price, the greater the quantity supplied • Supply summarizes how producers choose to offer a good, given their technologies and cost of production factors
- 22. 21 Supply reflects (marginal) cost of production Top photo: Dan Lamont/Corbis Bottom: Bettmann/Corbis
- 23. 22 Producer Surplus: The producer’s gain from exchange, or the difference between the market price and the minimum price at which a producer would be willing to sell a particular quantity. Total Producer Surplus: The area above the supply curve and below the price.
- 25. 24 Shifts in the Supply Curve
- 26. 25 Supply Shifters • Technological innovations and changes in the price of inputs • Taxes and subsidies • Expectations • Entry or exit of producers • Changes in opportunity costs
- 27. 26 Technological Innovations • Improvements in technology can reduce costs, thus increasing supply • A reduction in input prices also reduces costs and thus has a similar effect
- 28. 27 Taxes and Subsidies • A tax on output has the same effect as an increase in costs • A subsidy is the reverse of a tax
- 29. 28 Expectations • Suppliers who expect prices to increase will store goods for future sale and sell less today • The expectation of a future price increase therefore decreases current supply • Supply curve today shifts to the left • Yet it increases future supply – supply curve tomorrow shifts to the right
- 30. 29 Entry or Exit of Producers • The entry of new producers increases supply, shifting the curve down and to the right
- 31. 30 Changes in Opportunity Costs • An increase in opportunity costs reduces supply • With the new legal option to grow hemp, the opportunity cost of growing wheat increases • Some farmers will shift away from producing wheat, and will start growing hemp • Supply curve of wheat shifts to the left
- 32. 31 Market Equilibrium The price at which the quantity demanded is equal to the quantity supplied. • Intersection of the demand and supply curves • Equilibrium price and quantity are the only ones that are stable in a free market • At any other point, ‘economic forces’ push prices and quantities back toward equilibrium
- 34. 33 Demand/Supply and Quantity Demanded/Supplied • There is a big difference between demand/supply and quantity demanded/supplied • A change in demand/supply is a shift of the entire demand/supply curve • A change in quantity demanded/supplied is a movement along a fixed demand/supply curve • First look at changes in the quantities demanded/supplied
- 35. 34 Price Quantity 700 $60 $75 500 // 900 Supply Demand Price Above Equilibrium Disequilibrium Price Adjustment: Surplus
- 36. 35 Price Quantity 700 $60 $75 500 // 900 Supply Demand QD = 500 QS = 900 SURPLUS QS > QD Disequilibrium Price Adjustment: Surplus
- 37. 36 Price Quantity 700 $60 $75 500 // 900 Supply Demand Price is driven down towards equilibrium Disequilibrium Price Adjustment: Surplus
- 38. 37 Price Quantity 700 $60 $55 500 // 900 Supply Demand Price Below Equilibrium Disequilibrium Price Adjustment: Shortage
- 39. 38 Price Quantity 700 $60 $55 500 // 900 Supply Demand QS = 500 QD = 900 SHORTAGE QD > QS Disequilibrium Price Adjustment: Shortage
- 40. 39 Price Quantity 700 $60 $55 500 // 900 Supply Demand Price is driven up towards equilibrium Disequilibrium Price Adjustment: Shortage
- 41. 40 Oil Market Disequilibrium Price Adjustments
- 42. 41 Equilibrium and Gains From Trade • A free market maximizes the gains from trade: 1. Available goods are bought by buyers with the highest willingness to pay 2. Goods are sold by the sellers with the lowest costs 3. Between buyers and sellers, there are no unexploited gains from trade or any wasteful trades • These three conditions imply that the gains from trade are maximized
- 43. 42 Buyers are willing to pay $90 Unexploited Gains From Trade Price Quantity Supply Demand 70 $70 // Suppose quantity is less than equilibrium quantity (say 50) 50 90 $50 $90 Sellers are willing to supply for $50
- 44. 43 Buyers are willing to pay $90 Unexploited Gains From Trade Price Quantity Supply Demand 70 $70 // 50 90 $50 $90 Sellers are willing to supply for $50 Any trade between $50 and $90 will make both parties better off Unexploited gains from trade
- 45. 44 Wasted Resources Price Quantity Supply Demand 70 $70 // Suppose quantity is greater than equilibrium (say 90) 50 90 $50 $90 Sellers are willing to supply for $90 Buyers are only willing to pay $50
- 46. 45 Wasted Resources Price Quantity Supply Demand 70 $70 // 50 90 $50 $90 Sellers are willing to supply for $90 Buyers are only willing to pay $50 Sellers are losing money on these units Waste of resources
- 47. 46 Concluding Remarks • Choices are behind demand and supply • Price can equilibrate a market – Friedrich von Hayek • Free market maximizes the gains from trade For the Friday Lecture: • Demand/supply versus quantity demanded/supplied • Supply and demand plans change, changing the market equilibrium • Two types of dynamics; which one is faster?