Slide 1Thinking Economically: Marginal AnalysisMarginal Way in Action SimplifiedBoxesMaximizing Total Net BenefitsBasic Definitions for MB and MC and Maximization of TNBMarkets: The power of Demand and SupplyThe Theory of Demand for Goods and ServicesSlide 9The Law of DemandSlide 11Slide 12Catherine’s Demand ScheduleFigure 1 Catherine’s Demand Schedule and Demand CurveSlide 15Movements Along vs Shifts of the Demand CurveFigure 3 Shifts in the Demand CurveTheory of SupplySlide 19Slide 20Ben’s Supply ScheduleFigure 5 Ben’s Supply Schedule and Supply CurveSlide 23Movements vs. Shifts AgainFigure 7 Shifts in the Supply CurveMarket EquilibriumFigure 8 The Equilibrium of Supply and DemandFigure 9 Markets Not in EquilibriumFigure 9 Markets Not in EquilibriumFigure 10 How an Increase in Demand Affects the EquilibriumFigure 11 How a Decrease in Supply Affects the EquilibriumComparative StaticsRole of PricesRocking and Rolling: Comparative StaticsUsing Comparative Statics to Predict or Explain Market BehaviorExplaining Markets with TracksThe Invisible HandSlide 38DECISION-MAKING AND DEMAND AND SUPPLY ANALYSISTHINKING ECONOMICALLY: MARGINAL ANALYSISOptimization Assumption: an assumption that suggests that the person in question is trying to maximize some objectiveMarginal Benefit: the increase in the benefit that results from an actionMarginal Cost: the increase in the cost that results from an actionTotal Net Benefits: the difference between all benefits and all costsMARGINAL WAY IN ACTION SIMPLIFIEDThe Box ExampleIf the marginal benefit of an extra unity of the activity is greater than its marginal cost, increasing the activity will increase total net benefits.If the marginal cost of an extra unit of the activity is greater than its marginal cost, increasing the activity will decrease total net benefits.Therefore, to maximize total net benefits the level of an activity that maximizes total net benefits is where the marginal benefit equals the marginal cost of an extra unit of the activity.BOXESIf an extra unit of the activity (trades) results in getting more boxes (MB) than are being given up (MC) the stack of boxes grows (TNB).If an extra unit of the activity (trades) results in getting less boxes (MB) than are being given up (MC) the stack of boxes shrinks (TNB).If an extra unit of the activity (trades) results in getting the same amount of boxes (MB) that are being given up (MC) the stack of boxes is at its tallest ( maximum TNB).MAXIMIZING TOTAL NET BENEFITSTotal Way – select the level of the activity that maximizes the difference between total benefits and total costsMarginal Way – set the marginal benefit of to the marginal cost of an extra unitEconomist prefer the later because many decisions are not all or nothing. Most times people are deciding to increase or decrease the amount of something that they are doing.BASIC DEFINITIONS FOR MB AND MC AND MAXIMIZATION OF TNBMB=∆TB/ ∆Q=(TBNew-TBOld)/(Qnew-Qold)MC=∆TC/ ∆Q=(TCNew-TCOld)/(Qnew-Qold)TNB =TB-TCMax TNB at that level of Q where MB=MCMARKETS: THE POWER OF DEMAND AND SUPPLYA market is simply an institution that bring buyers and sellers together to agree on price and quantity traded.Competitive Marketsmany sellers and buyers →no one buyer or seller affect the price or they are price takersidentical or homogeneous goods→price is the only decision factorperfect information →there is only one pricefree entry and exit →profits (economic) will be zero in the long-runNon-Competitive MarketsMonopoly – one sellerOligopoly – few sellersMonopolistically Competitive – differentiated productsTHE THEORY OF DEMAND FOR GOODS AND SERVICESHouseholds or consumers buy goods and services for a variety of reasons, but can we model it?Economics assume that individuals are rational – they weigh the costs and benefits of their actions and then try and maximize TNB.What are the benefits? Economists have modeled benefits as satisfaction or utility (an injection is useful but usually not pleasant – it provides utility).What are the costs? Economist argue that the costs are opportunity costs – i.e. what does one give up to get a good or service.A person’s preferences or tastes, along with other factors, determine the benefit from a good.The price of the good, the price of similar or substitute goods, a person’s limited income, along with other factors, determine the opportunity costs of the good.Basically, the theory of demand is getting the most satisfaction from the goods and service one buys given the prices of goods and one’s income.While many factors affect demand, we begin by concentrating on the price of the good. Why? In competitive markets, the price of the good is the MC to the buyer.THE LAW OF DEMANDLaw of Demand – the price of a good and the quantity demanded are negatively (or inversely) related, ceteris paribus (Latin – all other things equal).Rational behavior suggests that as the P↑ this means that the MC↑, ceteris paribus, an individual will ↓Q, it’s that simple.Early theorists, however, concentrated on MB rather than MC. The believed that utility was measurable, so-called cardinal (after numbers) utility.Law of Diminishing Marginal Utility Jelly bean example and Econ U$A tape on the drought in California.If people are to buy more (↑Q), since the MB↓, the price must fall (↓P)More recent theorists use the concept of ordinal utility to come to a similar conclusion. A person is assumed to be able to rank bundles from most preferred to least preferred.Reaches the Law of Demand with less restrictive assumptions than cardinal utility.The Law if Demand and the Income and Substitution EffectsSubstitution Effect: as the price of a good falls its opportunity cost relative to other similar or substitute goods falls, so consumers use more of the good and less of other goods Income Effect: as the price of a good falls, the real purchasing power of income increases and consumers will buy more of the good (if the good is normal).The effect of incomes on demand is not clear. For normal goods, increases in income, increase demand, and for inferior goods the opposite happens.Cardinal utility, ordinal utility, and MB=MC, all arrive at Law of Demand.We now look at the Law of Demand and the Theory of Demand using numbers/schedules,