Econ 201 1st Edition Exam # 2 Study GuideLecture 10~19Lecture 10Principles of Supply and Demand: A Model of Markets Setting for MarketsMarkets are the buyers and sellers combined with the set of social institutions that facilitate their exchanges. Markets are not a place.Markets help an economy attain the correct point on the PPF: productive and allocative efficiency They do this by:1. Efficiently processing information on productive opportunities and social needs. Prices 2. Coordinating complex, multi-stage production processes that characterize a modernindustrialized economy. Incentives Competitive Conditions1. Many buye rsand sellers one can influence Price2. Free access to relevant information by all3. Similar product/service from each seller – homogeneous commodity 4. Free entry and exit from the marketlecture 11Demand: The Market Behavior of BuyersQd = quantity demanded = amount of a good buyers are able and willing to buy each time period.What influences this? What are the determining variables?Mainly: price (P), income (M), prices of other goods (Px, Py), tastes (T),expectations of buyers (Eb), and the number of buyers (Nb) RelationshipThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.Demand is the relationship between Qd and these other variables: Qd = f(P; IM Px, Py, T, Eb, Nb2Focus on the P determinant with other variables held constant (Ceteris Paribus): Qd = f(P)Law of Demand: Qd is larger when P is smaller, ceteris paribus. A negative relationship.ChangesDistinguish a change in quantity demanded (Qd) from a change in demand (the relationship).i.e. movement along the demand curve vs. shift of the curve.If the other variables change, the relationship between Qd and P changes.The demand curve shifts.Supply: The Market Behavior of SellersQs = quantity supplied = amount of a good sellers are willing to sell each time period.What influences this? What are the determining variables?Mainly: price (P), prices of inputs (W), technology of production (τ), expectations of sellers (Es), and the number of sellers (Ns)RelationshipSupply is the relationship between Qs and these other variables: Qs = h(P; W, τ, Es, Ns)Focus on the P determinant with other variables held constant (Ceteris Paribus): Qs = h(P) Law of Supply: Qs is larger when P is larger, ceteris paribus. A positive relationship.ChangesDistinguish a change in quantity supplied (Qs) from a change in supply (the relationship). i.e. movement along the supply curve vs. shift of the curve.3If the other variables change, the relationship between Qs and P changes. The supply curve shifts.Lecture 12EquilibriumEquilibrium is attained when the P, Q pair prevailing is on both the Supply and Demand curves. This is the market clearing price and quantity: P* Q* i.e. at P*, Qd = Q*= QsThe Law of Supply and Demand: Markets naturally tend toward equilibrium. Spontaneous movement toward equilibrium P* - Q* combination.Shortage:Qd > QsP1 P2 price rises Surplus: Qd < Qs ==> price fallsAnalysis of Shifts: Comparative Statics ProcedureReview “shifter” variables and consider impacts on equilibrium: P*, Q* . Three steps to Analysis:1. Determine which curve to shift2. Determine the direction of shift3. Examine impact on equilibrium point (the intersection).Example. Suppose the price of gasoline falls. What happens in the market for auto tires?Demand shifts right, supply is not changed. Q* rises and P* rises.Lecture 13What Is a Market?• A Market is not a place. • A Market is:– 1. A collection of individual actors interacting through exchanges (buyers and sellers)And– 2. The rules that govern their interactions. • Markets are social institutions ~ guides for social behavior.Social Role of Markets• Markets promote social cooperation ~ help avoid conflict.• Markets promote productive and allocative efficiency.– Markets help an economy attain the correct point on the PPF. • They do this by:1. Allowing specialization according to Comparative Advantage.2. Efficiently processing information on productive opportunities (Supply) and social needs (Demand). è Prices are the processed information.3. Coordinating complex, multi-stage production chains that characterize a modern industrialized economy. è Incentives guide individuals’ behavior toward cooperation.Conditions for a Competitive Market1. Many buyers and sellers No one influences price significantly; participants are Price Takers.2. Free access to relevant information by allInformation about production technology and prices. 3. Homogeneous commodity is the object of trading.Each seller offers the same product/service. 4. Free entry and exit from the marketExit is almost always available. Entry may be difficult. If so, the market is not competitive.Supply and Demand are Relationships ~ Not Quantities• Law of Demand: Actors buy more at a lower price. Negative relationship• Law of Supply: Actors sell more at a higher price. Positive relationship• Both laws assume Ceteris Paribus condition ~ All other things constant.• Distinguish changes in the relationships from changes in the quantities.– For both Demand and SupplyWhy do Supply and Demand Shift?Supply shifts occur when underlying conditions that affect seller behavior change. (Variables other than Price of the good.)Demand shifts occur when underlying conditions that affect buyer behavior change. (Variablesother than Price of the good.)Key Seller InfluencesNumber of sellers (NS)Prices of inputs (W)Transaction costsTechnology of productionExpectationsKey Buyer InfluencesNumber of buyers (NB)Income (M)Prices of other goods: Substitutes (PX) Complements (PY)TastesExpectationsComparative Statics ~ Analysis of Market Changes• How do changes in underlying conditions affect market equilibrium?• Three steps to Comparative Statics Analysis1. Determine which curve to shift. (S or D)2. Determine the direction of shift. (Left or Right)3. Examine impact on equilibrium point (the intersection). Increase or Decrease of Q*? Increase or Decrease of P*?• Example Suppose the price of gasoline falls. What happens in the market for tires?• Demand shifts right; supply is not changed. Q* and P* both increase. Lecture 14Elasticity• A measure of the response of one variable to changes in another. • Calculated as a ratio of percentage changes.– Response