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MSU EC 201 - Chap3

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Krugman and Wells Chapter 3Where we’re goingKey componentsDemandDemand: exampleDemand: using the modelDemand: shiftsDemand: shifts vs. movementsDemand: more on shiftsDemand: shiftersThe picture: subs vs. compsDemand: shiftersThe picture: normal vs. inferiorDemand: shiftersDemand: individual demandSupplySupply: exampleSupply: using the modelSupply: shiftsSlide Number 20Supply: shiftersSupply: shiftersPutting the pieces together…Slide Number 24Let’s pauseExample: the muffin marketMuffin supply and demandMuffin equilibriumMuffin example conclusionsChanges in supply and demandA shift (out) in the demand curveA shift (in) in the supply curve RecapTwo events: view 1Two events: view 2Some things to note 1Some things to note 2Krugman and Wells Chapter 3 Steven J. Haider EC201 Spring 2015p2 Where we’re going  This chapter introduces one of our central models: “perfect competition” or “supply and demand” or a “competitive market.” This chapter quickly lays out the pieces, so we can start to use the model. Later chapters will develop the pieces in more detail.  The model is relatively simple and applicable to a large number of markets  The key assumption: there are a large number of suppliers (/demanders), so that no individual supplier (/demander) can affect the price  Suppliers and demanders are “price takers”  Model probably works well for cotton  Model probably works poorly for computer operating systems  We will discuss the cotton market throughout this chapter, following the bookp3 Key components  The Demand Curve  Tells us how much consumers are willing to buy at each price Demand is downward sloping  The Supply Curve  Tells us how much a firm is willing to sell at each price Supply is upward sloping  Shifting vs. moving along a curve  Equilibrium  The model’s prediction for the resulting price and quantity transacted in the marketp4 Demand  Quantity demanded  Refers to the amount demanded at one particular price  Demand  Answers the question “what is the quantity demanded at every price?”  Price changes is key to market outcomes, so we consider this from the start  NOTE: text leaves off the underlined piece—I think it is an important addition to distinguish from “quantity demanded”  NOTE: Quantity demanded vs. demand is an arbitrary, but very important, naming convention  Two representations of demand  Demand Schedule: table form Demand Curve: the graph of the demand schedulep5 Demand: example  Demand schedule is table  Quantity demanded at $2.00 is 7.1b pounds  Demand is dark blue curvep6 Demand: using the model  “Law of Demand”  Quantity demanded is higher when prices are lower other things equal, or demand curves slope downward  This finding is so common we call it a “law”  Shifts in demand  Demand curve shows different quantities demanded for all prices, holding all else equal  What might shift demand? Change in tastes, for example  Movements along the demand curve  If just price is changing (perhaps dropping because of excess supply), the demand curve doesn’t shift--we just move along it  The demand curve already tells us the quantity demanded at every price When an economist says “demand for X changed”, we mean “the demand curve shifted”p7 Demand: shifts  “Demand increased” or “demand shifted out”  At every price, the quantity demand is greater in 2010 vs. 2007  Explanations? Population growth, increased popularity of cotton clothingDemand: shifts vs. movements  Shift  Example: D1 to D2  Interpretation: at every price (like $1.50), the quantity demanded is greater (compare A to C) Possible explanation: tastes changed  Movement along  Example: A to B, along D1  Interpretation: as price dropped ($1.50 to $1.00), qnty. demanded increased (8.1b to 10b pounds) p8p9 Demand: more on shifts  Increases vs. decreases in demand  Increase: to the right  Decrease: to the left Think about it as “at any given price”  Things that shift the demand curve 1. Price of related goods/services 2. Changes in income 3. Changes in tastes 4. Changes in expectations 5.Changes in the number of consumersDemand: shifters  Changes in prices of related goods  “Substitutes/complements in consumption”  Substitutes: goods that take the place of the good of interest  A decrease (/ increase) in the price of a substitute good will decrease (/ increase) the demand for a given good  Example: a decrease in the price of tea will decrease the demand for coffee Complements: goods that enhance the good of interest  A decrease (/ increase) in the price of a complement good will increase (/ decrease) the demand for a given good  Example: a decrease in the price of muffins will increase the demand for coffee p10The picture: subs vs. comps p11 PA↓ ⇒ QDA ↑ DB ↑ Substitutes A is hot dogs B is hamburgers DB ↓ Complements A is hot dogs B is hot dog buns NOTE: If the price went up for good A, then all arrows switch… PA QB QB QA PB PB D1 D2 D2 D1 DDemand: shifters  Changes in tastes  A greater (/lesser) taste for a good increases (/decreases) demand Example: see previous slides for 2007 vs. 2010 cotton  Changes in income  Normal good: an increase (/decrease) in income will increase (/decrease) the demand for a normal good  Most goods are normal goods  Inferior good: an increase (/decrease) in income will decrease (increase) the demand for an inferior good  Example: Chipotle lunch (normal) vs. Taco Bell lunch (inferior) p12The picture: normal vs. inferior p13 Income ↑ D ↑ Inferior Taco Bell for me D ↓ Normal Chipotle for me NOTE: If income went down, then all arrows switch… Q Q P P D2 D1 D1 D2Demand: shifters  Changes in expectations  We respond to future expectations for income and prices  Expected decrease (/increase) in price decreases (/increases) demand today Example: A new iPad is rumored to be available in May  Changes in the number of consumers  More (/less) consumers increases (/decreases) demand  Example: population movements to CA increased demand for housing p14p15 Demand: individual demand  The idea behind the last point is hopefully pretty clear, but… The demand curve thus far is the market demand curve  Individual demand curve: the quantity demanded at each


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