Note: I will begin the class by reviewing a few slides from last time.

Market Signals
Market transactions signal what to produce and act as incentives for producers and consumers. Market transactions can be described by the terms of the exchange (price) and the number of exchanges (quantity bought and sold) Price and quantity are determined by the interaction of buyers (demand) and sellers (supply).

Demand

The demand curve shows the relationship between the price of a good and the quantity that consuemrs are willing and able to buy in a given time period, other things remaining equal. The quantity demanded refers to people's planned purchases, not the amount they actually buy. Demand curves are drawn with the price on the vertical axis and the quantity on the horizontal axis. The demand curve slopes down and to the right. (The law of demand).

Law of Demand

The lower the price, the larger the quantity demanded (the more people will want to buy, other things remaining equal. People can buy more with the same money income The opportunity cost of this good is now less. The satisfaction from consuming it is now compared to the satisfaction from consuming smaller quantity of alternatives. Those who whose preferences for it are not very strong (i.e., those who value it only moderately) are now drawn into the market. Those already buying will increase their purchases in spite of diminishing marginal utility because the opportunity cost has fallen so MC < MB.

Other things remaining equal
The demand curve describes people's behavior so long as only the price of the good itself is changing and everything else remains the same, including: Income Price of other goods (substitutes, complements) Consumer preferences or tastes; advertising Population Expectations about future prices A change in one of the above shifts the demand curve.

Supply curve
The supply curve shows the relationship between the price and the quantity that producers are willing to sell in a given time period, other things remaining the same. Quantity supplied refers to the amount sellers plan to offer for sale, not the quantity they actually sell. The supply curve is drawn with quantity on the horizontal axis and price on the vertical. The supply curve slopes up and to the right.

The Law of Supply
The law of supply: the higher the price, the larger the quantity supplied (the more producers want to sell) in a given time period, other things remaining equal. Higher prices make it profitable to produce units with higher opportunity costs that were not proftable to produce when prices wer lower. The law of supply accounts fo the upward slope of the demand curve.

Other factors--supply side
The supply curve shows producer reactions to changes in the price of the good itself so long as nothing else is changing. A change in one of the following will shift the supply curve: Costs of inputs used to produce the product; taxes Technology Weather The number of producers The price of alternatives in production Producer expectations about future prices.

Market Equilibrium
An equilibrium is a position of rest; there are no forces leading to a change. The equilibrium price is that at which quantity supplied equals quantity demanded No unsatsified buyers pushing prices up to get the good No unsatisfied sellers cutting prices to sell The equilibrium is shown graphically by the point at which the supply and demand curves intersect.

Shortage
A shortage exists when consumers are willing to buy more than producers are willing to sell (quantity demanded exceeds quantity supplied) Shortages occur at prices below the equilibrium. An increase in the price will eliminate the shortage because consumers will cut back on the quantitiy they want to buy as the price rises plus the higher price will induce for-profit firms to supply more.

Surplus
A surplus exists when producers want to sell more than consumers are willing to buy. Surpluses occur when the price is above the equilibrium level. Falling prices eliminate the surplus; falling prices discourage firms from producing so much and induce buyers to purchase more.

Changes in the Market
The market will remain at the equilibrium price as long as everything else remains the same. A shift in the supply or demand curve will cause the equilibrium price and quantity to change The change in the price and quantity is predictable: Change Effect on price Effict on quantity Increase demand (right shift) Increase Increase Decrease demand (left shift) Decrease Derease Increase supply (right shift) Decrease Decrease Decrease supply (left shift) Increase Decrease

Increase in Demand
Refers to a rightward shift in the demand curve Caused by a change in "other things" such as An increase in consumer income (if it's a normal good) An increase in the price of a substitute (people will avoid the high price alternative and want this good instead) A decrease in the price of a complement (the package is cheaper) A shift in consumer preferences (tastes) in favor of this good An increase in population Increased expectations that prices will rise in the future (buy now) Causes a temporary shortage, followed by an increase in price and quantity bought and sold

Increased supply
Refers to a rightward shift in the supply curve Caused by a change in "other things," such as A fall in the price of inputs used in producing the good (lower opportunity cost of producing) Technological advancement which lowers the cost of producing A cut in taxes on the producers of the product An increase in the number of sellers The price of an alternative in production has declined. Increased producer expectations of future price decreases. Causes a temporary surplus, followed by a fall in the price of the product and an increase in quantity.

Using supply-demand analysis
Draw the market in equilibrium before the change Determine whether producers or consumers are DIRECTLY affect by the event you are explaining or whose effect you are predicting If consumers are directly affected, demand shifts If producers/sellers are directly affected, supply shifts Draw in the new supply or demand curve and determine the new equilbrium. The shift in the curve causes a shortage or surplus which a change in price eliminates. The analysis can predict the direction of change of price and quantity, but not the amount of change without additional information

Making predictions
Usually only one curve shifts. In these cases, you can predict the direction of change of both price and quantity. Sometimes both curve shifts due to independent and simultanteous change in 2 determinants. (coincidence happens) In these cases, you can predict the direction of change in price OR quantity but NOT both. Example: A simultaneous increase in demand and a decrease in supply will clearly reaise price. But whle increased demand increases quantity, a decrease in supply will cause the quantity bought and sold to decrease. The overall effect on quantity is indeterminant.