Markets and Prices: Understanding the Interplay of Supply and Demand, Study notes of Microeconomics

Download Markets and Prices: Understanding the Interplay of Supply and Demand and more Study notes Microeconomics in PDF only on Docsity! Econ 201 Lecture 6 Markets and Prices Why does Derek Jeter earn more than Sharon Weaver? Why do diamonds cost more than water? Why do Picasso’s paintings sell for more than Leroy Nieman’s? Is it cost of production that determines prices (as Adam Smith thought), or is it willingness to pay that determines prices (as Stanley Jevons thought)? Alfred Marshall (Principles of Economics, 1890) was the first to explain clearly how both costs and willingness to pay interact to determine market prices. Supply and Demand Analysis: An Overview Definition. The market for any good or service consists of all (actual or potential) buyers or sellers of that good or service. The Demand Curve Definition. The demand curve for a good or service tells us the total quantity of that good or service that buyers wish to buy at each price. The demand curve for lobsters: Price ($/lobster) Quantity (1000s of lobsters/day) 10 8 6 4 2 0 1 2 3 4 5 D D The demand curve is the set of all price-quantity pairs for which buyers are satisfied. ("Satisfied" means being able to buy the amount they want to at any given price.) Horizontal interpretation of the demand curve: If buyers face a price of $4/lobster, they will wish to purchase 4000 lobsters a day. Vertical interpretation of the demand curve: If buyers are currently buying 4000 lobsters a day, the demand curve tells us that buyers would be willing to pay at most $4 for one additional lobster. Demand curves slope downward for two reasons. 1. As the good becomes more expensive, people switch to substitutes. 2. As the good becomes more expensive, people can’t afford to buy as much of it. The Supply Curve Definition. The supply curve of a good or service tells us the total quantity of that good or service that sellers wish to sell at each price. The supply curve for lobsters Price ($/lobster) Quantity (1000s of lobsters/day) 10 8 6 4 2 0 S S 1 2 3 4 5 6 The supply curve is the set of price-quantity pairs for which sellers are satisfied. ("Satisfied" means being able to sell the amount they want to at any given price.) Horizontal interpretation of the supply curve:If sellers face a price of $4/lobster, they will wish to sell 2000 lobsters a day. Vertical interpretation of the supply curve: If sellers are currently supplying 5,000 lobsters a day, the supply curve tells us that the marginal cost of producing the last lobster is $10. 2 One reason the supply curve slopes upward is the low-hanging-fruit principle. (Harvest the lobsters closest to shore first.) More generally, as we expand the production of any good, we turn first to those whose opportunity costs of producing that good are lowest, and only then to others with higher opportunity costs. Market Equilibrium Quantity and Price Equilibrium occurs at the price-quantity pair for which both buyers and sellers are satisfied. Price ($/lobster) Quantity (1000s of lobsters/day) 10 8 6 4 2 0 1 2 3 4 5 D DS S At the market equilibrium price of $6 per lobster, buyers and sellers are each able to buy or sell as many lobsters as they wish to. Excess Supply A situation in which price exceeds its equilibrium value is called one of excess supply, or surplus. At $8, there is an excess supply of 2000 lobsters in this market. Price ($/lobster) Quantity (1000s of lobsters/day) 10 8 6 4 2 0 1 2 3 4 5 D DS S excess supply Excess Demand A situation in which price lies below its equilibrium value is referred to as one of excess demand. At a price of $4 in this lobster market, there is an excess demand of 2000 lobsters. Price ($/lobster) Quantity (1000s of lobsters/day) 10 8 6 4 2 0 1 2 3 4 5 D DS S excess demand At the market equilibrium price of $6, both excess demand and excess supply are exactly zero. Example 6.1. At a price of $2 in this hypothetical lobster market, how much excess demand for lobsters will there be? How much excess supply will there be at a price of $10?