Economics chapter 3

Circular flow diagram, demand + quantity demanded, supply + supply demanded, market outcomes +market mechanism, market change, price controls, efficency+surplus

Who are the direct participants of a market?

Individuals/household: maximize utility they can get from available income

Businesses/firms: maximize profits by selling goods that satisfy while keeping costs low

Who are the indirect participants of a market?

Government: maximize general welfare through policies

Market outcome

Examining levels of quantity and prices

Market demand

concept that explains consumption behavior in a market

Law of Demand

Quantity demanded of a good is negatively related to the market price of a good, ceteris paribus (means a direct relationship)

Quantity demanded (Qd)

Specific quantity that consumers are able and willing to buy at a specific market price, P (SPECIFIC PRICE)

Demand (D)

Set of all quantities of a good consumers are able and willing to buy at alternative prices in a given time period, ceteris paribus (RANGE OF PRICES)

Change in quantity demanded results in:

Buyer behavior does not change due to price change. movement along the demand curve, just goin up/down curve

Change in demand results in:

Shift of the demand curve: buyer behavior changes. Curve going left if price decreasing or right if increasing in price

Determinants of demand

• Change in household income

• Changing tastes/preferences

• Change in population

• Prices of related goods and services

  • Complements and substitutes

• Changes in expectations about the future (big decision making)

Market supply:

concept used to describe production behavior in a market

Law of Supply

Direct (or opposite) relationship between price (P) and quantity supplied (Qs), ceteris paribus

Supply

Set of all quantities of a good producers are able and willing to sell at alternative prices in a given time period, ceteris paribus

What is quantity supplied (Qs)

Specific quantity that producers are able and willing to sell at a specific market price (P)

What happens in change in quantity supplied?

Due to price change, it’s movement along curve

Shift in supply

Moves left/right, a change in supply

What are the determinants of supply?

• Change in the cost of inputs (increasing costs=less supply)

• Availability and quality of inputs

• weather and natural conditions

• government policies

• available technology (advanced tech=more productivity=more supply)

What are inputs

factors of production like labor, materials, etc

Equilibrium

A single market price where demand and supply meet

Surplus

Excess supply, quantity demanded exceeding supplied, above equilibrium

Shortage

Excess demand, below equilibrium

Why do markets reach equilibrium?

• Buyers act on their demand behavior (according to law of demand)

• Sellers act on their supply behavior (according to law of supply)

• Market mechanism leads market to equilibrium

We strive for equilibrium because…

it stable

What are the steps to model changes?

1. Model initial market BEFORE any changes occur (assume equilibrium)

2. Identify what side of market is changing and why

3. Is the change a decrease or increase (left or right)

4. How will market mechanism restore equilibrium

What are price controls?

Government mandated market price

What is a price floor?

Mandated minimum price limit

What is a price ceiling?

Mandated maximum price limit

What does it mean if a price control is binding?

Market mechanism is blocked and market can’t reach equilibrium

What does it mean if a price control is non-binding?

No effect on market mechanism and equilibrium

Economic effeciency

The economic system achieving maximum benefits and gains from trade as possible (equilibrium is a signal of this)

Surplus (or welfare)

Additional benefit for firms and consumers participating in market transactions

Consumer surplus

Difference between what a consumer is willing to pay and market price

Producer surplus

Difference between market price and what firm is willing to sell for (a signal of profit potential)

What is total welfare

“Sum of consumer and producer surplus”; how the efficiency of an economic system is determined; total welfare and efficiency are maximized

How does policy affect surplus/welfare?

As prices and quantity change, surplus may be transferred or lost (this depends on the policy innacted)

What is dead weight loss?

Total welfare that once existed but was lost due to changes

How can we tell who benefits from a policy?

Who gains/loses surplus(welfare)

Who does the price ceiling benefit and how can we measure?

Consumer surplus, is consumer surplus more than producer

Who does the price floor benefit and how can we measure?

Producer surplus, is producer surplus more than consumer