Introduction to Economics
Announcements and Logistics
Know your section letter: can be found on the registration worksheet, or visible when you log into Canvas. If not, go to courses.yale.edu, enter Econ 115, and view sections to identify your location.
If you can’t find it on Canvas, use the method above to locate your section.
Assignment deadline and grace period:
There is a one-hour grace period for uploads in case of technical issues, but the plan is not to rely on it.
Deadline meeting is noon next Monday; this will be a way to register for an absence if needed.
Flexibility in a large class:
The instructor emphasizes built-in flexibility because the class is large and life happens.
Example of flexibility: one-hour grace period on problem sets, and two problems are dropped.
Quick Recap of Last Section
Law of demand: as price increases, quantity demanded decreases; there is a link between marginal willingness to pay and demand.
Movements along the demand curve vs shifts in the demand curve:
Movements along the demand curve occur when only a single variable changes (usually price) along the same demand curve.
Shifts in demand occur when other factors change (e.g., price of a related good, tastes, income).
Delta notation and key drivers:
Changes in other prices, tastes, income, etc. cause shifts in demand.
The instructor highlights real-life examples and keeps an eye out for current events.
Example to illustrate demand concepts:
Two students with different demand for pizzas at different prices; the idea is to illustrate individual demand curves and how they aggregate to market demand.
Simple two-person economy:
At price $5, Student A demand = 12 pizzas, Student B demand = 10 pizzas; Market demand Qd(5) = 22.
At price $10, Student A demand = 7 pizzas, Student B demand = 3 pizzas; Market demand Qd(10) = 10.
Market demand is the horizontal sum of individual demand curves.
Market demand vs. market power:
Demand curves show how much is demanded at each price.
Supply curves show how much will be supplied at each price.
In a perfectly competitive market, the price is determined by the market, not by individual firms.
Firms in perfect competition do not set price; they respond to the market price.
Demand and Supply: Core Concepts
Demand vs. supply basics:
Demand curve: downward-sloping, showing quantity demanded at each price.
Supply curve: upward-sloping, showing quantity supplied at each price.
Market power and production decisions:
A relatively small number of sellers can have market power; examples include specific markets where competition is not perfect.
In perfectly competitive markets, firms do not set prices; prices emerge from market interactions.
Producers’ price-setting vs. output decisions:
Even if firms can't set the price, they decide how much to produce depending on the price they observe.
Opportunity costs in production:
All production has opportunity costs—the farmer could be doing something else with land or time.
Example: solar energy production has different opportunity costs depending on location (land efficiency varies by location, e.g., Arizona vs. Connecticut).
As price rises, higher opportunity-cost producers still find it worthwhile to produce if the price covers their costs.
On the non-entry vs. entry dynamic:
Higher prices can attract more producers into the market or induce existing producers to produce more.
The idea that price changes influence supply both through new entrants and through existing firms increasing output.
Textbook analogy and market power:
The lecture uses a corn market analogy and later references to a hypothetical demand for services (e.g., private tutoring) to illustrate supply decisions at different price levels.
Relationship between price and supply decisions:
When price rises, more supply is viable; when price falls, supply tends to fall unless fixed costs or other constraints bind.
Diminishing Returns and Marginal Costs
Diminishing returns concept:
Increasing production units leads to rising marginal costs due to diminishing returns.
Wheat production example (labor-based):
Labor inputs for output levels:
1 bushel: 2 hours
2 bushels: 5 hours
3 bushels: 9 hours
4 bushels: 14 hours
Total cost (TC) from labor at $/hour = $20:
TC(1) = 2 × 20 = $40
TC(2) = 5 × 20 = $100
TC(3) = 9 × 20 = $180
TC(4) = 14 × 20 = $280
Marginal cost (MC) of each additional bushel:
MC(1) = TC(1) = $40
MC(2) = TC(2) − TC(1) = $60
MC(3) = TC(3) − TC(2) = $80
MC(4) = TC(4) − TC(3) = $100
Conceptual takeaway:
The marginal opportunity cost rises with each additional unit produced, reflecting diminishing returns.
In general, MC rises as output expands, reflecting higher opportunity costs or increased input costs for additional output.
Distinction between marginal cost and marginal willingness to pay:
Marginal opportunity cost is a producer concept (costs to produce one more unit).
Marginal willingness to pay is a consumer concept (value a consumer places on one more unit).
Summary principle (the lecturer’s emphasis):
At low prices, producers with low opportunity costs produce; at higher prices, producers with higher opportunity costs begin to produce, and existing producers may expand output.
Core intuition: price acts as a signal to allocate resources to where the opportunity costs are just covered.
Expressing Demand and the Role of Input Prices
Expressing demand (and supply) connects with price and non-price determinants:
A slide mirrors the earlier “expressing demand” concept, now extended to supply.
Real-world data reference:
OurWorldInData is recommended as a resource for data on price trends (e.g., energy prices over time).
Energy price example (input price impact):
If input prices (like energy) rise, supply tends to decrease at a given price, shifting the supply curve left; or equivalently, fewer units are supplied at each price.
The price for inputs is a key determinant of production decisions across many sectors.
Negative prices:
The question about possible negative prices is acknowledged as an unusual exception; generally, prices are nonnegative and negative prices are rare and context-specific.
Contextual note:
The discussion uses electricity and airline tickets as examples to illustrate how input prices affect supply and the shifting of supply curves.
Equilibrium, Shortages, and Surpluses
Equilibrium concept:
Equilibrium price $p^$ and quantity $q^$ occur where demand equals supply, i.e., the intersection of the two curves.
At equilibrium, there is no excess demand or excess supply; no inherent pressure for price to change.
Mechanism of adjustment (thought experiment with tomatoes):
Start with a low price $P_1$: excess demand (shortage) because Qd > Qs.
As price rises to $P_2$, shortage persists but narrows because Qd falls and Qs rises.
If price goes very high to $P_3$, excess supply (surplus) occurs because Qs > Qd.
The unique stable point is $(p^, q^)$ where excess demand and excess supply are zero.
Graphical intuition:
The only price at which there is no pressure to move is the equilibrium price where the two curves intersect.
Practical takeaway:
If the market price is below equilibrium, there is pressure to rise; if above equilibrium, pressure to fall.
Equilibrium dynamics and visualization:
The instructor asks students to draw the dynamics themselves to reinforce how prices adjust toward equilibrium.
Positive vs Normative Statements and Empirical Testing
Positive statements:
Statements about facts and how the world is; they can be tested and evaluated for truth or falsity.
Normative statements:
Value judgments about what ought to be or what should be done.
The importance of testability in theory:
The lecture emphasizes that the economic model should be testable, and plans to run a market experiment to observe behavior.
Market experiment (Friday):
A trade exercise was conducted without using money; buyers had willingness-to-pay cards, sellers had opportunity-cost cards.
Result: The equilibrium price from the cards appeared near $6, with the observed mean close to 6; the model wasn’t perfect but was a useful approximation.
Demand and supply data collection via experiment:
The traders traded at different price points, and the price that balanced supply and demand emerged from the exercise.
The qualitative takeaway is that while models are simplifications, they can predict core patterns in real markets.
Real-World Contexts and Takeaways
Blue books demand discussion:
A Wall Street Journal article described demand for blue books (used in exams) in the context of AI and new testing formats; illustrates how demand responds to changes in exam formats or technology.
Apple and iPhone market power example:
The discussion contrasts individual consumer demand with firm-level pricing power (e.g., Apple as a large producer with pricing power vs. a competitive market in generic goods).
OurWorldInData usage:
Suggested as a resource for exploring empirical data (e.g., electricity prices over time) to ground theory in real-world trends.
Summary of the core takeaway:
Demand and supply determine market prices and quantities; price serves as the coordinating signal that aligns production with consumer valuations, subject to the degree of competition and market power.
Key Formulas and Concepts (Quick Reference)
Demand and market demand
Individual demand: Q_i(p)
Market demand: Qd(p) = \sum{i} Q_i(p)
Law of demand: \frac{dQ_d}{dp} < 0
Supply
Market supply: Qs(p) with \frac{dQs}{dp} > 0
Equilibrium
Equilibrium condition: Qd(p^) = Qs(p^)
Equilibrium price and quantity: p^, q^
Costs and prices (production)
Total cost: TC(n) for producing n units
Marginal cost: MC(n) = TC(n) - TC(n-1) for n \ge 1
Example: for wheat (labor input at $20/hour):
TC(1)=40,\, TC(2)=100,\, TC(3)=180,\, TC(4)=280
MC(1)=40,\, MC(2)=60,\, MC(3)=80,\, MC(4)=100
Opportunity costs
Marginal opportunity cost (producer) vs marginal willingness to pay (consumer)
Shortage and surplus
Excess demand: Qd(p) > Qs(p)
Excess supply: Qs(p) > Qd(p)
Positive vs normative statements
Positive: facts about the world; normative: value judgments about how the world should be
Empirical testing
Use simple market experiments to test predictions about equilibrium price and quantity
Connections to Foundational Principles and Real-World Relevance
The lecture ties together core microeconomic ideas:
How markets allocate resources through price signals under conditions of competition
The role of opportunity costs and diminishing returns in production decisions
The distinction between individual decisions and market outcomes (demand vs. supply, private costs vs. social outcomes)
Real-world relevance:
Input prices (energy, labor) influence firm supply and market outcomes in countless industries
Market power can alter price formation away from the perfectly competitive benchmark
Empirical testing (experiments) helps validate or refine theoretical models
Ethical and practical implications:
Understanding market dynamics informs policy debates (e.g., energy pricing, education-related inputs like exam formats, access to tutoring)
Distinctions between positive and normative statements matter for evaluating policy recommendations and for communicating findings clearly