July03

Outline for Thurs, July 3

� Remember

�Quiz on Friday

� Homework due Monday

� Review from Wednesday� Review from Wednesday

� The Supply & Demand Model

� Using the graph

� Assumptions

Review from Wednesday

� What do we mean by _____ and why is it

important to our understanding of markets?

� Scarcity

�Opportunity cost�Opportunity cost

� Decisions at the margin

� Rationality

Review from Wednesday

� What is the single key difference between positive

and normative claims?

Review from Wednesday

� What is the single key difference between positive

and normative claims?

Testability

Review from Wednesday

� What is the single key difference between positive

and normative claims?

Testability

� What makes a bad model?� What makes a bad model?

Review from Wednesday

� What is the single key difference between positive

and normative claims?

Testability

� What makes a bad model?� What makes a bad model?

�Wrong answers

� Inconsistent assumptions or answers

Review from Wednesday

� What is the single key difference between positive

and normative claims?

Testability

� What makes a bad model?� What makes a bad model?

�Wrong answers

� Inconsistent assumptions or answers

� What can we do with positive statements?

Review from Wednesday

� What is the single key difference between positive

and normative claims?

Testability

� What makes a bad model?� What makes a bad model?

�Wrong answers

� Inconsistent assumptions or answers

� What can we do with positive statements?

� Explain

� Predict

� Choose between policies, given a normative goal

What you’ll be tested on

� Explanations, not definitions

We need to speak the same language, but that doesn’t

mean memorizing the glossary

What you’ll be tested on

� Explanations, not definitions

We need to speak the same language, but that doesn’t

mean memorizing the glossary

(…until we get to game theory)

What you’ll be tested on

� Explanations, not definitions

We need to speak the same language, but that doesn’t

mean memorizing the glossary

(…until we get to game theory)

� For example, equilibrium is

What you’ll be tested on

� Explanations, not definitions

We need to speak the same language, but that doesn’t

mean memorizing the glossary

(…until we get to game theory)

� For example, equilibrium is

�Where the supply and demand curves meet

�Where no buyers and sellers wish to change their

actions

�What real markets should “tend towards” over time

What you’ll be tested on

� Explanations, not definitions

We need to speak the same language, but that doesn’t

mean memorizing the glossary

(…until we get to game theory)

� For example, equilibrium is

�Where the supply and demand curves meet

�Where no buyers and sellers wish to change their

actions

�What real markets should “tend towards” over time

� The general concept is more useful than a narrow

definition in most economic arguments

How do economists argue?

(1) Use mathematics as a shorthand language, rather

than as an engine of inquiry.

(2) Keep to them till you have done.

(3) Translate into English.(3) Translate into English.

(4) Then illustrate by examples that are important in

real life.

(5) Burn the mathematics.

(6) If you can't succeed in 4, burn 3.

This last I did often.

Alfred Marshall, S&D guy

Outline for Thurs, July 3

� Remember

�Quiz on Friday

� Homework due Monday

� Review from Wednesday� Review from Wednesday

� The Supply & Demand Model

� Using the graph

� Assumptions

What you know

Supply

Demand

Equilibrium

The curves: Demand

� The demand curve tells us how much will be bought

at every price

The curves: Demand

� The demand curve tells us how much will be bought

at every price

� It slopes downward (usually)

� This is the Law of Demand� This is the Law of Demand

� The exceptions are called Giffen goods

The curves: Demand

� The demand curve tells us how much will be bought

at every price

� It slopes downward (usually)

� All other factors besides price are held constant� All other factors besides price are held constant

The curves: Demand

� The demand curve tells us how much will be bought

at every price

� It slopes downward (usually)

� All other factors besides price are held constant� All other factors besides price are held constant

� A change in these factors creates a shift in demand,

moving the curve. This is also referred to as a

change in demand

The curves: Demand

� The demand curve tells us how much will be bought

at every price

� It slopes downward (usually)

� All other factors besides price are held constant� All other factors besides price are held constant

� A change in these factors creates a shift in demand,

moving the curve. This is also referred to as a

change in demand

� A change in the price of the good changes the

quantity demanded, moving it along the stationary

curve

The curves: Demand

The demand curve tells us how

much will be bought at every

price. It slopes downward

D

price

quantity demanded

The curves: Demand

A change in these factors

creates a shift in demand,

moving the curve. This is also

referred to as a change in referred to as a change in

demandp

q q2

D

D2

The curves: Demand

A change in the price of the

good changes the quantity

demanded, moving it along the

stationary curvestationary curve

p

q

p3

q3

D

The curves: Demand

For practice: what happens

when both the price and a

demand factor change

p

q

D

The curves: Supply

� The supply curve tells us how much will be sold at

every price

� It usually slopes upward, but there is no law of

supplysupply

� All other factors besides price are held constant

� A change in these factors creates a shift in supply,

moving the curve. This is also referred to as a

change in supply

� A change in the price of the good changes the

quantity supplied, moving it along the stationary curve

Using the curves: What’s happening?

Using the graph: What’s equilibrium?

S

D

Equilibrium

Equilibrium

� Where the supply and demand curves intersect is

called equilibrium

� It is a price and quantity, the ordered pair (p, q)

Equilibrium

� Where the supply and demand curves intersect is

called equilibrium

� It is a price and quantity, the ordered pair (p, q)

� At the equilibrium price, the quantity buyers wish to � At the equilibrium price, the quantity buyers wish to

buy is the same as how much sellers wish to sell. This

quantity is the equilibrium quantity

Equilibrium

� Where the supply and demand curves intersect is

called equilibrium

� It is a price and quantity, the ordered pair (p, q)

� At the equilibrium price, the quantity buyers wish to � At the equilibrium price, the quantity buyers wish to

buy is the same as how much sellers wish to sell. This

quantity is the equilibrium quantity

� Remember that this describes the market for a

single good, not the whole economy

Using the graph: How does the

equilibrium change?

S

What happens if…

� Demand increases

� Demand decreases

� Supply increases

E

D

pE

qE

� Supply increases

� Supply decreases

� Some combination

We don’t talk about

independent price

changes along

curves

Using the graph: Out of equilibrium

S

What happens if…

� The price is higher

than pE

E

D

pE

qE

p2

Using the graph: Out of equilibrium

S

What happens if…

� The price is higher

than pE

�Quantity supplied

surplus

E

D

pE

qE

exceeds quantity

demanded. This is

called excess

supply or a surplus:

q2S – q2D

p2

q2Sq2D

Using the graph: Out of equilibrium

S

What happens if…

� The price is higher

than pE

�Quantity supplied

surplus

E

D

pE

qE

exceeds quantity

demanded. This is

called excess

supply or a surplus:

q2S – q2D

�What about a

below-equilibrium

price?

p2

q2Sq2D

Using the graph: summary

You should understand

� What do the demand and supply curves mean?

� What makes demand and supply shift or change?

� How do shifts change the equilibrium, where the � How do shifts change the equilibrium, where the

curves intersect?

� What happens when we’re not at the equilibrium

price? shortages and surpluses

Using the graph: summary

You should understand

� What do the demand and supply curves mean?

� What makes demand and supply shift or change?

� How do shifts change the equilibrium, where the � How do shifts change the equilibrium, where the curves intersect?

� What happens when we’re not at the equilibrium price? shortages and surpluses

� Remember that quantity responds to price:

� Buyers choose how much to buy, not at what price to buy

� Sellers choose how much to sell, not at what price to sell

Supply & Demand Model

� Recall that a model is a set of assumptions

� The graph is simply a representation of our model

Supply & Demand Model

� Recall that a model is a set of assumptions

� The graph is simply a representation of our model

� We judge a model by its consistency and accuracy,

not the realism of its assumptionsnot the realism of its assumptions

Supply & Demand Model

� Recall that a model is a set of assumptions

� The graph is simply a representation of our model

� We judge a model by its consistency and accuracy,

not the realism of its assumptionsnot the realism of its assumptions

� We are talking about a single market, but it could

be broadly or narrowly defined

Supply & Demand Model

� Recall that a model is a set of assumptions

� The graph is simply a representation of our model

� We judge a model by its consistency and accuracy,

not the realism of its assumptionsnot the realism of its assumptions

� We are talking about a single market, but it could

be broadly or narrowly defined

� So, let’s go through the assumptions underlying our

market model

Assumption #1: Quantity responds to

price

� Why?

Assumption #1: Quantity responds to

price

� Why? There are a lot of buyers and sellers

� Not all goods have this (government contracts, prime

Manhattan real estate), so we can only consider

markets that do

Assumption #1: Quantity responds to

price

� Why? There are a lot of buyers and sellers

� Not all goods have this (government contracts, prime

Manhattan real estate), so we can only consider

markets that do

� This means that no single buyer or seller can choose the

price: sellers with too high a price will make no sales,

sellers with too low a price will be missing opportunities

Assumption #1: Quantity responds to

price

� There are a lot of buyers and sellers

� This only applies to certain markets

� This means that no one can choose the price

Assumption #1: Quantity responds to

price

� There are a lot of buyers and sellers

� This only applies to certain markets

� This means that no one can choose the price

� So buyers and sellers are both called price-takers� So buyers and sellers are both called price-takers

and this is called the price-taking assumption

Assumption #1: Quantity responds to

price

� There are a lot of buyers and sellers

� This only applies to certain markets

� This means that no one can choose the price

� So buyers and sellers are both called price-takers� So buyers and sellers are both called price-takers

and this is called the price-taking assumption

� This also suggests that buyers and sellers all pay

and see the same price, so there are no

Assumption #1: Quantity responds to

price

� There are a lot of buyers and sellers

� This only applies to certain markets

� This means that no one can choose the price

� So buyers and sellers are both called price-takers� So buyers and sellers are both called price-takers

and this is called the price-taking assumption

� This also suggests that buyers and sellers all pay

and see the same price, so there are no

� Transaction costs

� Search costs

Assumption #2: Scarcity

� The economy must have scarce resources because…

Assumption #2: Scarcity

� The economy must have scarce resources because…

If they are not scarce � an infinite amount of the

good could be made � so no one would pay for it

Assn. #3: Rationality

� People will take advantage of opportunities

Assn. #3: Rationality

� People will take advantage of opportunities

� Without this, we cannot be sure that equilibrium will

be reachedS

surplus

E

D

pE

qE

p2

q2Sq2D

surplus

Assn. #3: Rationality

� People will take advantage of opportunities

� Without this, we cannot be sure that equilibrium will

be reachedS

surplus

E

D

pE

qE

p2

q2Sq2D

surplus

Assn. #3: Rationality

� People will take advantage of opportunities

� Without this, we cannot be sure that equilibrium will

be reachedS

surplus� What really happens?

E

D

pE

qE

p2

q2Sq2D

surplusWhat really happens?

Review

� Remember

�Quiz on Friday

� Homework due Monday

� Review from Wednesday� Review from Wednesday

� The Supply & Demand Model

� Using the graph

� Assumptions