MARKET An arrangement which allows buyers and sellers to exchange money and goods. An arrangement which allows buyers and sellers to exchange money and.

MARKETMARKET An arrangement which An arrangement which

allows buyers and sellers to allows buyers and sellers to exchange money and goods.exchange money and goods.

WHY DO MARKETS EXIST ?WHY DO MARKETS EXIST ?

• We are not self-sufficient:We are not self-sufficient:

(We specialize in what we do best.)(We specialize in what we do best.)

• We trade what we make for goods or We trade what we make for goods or services we need, or for money to buy services we need, or for money to buy goods and services we need.goods and services we need.

Markets facilitate specialization and Markets facilitate specialization and exchange.exchange.

TWO TYPES OF MARKETSTWO TYPES OF MARKETS

• INPUT (FACTOR) MARKETS --

Firms pay resource owners (i.e., owners of labor, raw material, land, machinery and buildings) --households-- for the right to use their resources;

firm -- Resource-owner interaction

• OUTPUT (PRODUCT) MARKETS --

Consumers --households-- pay firms for consumer goods;

consumer -- firm interaction

Two of Economy’sTwo of Economy’s Primary ParticipantsPrimary Participants

FIRMSFIRMS HOUSEHOLDSHOUSEHOLDS

CIRCULAR FLOW OF ANCIRCULAR FLOW OF AN ECONOMYECONOMY

FIRMSFIRMS HOUSEHOLDSHOUSEHOLDS

PRODUCT MARKETPRODUCT MARKET

FACTOR MARKETFACTOR MARKET

ProductsProducts SuppliedSupplied

ProductsProducts demandeddemanded

InputsInputsSuppliedSupplied

Inputs forInputs forProductionProduction

Revenue fromRevenue fromSelling ProductsSelling Products

Payment forPayment forProductsProducts

FactorFactorCostsCosts

FactorFactorPaymentsPayments

What Do Firms Do What Do Firms Do ?

• Buy factors of production from Buy factors of production from households;households;

• Transform factors of production into Transform factors of production into finished products and services;finished products and services;

• Sell finished products and services to Sell finished products and services to households.households.

Firms Buy Factors of Production• LABOR MARKET

-- Hire workers and pay wages and salaries in exchange for work.

• CAPITAL MARKET

-- Households use savings to provide funds that firms use to buy machines, buildings and equipment.

• NATURAL RESOURCES MARKET

-- Households sell land, minerals, oil, etc.... to firms for use in production.

TYPES OF FIRMSTYPES OF FIRMS• Sole ProprietorshipSole Proprietorship

owned by one individual;owned by one individual;

individual earns all profits, responsible for all debts;individual earns all profits, responsible for all debts;

70% of all U.S. firms; 6% of total U.S. sales by firms.70% of all U.S. firms; 6% of total U.S. sales by firms.

• PartnershipPartnership owned by more than one individual;owned by more than one individual;

division of responsibilities and profits;division of responsibilities and profits;

each individual fully responsible for all firm’s debts;each individual fully responsible for all firm’s debts;

8% of all U.S. firms; 4% of total U.S. sales by firms.8% of all U.S. firms; 4% of total U.S. sales by firms.

• CorporationCorporation legal entity owned by stockholders (i.e., many owners);legal entity owned by stockholders (i.e., many owners);

owner’s liability for firm’s debt limited to value of stock;owner’s liability for firm’s debt limited to value of stock;

about 20% of all U.S. firms; 90% of all U.S. sales by firms.about 20% of all U.S. firms; 90% of all U.S. sales by firms.

Corporation Country Relative Size

General MotorsGeneral Motors USAUSA 11

Ford MotorFord Motor USAUSA 22

ExxonExxon USAUSA 33

Royal Dutch ShellRoyal Dutch Shell The NetherlandsThe Netherlands 4 4

ToyotaToyota JapanJapan 55

HitachiHitachi JapanJapan 66

IBMIBM USAUSA 77

MatsushitaMatsushita JapanJapan 88

General ElectricGeneral Electric USAUSA 99

Daimler-BenzDaimler-Benz GermanyGermany 10 10

MobilMobil USAUSA 1111

Nissan MotorNissan Motor JapanJapan 1212

British PetroleumBritish Petroleum United KingdomUnited Kingdom 1313

SamsungSamsung South KoreaSouth Korea 1414

Phillip MorrisPhillip Morris USAUSA 1515

IRIIRIItalyItaly 1616

SiemansSiemans GermanyGermany 1717

VolkswagonVolkswagon GermanyGermany 1818

ChryslerChrysler USAUSA 1919

ToshibaToshiba JapanJapan 2020

Corporation Country Relative Size

General MotorsGeneral Motors USAUSA 11

Ford MotorFord Motor USAUSA 22

ExxonExxon USAUSA 33

Royal Dutch ShellRoyal Dutch Shell The NetherlandsThe Netherlands 4 4

ToyotaToyota JapanJapan 55

HitachiHitachi JapanJapan 66

IBMIBM USAUSA 77

MatsushitaMatsushita JapanJapan 88

General ElectricGeneral Electric USAUSA 99

Daimler-BenzDaimler-Benz GermanyGermany 10 10

MobilMobil USAUSA 1111

Nissan MotorNissan Motor JapanJapan 1212

British PetroleumBritish Petroleum United KingdomUnited Kingdom 1313

SamsungSamsung South KoreaSouth Korea 1414

Phillip MorrisPhillip Morris USAUSA 1515

IRIIRIItalyItaly 1616

SiemansSiemans GermanyGermany 1717

VolkswagonVolkswagon GermanyGermany 1818

ChryslerChrysler USAUSA 1919

ToshibaToshiba JapanJapan 2020

CURRENCY MARKETS AND CURRENCY MARKETS AND EXCHANGE RATESEXCHANGE RATES

• Foreign Exchange Market Foreign Exchange Market -- Entity which -- Entity which provides for the exchange of one currency provides for the exchange of one currency for another;for another;

• Exchange Rate Exchange Rate -- Rate at which one -- Rate at which one currency can be exchanged for another. currency can be exchanged for another.

SUPPLY AND DEMANDSUPPLY AND DEMANDSUPPLY AND DEMANDSUPPLY AND DEMAND

• • Market interaction;Market interaction;

•• Represents buyers and Represents buyers and sellers in a particular sellers in a particular market;market;

•• Predicts equilibrium price Predicts equilibrium price and quantity in a and quantity in a particular market.particular market.

• • Market interaction;Market interaction;

•• Represents buyers and Represents buyers and sellers in a particular sellers in a particular market;market;

•• Predicts equilibrium price Predicts equilibrium price and quantity in a and quantity in a particular market.particular market.

MARKET DEMANDMARKET DEMANDMARKET DEMANDMARKET DEMAND

How much of a particular product How much of a particular product consumers are willing to buy consumers are willing to buy during a particular time period.during a particular time period.

How much of a particular product How much of a particular product consumers are willing to buy consumers are willing to buy during a particular time period.during a particular time period.

MARKET DEMANDMARKET DEMANDHow much a Consumer Demands of a How much a Consumer Demands of a

Product depends on:Product depends on:

MARKET DEMANDMARKET DEMANDHow much a Consumer Demands of a How much a Consumer Demands of a

Product depends on:Product depends on:

• Price of the product being demanded;Price of the product being demanded;

• Consumer income;Consumer income;

• Price of related goods;Price of related goods;

• The number of potential consumers The number of potential consumers (population);(population);

• Consumer taste and advertising;Consumer taste and advertising;

• Consumer expectations about future prices.Consumer expectations about future prices.

• Price of the product being demanded;Price of the product being demanded;

• Consumer income;Consumer income;

• Price of related goods;Price of related goods;

• The number of potential consumers The number of potential consumers (population);(population);

• Consumer taste and advertising;Consumer taste and advertising;

• Consumer expectations about future prices.Consumer expectations about future prices.

THE DEMAND CURVETHE DEMAND CURVE

• Shows how consumers exchange money Shows how consumers exchange money for goods and services;for goods and services;

• Shows relationship between price of a Shows relationship between price of a good and quantity consumers willing to good and quantity consumers willing to buy during a specific time period;buy during a specific time period;

• Total amount demanded of a product is Total amount demanded of a product is the sum of all consumers’ demand.the sum of all consumers’ demand.

THE LAW OF THE LAW OF DEMANDDEMAND

The lower the price, the The lower the price, the larger the quantity larger the quantity demanded.demanded.

TWO DEMAND EFFECTSTWO DEMAND EFFECTS

1.1. Substitution EffectSubstitution Effect:: The demand for one good normally purchased will The demand for one good normally purchased will

increase if its price relative to the price of another increase if its price relative to the price of another good(s) decreases: more of the original good may be good(s) decreases: more of the original good may be substitutedsubstituted at its new price. at its new price.

APPLESAPPLES BANANASBANANAS

Original Price $2/poundOriginal Price $2/pound $0.50/pound$0.50/pound

sacrificesacrifice 4 pounds bananas4 pounds bananas 1/4pound apples 1/4pound apples

New PriceNew Price $0.50/pound $0.50/pound $0.50/pound$0.50/pound

sacrificesacrifice 1 pound bananas1 pound bananas 1 pound apples 1 pound apples

TWO DEMAND EFFECTSTWO DEMAND EFFECTS2. Income Effect Income Effect -

A lower price for a product means A lower price for a product means that a given that a given amount of money will amount of money will buy more of all goods.buy more of all goods.

Given: Given: $5/week fruit budget; 1pound of apples/week;$5/week fruit budget; 1pound of apples/week;

APPLESAPPLES OTHER FRUIT OTHER FRUIT

Original PriceOriginal Price $2/pound$2/pound --------------

Original spendingOriginal spending $2 $2 $3$3

New PriceNew Price $0.50/pound$0.50/pound ------------

New spendingNew spending $0.50$0.50 $3$3

$1.50 remains for purchase of any desired product.$1.50 remains for purchase of any desired product.

Price drop increases Price drop increases real incomereal income..

Change in Quantity Change in Quantity DemandedDemanded

• A change in the quantity A change in the quantity resulting from a change in the resulting from a change in the price of a good;price of a good;

• Illustrated by movement along a Illustrated by movement along a demand curve.demand curve.

Price Price per per Pound Pound of of ApplesApples

Thousands of Pounds of Apples per day Thousands of Pounds of Apples per day

$$$$$$

1414 2020 2626 3232 3838

$0.20$0.20

$0.40$0.40

$0.60$0.60

$0.80$0.80

$1.00$1.00DEMANDDEMAND

Price / PoundPrice / Pound$$$$$$

Quantity DemandedQuantity Demanded(Pounds / Day)(Pounds / Day)

$0.80

14,000

$0.60

20,000

$0.40

26,000

$0.20

32,000

DEMANDSCHEDULE

DEMANDCURVE

What Causes the Demand Curve What Causes the Demand Curve to Shiftto Shift

(Change in Demand)(Change in Demand)

A demand curve shifts as the A demand curve shifts as the relationship between product price relationship between product price and the quantity of the good and the quantity of the good demanded changes.demanded changes.

Demand Shift CausesDemand Shift Causes

• Change in incomeChange in income:

--Normal Good--Normal Good: An increase in income increases demand, shifting demand curve right;

--Inferior Good--Inferior Good: A decrease in income increases demand, shifting demand curve right;



$$$$$$

1414 2020 2626 3232 3838

$0.20$0.20

$0.40$0.40

$0.60$0.60

$0.80$0.80


Rightward Shift


• Change in incomeChange in income:

--Normal Good--Normal Good: A decrease in income decreases demand, shifting demand curve left;

--Inferior Good--Inferior Good: An increase in income decreases demand, shifting demand curve left;



$$$$$$

1414 2020 2626 3232 3838

$0.20$0.20

$0.40$0.40

$0.60$0.60

$0.80$0.80


Leftward Shift


• Change In Price of Related GoodChange In Price of Related Good::

-- Substitute Good: -- Substitute Good: As price of one good increases, demand for other good increases;

-- Complement Good: -- Complement Good: As price of one good decreases, demand for other good increases.



$$$$$$

1414 2020 2626 3232 3838

$0.20$0.20

$0.40$0.40

$0.60$0.60

$0.80$0.80


Rightward Shift


• Change In Price of Related GoodChange In Price of Related Good::

-- Substitute Good: -- Substitute Good: As price of one good decreases, demand for other good decreases;

-- Complement Good: -- Complement Good: As price of one good increases, demand for other good decreases.



$$$$$$

1414 2020 2626 3232 3838

$0.20$0.20

$0.40$0.40

$0.60$0.60

$0.80$0.80


Leftward Shift

Other Factors Affecting Other Factors Affecting Demand (Shift)Demand (Shift)

• PopulationPopulation - An increase in population means more buyers, an increasing demand, and a rightward shift in the demand curve;

• Consumer Tastes and Advertising Consumer Tastes and Advertising - As advertising leads to greater consumer preference for a product, a rightward shift in demand occurs;

• Consumer Expectations of Future Prices Consumer Expectations of Future Prices - If consumers expect future prices for a product to be higher in the future, they will demand more of the product now.

Individual Demand CurveIndividual Demand Curve

Shows the relationship between the price of a good and the quantity that a single consumer is willing to buy (quantity demanded) during a particular time period.

The result of a rational choice by the consumer, based on the associated benefits and costs of consuming a good.

Individual Demand CurveIndividual Demand Curve

Individual Demand CurveIndividual Demand Curve• Given a Budget ($30);Given a Budget ($30);

• Spend all budget on two goods: Hamburgers and tacos;Spend all budget on two goods: Hamburgers and tacos;

• Consumption of Hamburgers depends on: Consumption of Hamburgers depends on:

– price of burgers;price of burgers;– price of tacos;price of tacos;– income;income;– underlying tastes or preferencesunderlying tastes or preferences

• Given a Budget ($30);Given a Budget ($30);

• Spend all budget on two goods: Hamburgers and tacos;Spend all budget on two goods: Hamburgers and tacos;

• Consumption of Hamburgers depends on: Consumption of Hamburgers depends on:

– price of burgers;price of burgers;– price of tacos;price of tacos;– income;income;– underlying tastes or preferencesunderlying tastes or preferences

How Many Burgers Does Bob Buy ?How Many Burgers Does Bob Buy ?

• at $3 ?8

• at $2 ?11

$3

8

$2

11

b

c

Burgers per Month

PriceofBurgers

Demand Curve

The Principle of Opportunity CostThe Principle of Opportunity Cost

The Opportunity CostThe Opportunity Cost::

• Of something is what you sacrifice to get it;Of something is what you sacrifice to get it;

• Of hamburgers is number of tacos given up to get one hamburger.Of hamburgers is number of tacos given up to get one hamburger.

• Of 1 hamburger is 3 tacos, if hamburgers cost $3 and tacos cost $1.Of 1 hamburger is 3 tacos, if hamburgers cost $3 and tacos cost $1.

Consumption of the first through eighth hamburger provides greater pleasure than Consumption of the first through eighth hamburger provides greater pleasure than consumption of the first taco.consumption of the first taco.

Substitution EffectSubstitution Effect

Change in consumption resulting from change in price of Change in consumption resulting from change in price of one good relative to the prices of other goods.one good relative to the prices of other goods.

If price of hamburgers decreases ($2), while price of tacos If price of hamburgers decreases ($2), while price of tacos remains constant, more hamburgers will be substituted for remains constant, more hamburgers will be substituted for tacos. (Opportunity cost of hamburgers, in terms of tacos tacos. (Opportunity cost of hamburgers, in terms of tacos decreases). decreases).

Income EffectIncome Effect

Change in consumption resulting from an increase in consumer’s real income.

Real income is measured in terms of the goods the money can buy.

Income EffectIncome Effect• At the original price ($3), Bob buys 8 burgers (cost = $24) and 6 At the original price ($3), Bob buys 8 burgers (cost = $24) and 6

tacos (cost = $6), for total cost of $30. tacos (cost = $6), for total cost of $30.

• If the price of burgers drops, Bob’s purchasing power increases.If the price of burgers drops, Bob’s purchasing power increases.

• Given lower price, Bob can buy more burgers and tacos.Given lower price, Bob can buy more burgers and tacos.

• Since Bob’s $30 can buy more burgers and tacos when the price of Since Bob’s $30 can buy more burgers and tacos when the price of burgers decreases, Bob’s burgers decreases, Bob’s real incomereal income increases. increases.

• Normal Goods - Most goods:

New clothing, air transportation, and meats are examples.

Consumption of normal goods increases as real consumer income increases.

• Normal Goods - Most goods:

New clothing, air transportation, and meats are examples.

Consumption of normal goods increases as real consumer income increases.

Income Effect

• Inferior Goods Inferior Goods - Consumption of inferior goods decreases - Consumption of inferior goods decreases as real consumer income increases. Examples:as real consumer income increases. Examples:

Used clothing, potatoes, inter-city busUsed clothing, potatoes, inter-city bus transportation.transportation.

Income EffectIncome Effect

The Market Demand Curve

• Shows for each price, the quantity of a particular good demanded by all consumers.

• It is the sum of quantities demanded by each consumer at a given price.

The Market DemandPrice ofBurgers

Burgers per Month

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

4 8 12 16 20 24 28

Bob’s DemandBob’s DemandAnn’s DemandAnn’s Demand

Total Consumer (Market) Demand

Total Consumer (Market) Demand

@ $3 market demand = 16Bob’s 4 + Ann’s 12

@ 50¢ market demand = 28 Bob’s 8 + Ann’s 20

@ $3 market demand = 16Bob’s 4 + Ann’s 12

@ 50¢ market demand = 28 Bob’s 8 + Ann’s 20

Market Demand AssumptionsMarket Demand Assumptions

• All, except price of the good itself, are held constant:All, except price of the good itself, are held constant:

• •Price of other goods, Price of other goods,

• •Income, Income,

• •Tastes, Tastes,

• •Number of consumers. Number of consumers.

UTILITYUTILITY

The benefit generated by consuming a good: the The benefit generated by consuming a good: the satisfaction or pleasure the consumer experiences satisfaction or pleasure the consumer experiences when he or she consumes the good.when he or she consumes the good.

Marginal Utility Marginal Utility

The change in utility resulting from one The change in utility resulting from one additional unit of a good.additional unit of a good.

The Law of Diminishing Marginal The Law of Diminishing Marginal UtilityUtility

As consumption of a particular good As consumption of a particular good increases, marginal utility decreases.increases, marginal utility decreases.

TotalUtility( TU )UTILS

MarginalUtility( MU )UTILS

20406080

100120140160180

5

2 3 54 6 7 8

1 2 3 4 5 6 7 8

Burgers / Month

Burgers / Month

Burgers MU TU

1

1015202530

1 26 262 24 50

3 22 72

4 20 92

5 18 110

6 16 126

7 14 140

8 12 152

The Marginal PrincipleThe Marginal Principle

Increase the level of an activity if its marginal Increase the level of an activity if its marginal benefit exceeds its marginal cost, but reduce the benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the benefit. If possible, pick the level at which the marginal benefit equals marginal cost. marginal benefit equals marginal cost.

MARGINAL UTILITY&

MARGINAL PRINCIPLE

Number of burgers

Marginal utilityburgers ( utils )

Numberof Tacos

Marginal utilitytacos ( utils )

Marginal CostBurgers

Given: $30 budget; taco price = $1; burger price = $3;

5 18 15 1 3

6 16 12 2 6

7 14 9 3 9

8 12 6 4 12

9 10 3 5 15

10 8 0 6 18

MARGINAL UTILITY&

MARGINAL PRINCIPLE

Number of burgers

Marginal utilityburgers ( utils )

Numberof Tacos

Marginal utilitytacos ( utils )

Marginal CostBurgers

Given: $30 budget; taco price = $1; burger price = $3;

5 18 15 1 3

6 16 12 2 6

7 14 9 3 9

8 12 6 4 12

9 10 3 5 15

10 8 0 6 18

5 18 15 1 3

6 16 12 2 6

7 14 9 3 9

8 12 6 4 12

9 10 3 5 15

10 8 0 6 18

The Utility Maximizing RuleThe Utility Maximizing Rule

A consumer will maximize his/her utility by picking A consumer will maximize his/her utility by picking the affordable combination of consumer goods that the affordable combination of consumer goods that makes the marginal utility per dollar spent on one makes the marginal utility per dollar spent on one good equal to that of a second good.good equal to that of a second good.

The Utility Maximizing Rule

Marginal Utility

of burgersMarginal Utilityof Tacos

=Price ofburgers

Price of Tacos

CONSUMER SURPLUSCONSUMER SURPLUS

The difference between the maximum amount The difference between the maximum amount that a consumer is willing to pay for a good or that a consumer is willing to pay for a good or service and the price he or she pays for the service and the price he or she pays for the product.product.

Demand Curve and Consumer SurplusDemand Curve and Consumer Surplus

• If Oscar’s demand for CDs is such that at:

Price Quantity Oscar Will Buy

$24 0

$21 1

$18 2

$15 3

$12 4

$9 5

CONSUMER SURPLUS FOR AN CONSUMER SURPLUS FOR AN INDIVIDUAL CONSUMERINDIVIDUAL CONSUMER

10

12

14

16

18

20

22

24

1 2 3 4 5

$11

$8$8$5

$2

PRICEPRICEOFOF

CD’sCD’s($)($)

NUMBER OF CD’s PER MONTHNUMBER OF CD’s PER MONTH

Individual DemandIndividual DemandCurveCurve

Price = $10Price = $10

t t u u

v v

w w

x x

y y

CDsCDs Willing toWilling to ConsumerConsumerPayPay SurplusSurplus

11 $21$21 $11$1122 $18$18 $8$833 $15$15 $5$544 $12$12 $2$2 TotalTotal $26$26

MARKET An arrangement which allows buyers and sellers to exchange money and goods. An arrangement which allows buyers and sellers to exchange money and.

Documents

firms debts

market demandhow

capital market

consumers exchange money

particular product consumers

individual individual

natural resources market

quantity consumers