Chapter 1

What is
Economics About

Definition of Economics
SCIENCE of how individuals and
societies deal with the fact that
wants are greater than resources
available to satisfy those wants

Scarcity
Wants are greater than the resources available to
fill those wants
What do you have scarcity of???
Money
Time

What do firms have scarcity of???

Labor
Land
Capital

Thus.
Economics is the
SCIENCE of SCARCITY

Normative vs. Positive Economics

Normative
What ought to be

Positive
What is

Examples: Positive or Normative?

The government fought inflation during the early
1980s because it felt the inflation was damaging
potential long-term economic growth.
The government should cut taxes in order to stimulate
consumption.
Increases in consumer spending improved the
Japanese economy last year.
Balancing the federal budget would be good for the
economy.

Micro vs. Macro

Microeconomics
Study of human behavior and choices
Looks at SMALL units (individual, market, single
firm)

Macroeconomics
Study of human behavior and choices
Looks at LARGE units (aggregated markets, whole
economy)

Economic Way of Thinking

Watch
An economist is someone that sees
something working in practice and
asks if it would would in principle

Think
Identify

Why Study Economics?

Social Problems
Discrimination
Crime

Understand why things happen

Coupons
Minimum Wage

Understand the Political Process

Homework
th
due Friday April 4
Chapter 1
Questions 1 and 2

Beginning to Think Like an

Economist
is this a good thing?

Defining Economic Goods

Utility
Satisfaction you receive from consuming a product
Good vs. Bad

Tangibility
Can the good be touched or is it a service?

Resources or factors of production used

Land: natural resources
Labor: Physical and mental talents of people
Capital: produced goods that can be used as inputs for
further production
Entrepreneurship: talent of organizing resources, seeking
new opportunities, and developing new ways of doing things

Remember Scarcity Runs the

Show
What was scarcity??
Sohow do we make sure that only those who
REALLY need the good get it??
Prices
System of rationing of the good
Cause people to compete for the item

Opportunity Cost
Value of the next best alternative foregone
Pizza vs CD
Pizza for $1.00 per slice; CD for $15.00

Revolutionary War
The British and their red coats

Big Macs
Big Macs in Japan cost $8.25

Highway System
Paid for with taxes

Summary Statement of Scarcity

and Related Concepts

Costs and Benefits at the

Margin
What is the margin??
The last or additional

Marginal Cost
The cost of the last unit employed

Marginal Benefits
The benefit of the last unit employed

Unintended effects
Minimum wage
Gun bounties
Seat belts

Efficiency
What is the right amount of time to study?
Right amount = optimal or efficient amount
Marginal Costs = Marginal Benefits

Economic way of thinking

includes

Analyzing scarcity
Look at opportunity cost of decisions
Measure costs and benefits
Look at marginal effects
Examine unintended effects

Economic Thinking Errors

Association vs. Causation
You hit red lights because you are running late
Dont study for a test so you fail

Fallacy of Composition
What is good for the individual is good for the group

Forgetting Ceteris Paribus

All else remains constant

What is this?

Model
Simplified version of reality
Includes only the important aspects

Why is a model necessary??

Parts of a Theory
Variables
Magnitudes that can change

Assumptions
Ideas about event that will not allow to change

Hypothesis
Educated guess

Predictions
Based on hypothesis and assumptions

Scientific Approach

What do you want to predict/explain?

What variables are important?
State assumptions
State hypothesis
Test
If results are goodYeah You!!
If results are badamend or reject theory

Building and Testing a Theory

Evidence supports the
theory. No further action is
necessary, although it is a
good idea to continue to
examine the theory closely.

Decide on what
it is you want to
explain or
predict.

Identify the
variables that
you believe are
important to
what you want
to explain or
predict.

State the
assumptions of
the theory.

State the
hypothesis.

Test the theory

by comparing
its predictions
against realworld events.

Either

Or

Return

Evidence rejects the theory, so

either formulate a new theory,
or amend the old theory in terms
of its variables, assumptions,
and hypotheses.

How do we judge theories?

Look at how well they predict
NOT by the assumptions
Example: Firms try to maximize profits
Do they thing about this every second?
Probably not
Over the course of the yearmake decisions to
maximize profits

Appendix A
Working with Diagrams

Types of Relationships between

variables
Direct
Positive

Inverse
Negative

No Relationship
Variables are independent

Two-Variable Diagram Representing an

Inverse Relationship

Price of CDs ($)

20
18
16
14
12
0

A
B

The variables price

and quantity
demanded are
inversely related.
C
D

Demand for CDs

100 120 140 160 180

Quantity Demanded of CDs

Two-Variable Diagram Representing a

Direct Relationship
Consumption ($)
360

300

240

180

120
60
0

The variables
income and
consumption are
directly related.

A
100 200 300 400 500
Income ($)

Two Diagrams Representing

Independence between Two
Variables
Y

Variables X and Y are

independent (neither variable
is related to the other).

Variables X and Y
are independent.

40

40

30

30

20

10

20

10
0

10

20
(a)

30

40

10

20

30

40
(b)

Slope
Used to see how a variable changes in
response to another variable changing

Y
vertical
Slope

X horizontal

To calculate slope
Find two points on any straight line

Y2 Y1
Y1 Y2
or
X 2 X1
X1 X 2

What sign do you expect the slope

to have?
Direct relationship
Positive

Inverse relationship
Negative

No Relationship
0 or infinity

Calculating Slopes
Y

Y
10
Slope= =
= 1
X
10
(negative slope)
A

40
Y

30

20
10

20

30

C
B

20
D

10

Y +10
=
= +2
X
+5
(positive

Slope =

40
B

30

40

10
X

10 15 20

Calculating Slopes
Y

40
30

20

Y
0
=
Slope =
=0
X
10
(zero slope)

10
0

10

20
(c)

30

40

40

30

20

10

Y
+10
=
=`
X
0
(infinite slope)

Slope =

10

20

30

40
(d)

The 45 Line
45 Line

20

45
20

Appendix B
Should you major in Economics??

Five myths about economics and an

economics major
Economics is all mathematics and statistics
Economics is only about inflation, interest rates,
unemployment, and other such things
People become economists only if they want to make
money
Economics wasnt very interesting in high school, so it
isnt going to be interesting now
Economics is a lot like business, but business is more
marketable

Chapter 2

Economic
Activities:
Producing and
Trading

Efficiency
Efficiency of Production is goal
If a firm is producing the max possible given
available resources and technology

Production Possibility Frontier

(PPF)
Shows all possible combinations of goods for a
particular economy at a particular point in time,
given its resources and technology constraints

Production Possibilities Frontier

for Grades
HOURS S PENT
S TUDYING
S OCIOLOGY

GRADE IN
S OCIOLOGY

HOURS S PENT
S TUDYING
ECONOMICS

GRADE IN
ECONOMICS

POINT IN
PART (b)

90

60

85

65

80

70

75

75

70

80

65

85

60

90

(a)

Production Possibilities Frontier for Grades

Grade in S o c io lo g y
90

Part (b)

(S o c . 90, Ec o n. 60)
B

85

(S o c . 85, Ec o n. 65)
H

80

Pro duc tio n

Po s s ibilitie s
Fro ntie r (PPF)

75

70

65

G
60

60

65

75
80
70
85
Grade in Ec o no mic s

90

Where are we on the PPF?

Can we be on the PPF?
Yes!
efficient

Can we be under the PPF?

Yes!
Inefficient

Can we be over the PPF?

NO

Two types of Production Possibility

Frontiers
Constant Opportunity Costs
STRAIGHT LINE
DOWNWARD SLOPED (inverse relationship)
1 to 1 relationship (slope constant)

Production Possibilities Frontier

(Constant Opportunity Costs)

COMBINATION

COMPUTERS AND
TELEVIS ION S ETS
(numbe r o f units pe r ye ar)

POINT IN
PANEL (b)

50,000

and

40,000

and

10,000

30,000

and

20,000

20,000

and

30,000

10,000

and

40,000

and

50,000

Part (a)

Production Possibilities Frontier

(Constant Opportunity Costs)
Pa rt (b)

Co mpute rs (th o us a nds p e r ye ar)

50
40
30
20
10

A
A s traig ht-line PPF
illu s trate s c o n s tan t
o pp o rtun ity c o s ts .

B
C

D
E
F

10
30
20
40
50
Te le vis io n S e ts (tho us and s pe r ye a r)

Second Type of PPF

Changing Opportunity Costs
BOWED OUT PPF
Real world PPF
Changing slope with every point

Production Possibilities Frontier

(Changing Opportunity Costs)
Pa rt (a)

COMBINATION

COMPUTERS
AND TELEVIS ION S ETS
(nu mbe r o f un its pe r ye a r)

POINT IN
PANEL (b)

50,000

and

40,000

and

20,000

25,000

and

40,000

and

60,000

Co mpute rs (tho us ands pe r ye ar)

50

A
Part (b)
B

40

30
C

25
20

10

A bo we d o utward
(co ncave ) PPF illus trate s
inc re as ing o ppo rtunity
c o s ts .

Production
Possibilities
Frontier
(Changing
Opportunity
Costs)

D
0

10

20

30

40

50

Te le vis io n S e ts (tho us ands pe r ye ar)

60

Law of Increasing Opportunity

Costs
Goes along with CHANGING OPPORTUNITY
COSTS
As more of a good is produced the opportunity
cost to produce that good increases.

Go o d X

A
100
95

}5

50

A Summary Statement
about Increasing
Opportunity Costs and
a Production
Possibilities Frontier
That Is Bowed
Outward (Concave
C
Downward)

20
D

30
10
0

60 70
Ho us e s

10
110

120

Economic Concepts illustrated by

PPF

Scarcity
Choice
Opportunity Costs
Law of Increasing Opportunity Costs

Examples of Law of Increasing

Opportunity Costs
Armed Services
WWI, WWII and Korean War draft was irrelevant of
job or education level; Civil War education and job
level mattered

Home Improvements
Swedish men make more improvements
themselves compared to US men

Economic Growth
Increase in resources
Increase in technology
Shift of PPF outward

How would each of the following

affect the US PPF?
A rise in the unemployment rate
The invention of the computer
An increase in the number of birth in the United
States
An increase in the number of births in Russia

Economic Growth within

a PPF Framework
Military Go o ds
Ec o nomic g ro wth s hifts
the PPF o utward.

PPF
2
PPF
1

Civilian Go o ds

Production Possibilities Frontier

for Grades
HOURS S PENT
S TUDYING
S OCIOLOGY

GRADE IN
S OCIOLOGY

HOURS S PENT
S TUDYING
ECONOMICS

GRADE IN
ECONOMICS

POINT IN
PART (b)

90

60

85

65

80

70

75

75

70

80

65

85

60

90

(a)

Production Possibilities Frontier for Grades

Grade in S o c io lo g y
90

Part (b)

(S o c . 90, Ec o n. 60)
B

85

(S o c . 85, Ec o n. 65)
H

80

Pro duc tio n

Po s s ibilitie s
Fro ntie r (PPF)

75

70

65

G
60

60

65

75
80
70
85
Grade in Ec o no mic s

90

More Hours of Study Shifts the

Production Possibilities Frontier
Grade in S o c io lo g y
95
90
85
80
77.5
75

X (S o c . 80, Ec o n. 75)
Y (S o c . 77.5, Ec o n. 77.5)
Z (S o c . 75, Ec o n. 80)

70
PPF1
(6 ho urs )

65
60

60 65

70

75 80 85 90
77.5
Grade in Ec o no mic s

PPF2
(7 ho urs )
95

EfficiencyAgain
Produce max amount possible given resources
and technology
ON PPF EFFICIENT
UNDER PPF INEFFICIENT
OVER PPF NOT POSSIBLE

Unemployment
Economy is not producing the maximum output
given the resources and technology available
Efficient?
On, over, or under PPF?

Efficiency Criterion
Will alternate arrangements of resources or
goods make at least one person better off
without hurting someone else?
Yes? Inefficient
No? Efficient

Efficiency, Inefficiency, and Unemployment Resources,

Te le vis io n S e ts
within a PPF Framework
A

55

50

35

28

15

Effic ie nt po ints lie o n

the pro duc tio n po s s ibilitie s
fro ntie r; ine ffic ie nt po ints
lie be lo w the fro ntie r.

15

35
45
Cars (tho us ands )

52

Trade or exchange
Process of giving up one thing for something
else
Why would you trade?
Make yourself better off
Give up something that you value less for
something you value more

Example: a leather jacket is $100what does

this show??
Value the $100 less than you value the jacket

Periods relevant to trade

Before the trade takes place
Ex ante
Decision takes place $2000 of other goods or the $2000
television set?
Which makes me better off?

At the point of the trade

The $2000 changing hands

After the trade

Ex post
No guarantee that trade will meet expectations
Buyers remorse

Benefits of Trade
Compare the consumers and producers point
of views
Consumer Surplus
Maximum buying price price paid
Satisfaction gained by not having to pay as much

Producer Surplus
Price received minimum selling price
Satisfaction gained by getting more than anticipated for
the good

Which makes you better off?

Increases in Consumer or Producer Surplus?
Consumer

Why?
Price that you pay will be lower

Terms of Trade
Trade is where things are given up to get
something else
What things?
Money, goods, services

Terms of trade is how much is given up

Which part does buyers remorse fit into?
terms of trade
Where the money usually comes in

Costs of Trade
Transaction costs
Time and effort needed to search out, negotiate,
and consummate a trade
May cause trades to not take place
Dont know about the good
Shipping costs are too high
Dont like to work with salesperson

Third-party effects
Impacts of trade on parties not immediately
involved
Second hand smoke (negative externality)

Producing and trading

Two people: Elizabeth
and Brian
Each produce two
goods: Bread and
Apples
Elizabeth 10 loaves of
bread and 10 apples
Brian 5 loaves of
bread and 15 apples

Elizabeth
Apples

Elizabeth
Bread

20

10

10

20

Brian Apples

Brian Bread

10

15

30

Comparative Advantage
Should both produce apples and bread or
should they specialize?
What does specialize mean?
Produce the good that you do best
Produce at a lower costs than other person(s) can
Called comparative advantage
Looks at opportunity cost
What was that?
What you have to give up
Give up less?? Have the comparative advantage

What are the opportunity costs?

Elizabeth
If give up 10 apples how much
more bread can she produce?

Elizabeth
Apples

Elizabeth
Bread

20

10

10

20

10 units

If give up 10 loaves of bread

how many more apples can
she produce?
10 units

Opportunity Costs
10 Bread = 10 Apples
1 Bread = 1 Apple

What are the opportunity costs?

Brian
If give up 15 apples how much
more bread can he produce?

Brian
Apples

Brian
Bread

10

15

30

5 units

If give up 5 loaves of bread

how many more apples can he
produce?
15 units

Opportunity Costs
5 Bread = 15 Apples
1 Bread = 3 Apples
1/3 Bread = 1 Apple

Should we specialize?
Elizabeth
1 Bread = 1 Apple

Brian
1 Bread = 3 Apples
1/3 Bread = 1 Apple

Who produces apples cheaper?

What does cheaper mean?
Lower opportunity cost (give up less)

Brian!!! Give up only 1/3 loaves of bread

Who produces bread cheaper?

Elizabeth!!! Give up only 1 apple

Here is the deal

Elizabeth produces only bread (20 loaves)

Brian produces only apples (30 apples)
Trade 8 loaves of bread for 12 apples
Breakdown of end result
Elizabeth Bread?
12 loaves (20 - 8 traded)

Elizabeth Apples?
12 apples (0 + 12 traded)

 Brian Bread
8 loaves (0 + 8 traded)

Brian Apples
18 apples (30 -12 traded)

Are they better off??

Are they better off??

No
Specialization Gains from
Specialization
and Trade
trade
or Trade
Elizabeth
Bread
Elizabeth
Apples
Brian
Bread
Brian
Apples

Are they better off??

No
Specialization Gains from
Specialization
and Trade
trade
or Trade
Elizabeth
Bread

10

Elizabeth
Apples

10

Brian
Bread

Brian
Apples

15

Are they better off??

No
Specialization Gains from
Specialization
and Trade
trade
or Trade
Elizabeth
Bread

10

12

Elizabeth
Apples

10

12

Brian
Bread

Brian
Apples

15

18

Are they better off??

No
Specialization Gains from
Specialization
and Trade
trade
or Trade
Elizabeth
Bread

10

12

+2

Elizabeth
Apples

10

12

+2

Brian
Bread

+3

Brian
Apples

15

18

+3

Are they better off??

No
Specialization Gains from
Specialization
and Trade
trade
or Trade
Elizabeth
Bread
Elizabeth
Apples
Brian
Bread
Brian
Apples

Both are Better off!!

Economic System
The way in which a society decides to answer
key economic questions
What goods will be produced?
How will the goods be produced?
For whom will the goods be produced?
Where on the PPF will the economy operate?
What is the nature of trade?
What function do prices serve?

Two major economic systems

Capitalism
An economic system based on private ownership of
capital
Market economy

Socialism
An economic system based on state ownership of
capital

Most use pieces of each mixed capitalism

How do they differ

PPF
Capitalist: Buying behavior of consumers signal for
producers to produce more/less
Socialist: Government sets up how much to
produce

What good to produce?

Capitalist: Consumers and producers decide
Socialist: Government decides

 How goods will be produced?

Capitalist: producers decide
Socialist: government decides

For whom to produce?

Capitalist: Consumers decide if they are able and
willing to purchase the good
Socialist: Government may redistribute funds to get
certain people certain items

Trade
Capitalist view: Trade benefits both sides
Socialist view: Trade benefits one side at the
expense of the other

 Prices
Capitalism views
Rations goods and services
Conveys information
Serves as an incentive to respond to information

Socialism views
Price is set by greedy businesses with much economic
power
Price controls (cant charge more or less than a certain
price)

Now we want to
use these questions
for the next chapter
as we look at:
What a market is and how is it
established.

Chapter 3

Supply, Demand:
Theory

Market
Market is an arrangement by which people
exchange goods and services including money
Two sides
Buyer
Seller

Starting with the Buyer Side

Quantity demanded
Amount of a good people are willing and able to buy
at a particular price at a particular point in time

Important parts of definition

Willing
Able
Particular Price
Particular point in time

Demand
Quantity demanded over all prices during a
specific point in time
Important parts:
Quantity demanded
All prices
Specific point in time

So.
So.

Who does what in the Market?

Consumers
Buy goods
Sell Labor

Firms
Sell goods
Buy Labor

Circular Flow
Depiction of how the market works in the
economy
Includes both buyers and sellers
Shows the flow of goods and services between
consumers and firms

Law of Demand

As price of a good (decreases) increases

the Quantity demanded of that good
(increases) decreases

Demand Schedule
Numerical table of quantity demanded at
different prices
Price
4
3
2
1

Quantity
10
20
30
40

Demand Curve
Graphical representation of the demand
schedule
Used to represent the relationship between
price and quantity
Why type of relationship do you expect price
and quantity to have?

Demand Schedule and Demand

Curve
DEMAND S CHEDULE FOR GOOD X

Pric e (do llars )

PRICE
(do llars )

QUANTITY
DEMANDED

POINT IN
PANEL (b)

10

20

30

40

A
De mand Curve
B

10

20

30

40

Quantity De mande d o f Go o dX
(a)

(b)

Market Demand
Previous demand
Curves
curve was for an individual
Single buyer

How can we get the market curve from

individual demand curves?
All buyers

Sum the individual Demand curves

Therefore.

Deriving a Market Demand

Schedule & Curve
Part (a)
QUANTITY DEMANDED
PRICE

JONES

S MITH

OTHER BUYERS ALL BUYERS

$15

20

23

14

45

50

13

70

77

12

100

109

11

130

141

10

160

173

Part (b)
Pric e ($)
12
11

De mand Curve
(Jo ne s )
A1
B1

12
11

4 5
Quantity Demande d

Pric e ($)

Pric e ($)

12
11

De mand Curve
(o the r buye rs )
A3
B3

0
100 130
Quantity De manded

De mand Curve
(S mith)
A2
B2

5 6
Quantity De mande d

Pric e ($)
12
11

Deriving a
Market
Demand
Schedule
& Curve

Marke t De mand
Curve
A4
B4

0
109 141
4 + 5 + 100
Quantity De mande d
5 + 6 + 130

Determinants of Demand
Income
Normal good
Inferior good

Preferences
Prices of Related Goods
Substitutes
Compliments

Determinants Continued
Number of Buyers
Expectations of Future

Change in Demand vs.

Change in Quantity Demanded
Change in Demand
SHIFT OF CURVE
Due to any non-price determinate

Change in Quantity demanded

MOVEMENT ON ORIGINAL CURVE
Due only to a change in price

Pric e

Change in Demand versus

Change in Quantity
Demanded
Pric e
A c hang e in
quantity demande d
(a mo ve me nt alo ng
the de mand c urve , D )

A c hang e in de mand
(a s hift in the
de mand c urve )

D
D
0

Quantity De mande d
(a)

D
0

Quantity De mande d
(b)

Change in Demand
SHIFT OF CURVE
SHIFT LEFT??
DECREASE IN DEMAND

SHIFT RIGHT??
INCREASE IN DEMAND

Shifts in the Demand Curve

Part (a)
Pric e (do llars )
Rig htward s hift
in de mand c urve
(inc re as e in de mand)

30

D
D
0

500

700

Quantity De mande d o f Blue Je ans

Shifts in the Demand Curve

Part (b)
Pric e (do llars )
Le ftward s hift
in de mand c urve
(de c re as e in de mand)

30

D
D
0

450

650

Quantity Demande d of Blue Je ans

Change in price of related

goods
Substitutes
Something used in replace of another good
Price of Coke increases...

Compliments
Something used with another good
Price of Tennis Rackets increase

Substitutes and Complements

Part (a)
S UBS TITUTES
Pric e

Pric e

P2

If Co c a-Co la and
Pe ps i-Co la are
s ubs titute s , a
hig he r pric e fo r
Co c a-Co la le ads to . . .
A

P1

. . . a rig htward
s hift in the de mand
c urve fo r Pe ps i-Co la.
DCC
0

Qd 2

Qd1

Quantity De manded o f Co c a-Cola

DPC 2
DPC 1

0
Quantity De mande d o f Pe ps i-Cola

Substitutes and Complements

Part (b)
COMPLEMENTS
Pric e

P2
P1

If te nnis rac ke ts and

te nnis balls are
c o mple me nts , a hig he r
pric e fo r te nnis
rac ke ts le ads to . . .
B
A

Pric e

. . . a le ftward
s hift in the de mand
c urve fo r te nnis balls .
DTB 1
DTR

Qd 2 Qd1
Quantity De mande d o f Te nnis Rac ke ts

DTB 2
0
Quantity De mande d o f Te nnis Balls

SELF TEST-Do we
Substitutes understand??

Coke vs. Pepsi --- what happens if the price of

Coke increases?
Qd of Pepsi?
NOTHING

Qd of Coke?
DECREASES

Demand for Coke?

NOTHING

Demand for Pepsi?

INCREASES

 Compliments
Tennis Balls and Tennis Rackets --- what happens
if the price of Tennis Rackets increase?
Qd of Tennis Balls?
NOTHING

Qd of Tennis Rackets?
DECREASES

Demand for Tennis Balls?

DECREASES

Demand for Tennis Rackets?

NOTHING

Examples
The housing market: Consumers income
increases
The sugar market: Saccharine is found to lead to
cancer
The jelly market: The price of peanut butter
increases
The beer market: The price of beer decreases

Does the Law of Demand

Hold?
The price of eating out increases from $10 to
$15 and the quantity demanded of restaurants
increases from 10 to 14 meals.

Pric e ($)

The Law
of
Demand
Holds

15

The s e two
po ints ,
A and B,
are o bs e rve d.

10

10 14
Quantity De mande d
o f Re s taurant Me als (millio ns )
(a)
WRONG

RIGHT

Pric e ($)

15
10

B
A

0
10 14
Quantity De mande d
o f Re s taurant Me als
(millio ns )
(b)

Pric e ($)
15
10

B
A

0
10 14
Quantity De mande d
o f Re s taurant Me als
(millio ns )
(c )

The other sidesupply

Quantity supplied
Amount of a good that producers are willing and
able to sell at a particular point in time at a
particular price

Important Parts

Able
Willing
Particular price
Particular point in time

Supply
Quantity Supplied at all prices during a specific
time period
Thus

Law of Supply

As the price of a good increases (decreases)

the quantity supplied of that good increases
(decreases)

Supply Schedule
Numerical table of quantity supplied at different
prices
Price
4
3
2
1

Quantity
40
30
20
10

Supply Curve
Supply Curve
Graphical representation of the relationship
between price and quantity supplied

What type of relationship do we have between

price and quantity supplied?

Supply Curve
Exhibit 7
Pric e (do llars )
S upply Curve
4

2
1

B
A

20
40
10
30
Quantity S upplie d of Go o dX

Stuff continued
Change in supply
SHIFT OF SUPPLY CURVE
Change in quantity supplied
MOVEMENT ALONG ORIGINAL SUPPLY
CURVE
Increase in supply --- shift right
Decrease in supply --- shift left

Change in Supply versus

Change in Quantity Supplied
Pric e

Pric e
S

A c hang e in s upply
(a s hift in the
s upply c urve )
0

Quantity S upplie d
(a)

A c hang e in
quantity
(a mo ve me nt alo ng
the s upply c urve ,S )

Quantity S upplie d
(b)

Shifts in the Supply Curve

Part (a)
Pric e (do llars )
Rig htward s hift
in s upply c urve
(inc re as e in s upply)

200

S
S

300

Quantity S upplie d o f Go o d X

Shifts in the Supply Curve

Pa rt (b)
Pric e (do llars )
S2

S1

Le ftward s hift
in s upply c urv e
(de c re as e in s upply)
0

50
150
Qu antity S upp lie d o f Go o d X

Question???
Can the supply curve ever be vertical?

Firstwhat does a vertical curve indicate about

the relationship between price and quantity
supplied?

Pric e

Supply Curves When There Is No

Time to Produce More or No More
Can Be Produced
Pric e
S upply Curve o f
The ate r S e ats
fo r To nig hts
Pe rfo rmanc e

500
Numbe r o f The ate r S e ats
(a)

S upply Curve o f
S tradivarius Vio lins

X
Numbe r o f S tradivarius Vio lins
(b)

Determinants of Supply

Price of inputs
Technology
Number of sellers
Price expectations
Taxes and subsidies

Examples
The computer market: The price of computer chips
decreases
The fast food market: McDonalds opens three new
stores in Bakersfield
The pencil market: The price of pencils increases
The gasoline market: A tax is imposed on gas station
owners for each gallon of gas pumped out of their
station

Market Supply Curves

Previous supply curve was for an individual
Single seller

How can we get the market curve from

individual supply curves?
All sellers

Sum the individual supply curves

Therefore.

Deriving a Market Supply

Schedule & Curve
Part (a)
QUANTITY S UPPLIED
PRICE

BROWN

ALBERTS

OTHER S UPPLIERS ALL S UPPLIERS

$10

96

99

11

98

103

12

102

109

13

106

115

14

108

119

15

110

123

S upply
Pric e ($) Curve
(Bro wn)
12
11

A1

Part (b)
upply
Pric e ($) SCurve
(Albe rts )

B1

0
2 3
Quantity S upplie d

Pric e ($)

S upply Curve
(o the r
s upplie rs )

12
11

B3

A3

0
98 102
Quantity S upplie d

12
11

A2

B2

3 4
Quantity S upplie d

Marke t
Pric e ($) S upply
Curve
12
B4
11
A4

0
103 109
2 + 3 + 98 Quantity S upplie d
3 + 4 + 102

Deriving
a Market
Supply
Schedule
& Curve

Next Step.

Putting Supply and Demand

Together

Auction
Model
Can think of supply and
demand as an auction
where buyers bid the price
down and sellers bid the
price up until Qs and Qd
are equal at the same price

But
There is only one price where Qs=Qd
This is called the equilibrium price
The market is always working towards this
price

Scissors and economics?

Alfred Marshall compared Supply and demand
to a pair of scissors
It is impossible to say which blade is actually doing
the cutting just like it is impossible to say whether
demand or supply is responsible for the price

What determines the price?

The interaction of supply and demand

Equilibrium
Also called the market clearing price
When Qs=Qd

Disequilibrium
When Qs=Qd

At Disequilibrium can have

Shortage (excess demand)
Qd > Qs
Price too low
Price must increase to rid shortage
Surplus (excess supply)
Qd < Qs
Price too high
Price must decrease to rid surplus

Pric e (do llars )

Moving to Equilibrium
S

15

S urplus

10

PRICE

Qs

Qd

$15

150

50

S urplus

10

100

100

Equilibrium

50

150

S ho rtag e

S ho rtag e

D
0

50

100
Quantity

150

CONDITION

Moving to Equilibrium
If we have a surplus, price must _______ to get
to equilibrium.
Decrease
If we have a shortage, price must _______ to
get to equilibrium.
Increase

Do Shortage and Scarcity refer to

the same thing???
NO!!
Shortage is only when price is less than the
equilibrium price
Scarcity is always present (at all prices)

Applications of Supply and Demand

Romanee-Conti Wine
Dated back to 1990 and sells for $800 a bottle or $8 a sip
why?

Ticket scalping
Why would people pay higher prices to see an event?
Prices must have been below equilibrium.

Freeway
Why would people be willing to pay a toll to use a road?

Remember..
Equilibrium price and quantity are determined
by the INTERACTION of supply and demand
A change in supply, demand, or both will
change the equilibrium price
Exception: If supply and demand move in
same direction and magnitude so changes are
offset

Change in Supply and Demand but no change in

equilibrium price

What Happens???

Increase D and S constant?

Decrease D and S constant?
D constant and increase S?
D constant and decrease S?
D increase and S decreases by equal amounts?
D decrease and S increases by equal amounts?
D increases more than S decreases?
D increases less than S decreases?

A Summary Exhibit of a Market

MARKET

PRICE,
QUANTITY

DEMAND

Prefe renc e s

Inc o me

Numbe r
o f Buyers
Expe c tatio ns
o f Future Pric e

Pric e s o f
Re late d Go o ds
(S ubs titute s
and
Co mple me nts )

S UPPLY

Pric e s o f
Re le vant
Re s ouc e s

Numbe r
of
S e lle rs

Taxe s
and
S us idie s
Go ve rnme nt
Re s tric tio ns

Te c hno lo g y
Expe ctatio ns
of
Future Pric e

Price Controls
Produces a barrier to which the economy can
no longer operate freely
Cant get to equilibrium price

Two types
Price ceiling
Price Floor

Price Ceiling
Government mandated maximum price
above which legal trades cannot be
made
Price ceiling is below equilibrium price.

Pric e
(do llars

Price
Ceiling

18

Eq uilibrium
Pric e
Pric e
Ce iling

A pric e c e iling
c re ate s a s ho rtag e

12

8
S h o rtag e

D
0

100

150

190

Eq uilibrium
Qu antity

Qu antity o f Go o d X

Impacts of Price Ceilings

Shortage sustained
Fewer exchanges
Non-price rationing schemes
First come first served

Buying & selling at prohibited prices

Black markets

Tie in Sales
Pay certain amount for rent of the house and an amount for
renting the refrigerator

Distort normal economic information and incentives

Lower prices is supposed to mean greater availability

Price Floor
Government mandated minimum price below
which legal trades cannot be made
Price floor is above equilibrium price

Pric e
(do llars )
Pric e
Flo o r
Equilibrium
Pric e

Price
Floor

S
S urplus

20

A pric e flo o r
c re ate s a s urplus

15

D
0

90

130

180

Equilibrium
Quantity

Quantity o f Go o d X

Impacts of Price Floors

Sustained surpluses
Fewer exchanges
Example: Minimum wage

Minimum Wage
In California the minimum wage is $6.75 per
hour
Increased from $6.26 on January 1, 2002

Government mandated minimum wage is $5.15

Last increase was on September 1, 1997

Impacts of Minimum Wage

Surplus of unskilled
Fewer workers overall employed
Supply and Demand would determine wage
Minimum wage doesnt guarantee better
standards of living for low wage employees

Wag e Rate
(do llars )
Minimum
4.25
Wag e 5.75

S
S urplus

Effects of
the Minimum

Equilibrium
3.25
Wag e 4.25

Wage

D Numbe r o f
Uns kille d Wo rke rs
0
N
2
Numbe r o f Wo rke rs
Emplo ye d at
Minimum Wag e

N
1
Numbe r o f Wo rke rs
Emplo ye d
atEquilibrium Wag e

N3
Numbe r o f Wo rke rs
Who Want to Wo rk at
Minimum Wag e

Chapter 5
Elasticity
You are responsible for reading Chapter 4!!!

What have we done?

Chapter 3 gave us downward sloping demand
curves
Law of demand

Now want to see how Qd changes when price

changes

Elasticity
Response of one variable to a change in
another variable
Price elasticity of demand
Measure of the responsiveness of Qd of a product to
a change in the price of that product

%Q
Ed
%P
Qd
Q
Ed
P
P

So
What if Ed = 3?
If price was increased from the prevailing
point the % change in Qd would be 3 times
the change in price

Shouldnt it be negative?
So price increases and Qd decreases?

Yes!!
For ease we look at the absolute value, but
know that the law of demand holds

Point elasticity
Measures the change between two observed
points.

Qb Qa
Qd
Qa
Q
Ed

P
Pb Pa
P
Pa

example

P1 = 10
P2 = 12
Q1 = 100
Q2 = 50
Elasticity??
Which is Point A???
Big Problem!!!

50 100
100
A 1;
2.5
12 10
10
100 50
50
A 2;
6
10 12
12

Problem
Answers vary depending on where you start
Becomes more important the larger the change

Arc Elasticity
To avoid the endpoint problem take elasticity at the
midpoint (average) of the two points

Qd
Qd 1 Qd 2
Qd 1 Qd 2
Qd 1 Qd 2

2
2

Ed

P
P1 P2
P1 P2
P1 P2

2
2

Differences
With arc elasticity it is clear which points are
used
P1 is the first price
P2 is the second price
Qd and Qd are the first and second quantity
demanded respectively
1

Price elasticity of demand can yield

5 basic results

Numerator > Denominator

Numerator < Denominator
Numerator = Denominator
Numerator = 0
Denominator = 0
Each has a specific name and result

Elastic Demand
Ed > 1
% change in quantity demanded > % change in
price
FLATTER CURVE
What are some examples of an elastic good???

Inelastic Demand
Ed<1
% change in the price > percent change in
quantity demanded
STEEPER CURVE
What are some examples of an inelastic good?

Price Elasticity of Demand

Price

Part (a)

Price

Part (b)
Ed < 1
Inelastic

Ed > 1
Elastic
P2
P1

P2

10%
D

P1

20%

10%

4%
D

Q2

Q1

Quantity Demanded

Q2 Q1
Quantity Demanded

Unit Elastic Demand

Ed=1
% change in price = % change in quantity
demanded
Change in price brings a proportionate change
in quantity demanded
CURVE

Price Elasticity of Demand

Part (c)

Price

Ed = 1
Unit Elastic
P2
P1

10%
10%

Q2

Q1

Quantity Demanded

Perfectly Elastic Demand

Ed =
(denominator = 0)
% change in quantity demanded is A LOT in
response to a change in price
Price increases and quantity demanded goes
to 0
Totally flat --- horizontal
Extreme
Examples???

Perfectly inelastic demand

Ed = 0
% change in quantity demanded
DOESNT CHANGE in response to a
change in price
Totally steep --- vertical
Extreme
Examples???

Price Elasticity of Demand

Price

P2
P1

Part (d)

Price

Ed =
Perfectly Elastic
1%

P2
D

Q1

Quantity Demanded

P1

Part (e)
D

Ed = 0
Perfectly Inelastic
10%

Q1

Quantity Demanded

Arent demand curve downward

sloping?
Because the extremes (perfectly inelastic and
perfectly elastic) are not.
Use as points of reference only

How does a change in price affect Total

Revenue of a Firm?
Revenue depends on elasticity
Michael Jordan and Nike shoes
No substitutes -- inelastic demand
What happens to Qd if price increases?

Substitutes elastic demand

What happens to Qd if price increases?

What is total revenue??

Total revenue = price*quantity
Firm uses to decide if to produce more or less

examples
Elastic demand
Price increase
Price decrease
Inelastic demand
Price increase
Price decrease
Unit elastic demand
Price increase
Price decrease

TR

TR

TR

TR

TR

TR

Ed > 1

Ed < 1

Ed = 1

Elasticities,
Price
Changes, and
Total
Revenue

Important to look at because

Elasticity of the demand determines if with a
price increase
Total revenue increases
Total revenue decreases
Total revenue remains the same

Price elasticity of demand and a

straight line
Demand is downward sloping
Along the line elasticity varies from highly
elastic to highly inelastic
Butremember SLOPE is constant

Point
A
B
C
D
E
F
G

P
8
7
6
5
4
3
2

Qd
3
4
5
6
7
8
9

Price Elasticity of Demand along

a Demand Curve
Price (dollars)
(3)
(1)
(2)
QUANTITY (4)
POINT PRICE DEMANDED Ed
A

$8

2.14
1.44
1.00
0.69

Unit Elastic
Range

5
4

0.47

0.29

Inelastic
Range

F
G

1
(a)

Elastic
Range

3 4 5 6 7 8
Quantity Demanded
(b)

Summary
Upper end of Demand Curve
Qd is low and price is high
One unit change in demand is much larger
in terms of percent than change in price

Lower end of Demand Curve

Qd is high and price is low
One unit change in demand is much
smaller in terms of percent than change in
price

So
As move down the demand curve from higher
prices to lower the price elasticity of demand
goes from elastic to inelastic

Determinants of price elasticity of

demand
Number of substitutes available
Increase substitutes increases elasticity
More narrowly defined goods have more substitutes
(compared to broadly defined)
Example: Fords vs all cars

More Determinants
Percentage of ones budget that is spent on the
good
More expensive??? More elastic
More affected by price (even small changes)

Final Determinants
Amount of time that passed since price change
Increase time passed gives more opportunity to
change behavior or react to price change
Overtime can look for substitutes
Increase time increases elasticity
More elastic in long term than short

Cross Elasticity of Demand

Measures the responsiveness of quantity
demanded to a change in price of ANOTHER
good
Q Q
x2

x1

Qx 2 Qx1

%Qdx
2

Ec

Py 2 Py1
%Py
Py 2 Py1

When would you use Cross Price

Elasticity?
To determine if goods are substitutes or compliments
Ec>0 substitutes
% change in quantity demanded and price move
in same direction
Ec<0 compliments
% change in quantity demanded and price move
in opposite directions
Ec=0 goods unrelated

Income elasticity of demand

Measures the responsiveness of
quantity demanded to the change in
income

%Qd

Ey

%income

Qx 2 Qx1
Qx 2 Qx1

Y2 Y1
Y2 Y1

Why use income elasticity of

demand?
Use to determine if a good is normal or inferior
Ey>0 normal good
As income increases Qd increases

Ey<0 inferior good

As income increases Qd decreases

Can also say

If |Ey| > 1
% change in Qd > % change in Y
Income elastic
If |Ey| < 1
% change in Qd < % change in Y
Income inelastic
If |Ey| = 1
% change in Qd = % change in Y
Income unit elastic

Can we use income elasticity in the

real world??
If invest in the stock market do you want to
invest in a normal or inferior good?
Normal
Why
Increase income would increase quantity
bought and increase stock prices

Price Elasticity of Supply

Measures the responsiveness of quantity supplied of
a good to the change in the price of that good

%Qs
Ed

%P

Qs1 Qs 2
Qs1 Qs 2

P1 P2
P1 P2

Classification is like demand

Es > 1
Elastic

Es < 1
Inelastic

Es = 1
Unit elastic

Each of these will result in a normal upward sloped

supply curve

Any extreme elasticities???

Yes!!
Es =

elastic or horizontal
Perfectly

Es = 0
Perfectly inelastic or vertical

Price Elasticity of Supply

Price

Part (a)

Price

Es > 1
Elastic
P2
P1

S
P2

10%

P1
20%

Part (b)

Q1
Q2
Quantity Supplied

Es < 1
Inelastic

10%

4%

Q1 Q2

Quantity Supplied

Price Elasticity of Supply

Part (c)

Price

P2
P1

Es = 1
Unit Elastic

10%

10%

Q1 Q2
Quantity Supplied

Price Elasticity of Supply

Price

Part (d)

Es =
Perfectly Elastic
P1

P2
S

Q1

Quantity Supplied

Part (e)
S

Price

P1

Es = 0
Perfectly
Inelastic

10%

Q1

Quantity Supplied

Does time play a role in elasticity of

supply?
Yes!!
Overtime producers are able to adjust their
behavior and production patterns
Supply becomes more elastic as time passes

Elasticity and taxes

If government levies a tax on a product who
pays the tax??
Producers?? Consumers?? Share??
Depends on the elasticity of demand and
supply

How find??

Find equilibrium price

Supply shifts left in the amount of the tax
Find new equilibrium
Find point of second equilibrium on ORGINAL
supply curve
Shows the actual price realized by firm or
equilibrium price tax = point in question
Difference between points determines how much of
tax you pay

Who
Pays
the
Tax?
Price
(dollars)

Part of tax paid

by consumers in
terms of higher
price paid.

S2 (after tax)
S1 (before tax)

9.00
8.50
8.00

B
A

$1 Tax

7.50
Part of tax paid
by producers in
terms of lower
price kept.

D1

Q2 Q1
Quantity of VCR Tapes

Who pays more of the tax??

Perfectly inelastic demand

Perfectly elastic demand
Demand more elastic than supply
Supply more elastic than demand

Different Elasticities and Who

Part (a) Pays the Tax Part (b)

Price (dollars)

Price (dollars)

S2

D1

Producers pay
full tax

S1
9.00
8.00

S2
S1

$1 Tax

8.00

Q2

Q1

$1 Tax
D1

Consumers pay
full tax
0

Q1
Quantity of VCR Tapes

Quantity of VCR Tapes

Summary
Ed > Es producer bears most of the tax burden
Ed < Es consumer bears most of the tax burden
Ed = Es equally share the tax burden

Chapter 6
Consumer Choice:
Maximizing Utility and
Behavioral Economics

Diamond-Water Paradox
Why is water (necessary to life) so cheep while
a diamond (not necessary to life) is so
expensive?

Two types of value for a good

Value of Exchange
Price

Utility
Satisfaction or wellbeing

How do you measure utility?

Construct an artificial measure called a UTIL
Remember we assume people are rational
What does it mean to be rational?
Will not consume a bad voluntarily

All consumed goods have utility or you would

not consume it.

Total Utility
Amount of satisfaction or use value you
receive from consuming a particular good
Thus

Marginal Utility
Additional utility gained from consuming an
additional unit of a good
Change in total utility brought about by the
additional consumption

Thus

Calculate the Marginal Utility

Quantity

Pizza Slices
Total Utility

10

16

18

19

Law of Diminishing Marginal Utility

The more units of a good we consume during a
period of time the less additional satisfaction
we get from the additional units

(1) UNITS OF
GOOD X

(2) TOTAL
(3) MARGINAL
UTILITY (utils) UTILITY (utils)

0
1
2
3
4
5

0
10
19
27
34
40

10
9
8
7
6

Total Utility (utils)

TU

40

Marginal Utility (utils)

10
9

34

8
7

27

MU

19
10

5 Good X

5 Good X

Does the law always hold?

Some goods have increasing MU initially then
decreasing later, but the law says satisfaction
should begin to decrease with the second unit
Tennis
As you get better you like it more, so the 10 th game
may be more enjoyable

Soften the Law

Principle of Diminishing Returns
For a given period of time the MU gained from
consuming equal successive units of a good will
eventually decline as the amount consumed
increases.

Examples
Car rides
Fads
eating

Thusthe law says

At some point successive units of a good
consumed by the SAME individual will become
less valuable to that individual
What about to someone else or the
interpersonal utility?
Cant do because we dont know with certainty
another persons preferences

Example
Who would value a dollar more: a poor person
or a millionaire?
Money hungry millionaire?
Answer would be millionaire

Dollar is not much of a million

Answer would be a poor person

Dont guess at utility

Diamond-Water Paradox revisited

Goods have Total and Marginal Utility values
Water

TU?
High because need it to live
MU?
Low because it is plentiful and we consume it in large
quantities

Diamond-Water Paradox continued

Diamonds
TU??
Low because not really necessary to live
MU??
High because very limited supply and consume in
small quantities

Solution to Diamond-Water Paradox

Things with great value in use have little value
in exchange
Those with little use value have higher
exchange value
Prices (value of exchange) are most often
determined by
Marginal Utility

Is gambling worth it?

If only want to win??? NO!!
If gain pleasure from the gambling process???
YES!!

How do we compare MU of different

units?
Example: What is the MU of an apple vs. an
orange?
Relative Marginal Utility of the good
MU per dollar of purchase price

Decision Making Process

If the MU of good A relative to its price is
greater than the MU of good B relative to its
price we should buy more of A and less of B
Compare
of each good

MU
P

Example

MUorange = 30
MUapple = 20
Income = $20
Buy 10 oranges for $1 each and 10 apples for $1
each

Good??

MU o MU A

Po
PA

Not Good
We could do better by buying more oranges
because per dollar it brings more satisfaction
Buy one more orange and one less apple
increases TU
What happens to the MU of oranges?
Decreases MU of oranges
Why?
Diminishing MU when buy more

What happens to the MU of apples?

Increases MU of apples
Why?
Increasing MU when buy less

When do we stop?

Consumer Equilibrium
The combination of goods where our income
cant be redirected to improve our situation
Therefore:

MU o MU A

Po
PA

Example
P =$2; P =$1; Income=$60
M

# muffins

MUM

# cookies

MUc

11

44

46

48

50

What if the price of a good

changes?
Must recalculate

MU
P

Pa=$1;Pb=$1? Pa=$0.50;Pb=$1?
Income = $7.00
#a
1
2
3
4
5
6
7

MUa
12
11.5
11
10
9
8
7

#b
1
2
3
4
5
6
7

MUB
22
20
18
16
14
12
10

Consumer Equilibrium and a Fall in Price

GOOD A
Units of Go od A
Marg inal Utility

Orig inal
Purc has e

Ne w
Purc has e

12

11.5

11

10

Ne w
Purc has e

GOOD B
Units o f Go o d B
Marg inal Utility

Orig inal
Purc has e

22

20

18

16

14

12

10

Orig inal
Purc has e
Go o d A
Go o d B

Ne w
Purc has e
Go o d A
Go o d B

12 utils
12 utils
=
$1.00
$1.00

8 utils
16 utils
=
$.50
$1.00

So
As price decreases relative MU increases so
consumers buy more to gain consumer
equilibrium again
Shows a negative relationship between price
and amount people buy
JUST LIKE THE DEMAND CURVE

Do RATS understand the inverse

relationship between price and quantity?
Choice between two liquids
Root beer
Collins mix

Given 300 pushes (each liquid had a different number

of pushes to get it price)
Found rats switched to the cheaper liquid when the
price changed

Why isnt education and medical

care free?
If cost = 0 when do we stop using it?
When MU = 0
Thus we will see a lot of frivolous use of
programs. It costs you nothing so use it.

Consumer Surplus
The difference between the actual price buyers
pay for a good and the maximum amount they
are WILLING and ABLE to pay for it
Dollar measure of benefit gained from a price
decrease

Consumer Surplus cont.

Triangle under the demand curve and above
the equilibrium price out to the equilibrium
quantity

Consumers' Surplus
Part (a)

Pric e

Co ns ume rs
S urplus

Windo w
P
S

CS

$7
$5
$5
D
0

D
0

100

Quantity

50 100

Changes in Supply affect Consumer

Surplus

Decrease in the number of sellers

Advance in technology
Increase in the price of relevant resources
A per-unit subsidy placed on
producers/seller

Consumers' Surplus
Pric e

S2

Part (b)

Windo w

A
S1

P2

P1

CS with S 1 :

P1

A
CS with S 2 :
P2
D1
0

Quantity

Sales schemes
Consumer is willing to buy
One pair of shorts for $40
Second pair of shorts for $30

Store has a choice

Sell shorts for $30
Have sale where buy first for $40 get $10
off second pair?
Which has more CS??? (hint only use the
demand curve)

Consumers Surplus and

Two Pricing Schemes
Pric e

Bo bs demand
fo r pairs o f
tro us e rs

$40
$30

Pric e
A

Pric e
A

($30) F

D
1

Pairs o f
Tro us e rs
(a)

Cas e whe n
e ac h
pair o f ($40) C
tro us e rs
D is $30 ($30)F

Cas e whe n
firs t
pair o f
B
tro us e rs
D is $40 and
E
s e c o nd pair
is $30

D
0
Pairs o f
Tro us e rs

2
(b)

Pairs o f
Tro us e rs

2
(c )