A simulation….

Magic of Markets

Where do prices come from ?

Adam Smith

• there is a human propensity to truck, barter and exchange…

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• exchange promises gains that humans seek relentlessly in all social interactions.

What are the incentives that motivate consumers (buyers) in a market economy?

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What are the incentives that motivate producers (sellers) in a market economy?

The Market: Computer Chips

The rules of the game….

• You are either a producer or consumer of chips…. for all rounds
• New card for every transaction
• Only sellers report the transaction price to me
• Gains/losses are cumulative
• Make as many transactions as you can
• Transactions are made in 10¢ increments

Was it possible to trade without bearing an opportunity cost?

• Who was competing against whom in this simulation?
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Did trade make everyone better off?

Awards Ceremony

The Magic of Markets�…the 8^th wonder of the world

• The world of supply and demand, the secret to innovation and economic prosperity

Adam Smith

• there is a human propensity to truck, barter and exchange…

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• exchange promises gains that humans seek relentlessly in all social interactions.

• In a free market, a symphony of desires comes together, and they’re met by people who constantly rack their brains to provide better services and invent solutions to our desires.

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John Stossel 

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Markets encourage innovation

http://www.youtube.com/watch?v=nlcIKh6sBtc

Markets are Miraculous

• How miraculous is it that the actions of millions of people who have never met can be directed by prices. Resources move toward their highest valued use, and goods and services produced are available to the consumers who desire them.

New York City is amazing… there is seldom a shortage of…

……..Today’s markets

• In this day and age we can……monitor home electricity or book a flight to Atlanta from smartphones, we never run out of tissues, mint oreos or pilates classes,we have root-canals performed by certified periodontists, on-line textbooks, knee-replacement surgery, access to every global newspaper, pasteurized as well as nut milks, skin biopsies, auto-flushing toilets, keyless entry to cars and homes, piped-in hot water, wicking workout clothes, LED bulbs, waterproof cosmetics, antidepressants, powerful sunscreen, solar panels, contact lenses and hearing aids, Craigslist, Apple watches

and the insulin pump, smart coffee makers, MRI’s, hair dye, craft beers, prepared hot foods in grocery stores, music downloads, disposable diapers, automatic wheelchairs, pumpkin spiced lattes, gigabytes of cloud storage, Netflix, jeans, snowboards, home mortgages, Wifi, Visa cards, underground sewage, flu and Covid shots, chlorinated water, hair-straighteners, novacaine, subway systems, fresh cut roses in winter, volumizing shampoo, Playstation, Prime Delivery, self-parallel parking cars, velvet Converse seakers, zip-lock bags, Instapots, GPS, bubble tea, Snapchat! and the Eras Tour…

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What is spontaneous order?

Markets are…

the arrangements used to bring consumers and producers together

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Demand

• Demand the amount of a product that consumers are willing and able to buy in a specific time period.
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• The Law of Demand: when price increases, quantity demanded decreases. (vice versa)

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↑P, ↓Qd ↓P, ↑Qd

Quantity Demanded

The total number of units that consumers would purchase at each price.

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There is an inverse relationship between P and Qd.

Determinants of Demand

Preferences and Tastes

Market size (# of consumers)

Income (normal and inferior goods)

Prices of Related Goods (substitutes and complements)

Consumer Expectations

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Income is the variable in determining:

• Normal goods – demand increases as income increases

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• Inferior goods – demand decreases as income increases

Substitutable goods

• An increase in price causes an increase in

demand for a substitute good (vice versa)

butter and margarine

Complementary goods

A decrease in price of one good leads to an increase in demand for the other good. (vice versa)

cake mix and frosting

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Movement along a D curve, when there is a change in price.

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Shift in a D curve due to determinants

Q

Pizza

Q1

Q2

Determinants shift demand curves

Assumptions underlying the Law of Demand

(These help to define demand):

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• Diminishing marginal utility
• Income effect
• Substitution effect*

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Diminishing Marginal Utility

• As more units of a good are consumed, the utility received from each additional unit declines, until the consumer will accept an additional unit only if the price is zero.

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PIZZA

Miki can eat 5 slices of margherita pizza in one sitting!

Will also exhausts his utility for pepperoni pizza at the 5th slice in a given time period.

4th of July Nathan’s hot dog eating contest in Coney Island:

Joey “Jaws” Chestnut is the 2025 winner - 73 dogs in 10 minutes! (short of the 2021 record of 76)

Major League Eating (MLE)

Nathan's Hot Dog Eating Contest 17 year champion!

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Income effect

• If the price a good you regularly purchase changes… this affects your purchasing power
• sometimes you buy more of that same good when the price decreases

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gas!

Purchasing Power (real income)

• the means by which one can immediately acquire goods and services

Substitution effect

When P increases, we buy less of it and choose a substitute, so Qd falls

When P falls, we buy more of it, and forego substitutes

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Supply

Represents the amount of a good or service a producer is willing and able to supply at particular prices in a given time period.

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• Law of Supply: when price increases, quantity supplied increases. (vice versa)

Producers prefer to produce at higher prices!

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Quantity supplied

The total number of units that producers will produce at each price.

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There is a direct relationship between price and Qs.

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↑P, ↑Qs ↓P, ↓Qs

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Determinants of Supply

Costs of production (inputs)

Prices of related goods

Competition (# of firms)

Government intervention (taxes, subsidy, regulation)

technology

Producer expectations*

(*supply shocks)

Equilibrium

Qd = Qs

A market finds equilibrium through thousands of interactions between consumers and producers.

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Excess supply or Surplus

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Qs > Qd

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Excess demand or Shortage

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Qd > Qs

Back to Supply and Producers….

Producers and Supply

• It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity but to their self love, and never talk to them of our own necessities but of their advantages.

Adam Smith…from The Wealth of Nations

Determinants of Supply

Costs of production (inputs)

Prices of related goods

Competition (# of firms)

Government intervention (taxes, subsidy, regulation)

technology

Producer expectations*

(*supply shocks)

Also: prices of related (alternative) goods, competition, producer expectations

Movements Along a Supply Curve Versus Shifts of a Supply Curve

• A change in price, other things constant, causes a movement along a supply curve from one price-quantity combination to another.
• A change in one of the determinants of supply other than the price causes a shift of a supply curve, changing supply.

ceteris paribus –

other things held equal

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• In learning and discussing economics we assume that all variables are constant other than the one variable that we are changing.

Markets

Markets

• are the arrangements used to buy and sell a good or service.
• bring consumers and producers together
• reduce the transaction costs of exchange (time and information).
• Coordination happens…as illustrated by Adam Smith’s invisible hand.
• http://learnliberty.org/content/adam-smith-invisible-hand

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In a market system:

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Prices send signals and incentives and lead to the allocation of resources

This determines what gets produced, how it gets produced and for whom it gets produced and is constantly subject to change.

Price signaling -

is simply the market mechanism at work. Adam Smith’s invisible hand coordinating the buying and selling decisions of countless consumers and producers in an economy without the heavy hand of a central authority (gov’t).

Prices and wages are important not because they reflect what an individual deserves, but because they provide information to producers about which products, services, skills, and attributes people are willing to give up some of their hard-earned labor to purchase. Prices aggregate information from myriad individual transactions, providing a signal and an incentive that shifts resources toward people’s needs and desires.

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Excess supply or Surplus

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Qs > Qd

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Excess demand or Shortage

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Qd > Qs

SUPPLY AND DEMAND TOGETHER

At P 2.00, the quantity demanded is equal to the quantity supplied!

Demand Schedule

Supply Schedule

Stradivarius Violins

Vertical Supply curve

Thursday Jan 20, 8:30 Theatre tickets

Nobel Prize in Economics

Claudia Goldin Wins Nobel Prize In Economics For Studying Women At Work

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Markets Part 2

Pizza

Equilibrium

Qd = Qs

A market finds equilibrium through thousands of interactions between consumers and producers.

Surplus

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Qs > Qd

Puts downward pressure on price

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(Disequilibrium – the time required for a market to adjust to reach a goal).

Shortage

Qd > Qs

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Puts upward pressure on price

Why markets best determine optimal prices

• individuals acting as entrepreneurs, investors, consumers, workers – each putting his or her own money, time, and reputation where his or her mouth is.
• the freedom to choose
• “governments” suffer from the knowledge problem and fail to achieve better outcomes

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83

Total Surplus

Coff

Gasoline

Consumer Surplus

is the benefit consumers receive when they pay a price below what they are willing to pay.

Producer Surplus

is the benefit producers receive when they receive a price above the one at which they were willing to supply the good.

HL CS and PS Calculations

You are the manager of Fun World, a small amusement park. The accompanying diagram shows the demand curve of a typical customer at Fun World.

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a. Suppose that the price of each ride is $5. At that price, how much consumer surplus does an individual consumer get?

b. Suppose that Fun World considers charging an admission fee, even though it maintains the price of each ride at $5. What is the maximum admission fee it could charge? (Assume that all potential customers have enough money to pay the fee.)

HL

Peanut butter is an inferior good. If there is an increase in income, total surplus in the peanut butter market:

a. will increase.

b. will decrease.

c. will not change.

d. may change, but we cannot determine the change without more information.

HL

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1. If the price of a ticket to see The Nutty Nutcracker is $50, then Marsha’s producer surplus is:

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• If the price of a ticket to see The Nutty Nutcracker is $75, then Andrew’s producer surplus is:

HL

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5. If the price of the good is $2, consumer surplus will equal:

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6. If the price of the good increases from $3 to $4, consumer surplus will decrease by:

HL

equilibrium and disequilibrium

Price signaling and Strawberries

Suppose consumers decide to eat more of these due to the health benefits…

this creates a shortage at the initial price.

At the new price, the

shortage disappears.

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Allocative efficiency: producing the quantity of goods most wanted by society.

MB = MC at market equilibrium

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(where the demand curve is a marginal benefit curve and the supply curve is a marginal cost curve)

http://youtu.be/t3QMC_TeP-Q

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YouTube, I, Rose – the marvel of markets and fresh roses

The degree of scarcity of one good relative to another helps determine each good’s relative price.

Utility also determines the value of a good or service to the individual.

Demanders pay the price and suppliers receive it.

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Quiz questions

Use this example to name and explain the concept that defines demand as finite in a given period of time.

This box of macaroni and cheese represents what type of good?

What determinant do these goods represent?

Write a scenario that would shift a curve.

What determinant do these goods represent?

Write a scenario that would shift a curve.

Write a scenario about yourself indicating that you are part of demand for this sweet car.

Cotton field in Mississippi

How many determinants of supply can you relate to this picture?

Explain the metaphor of the “invisible hand” as it has to do with resource allocation.

Ideas rock our world

The more we prosper, the more we can prosper. The more we invent, the more inventions become possible. The world of things is often subject to diminishing returns. The world of ideas is not: The ever-increasing exchange of ideas causes the ever-increasing rate of innovation in the modern world. There isn’t even a theoretical possibility of exhausting our supply of ideas, discoveries, and inventions.

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Human ingenuity…..the most valuable of all resources (Julian Simon, “The Ultimate Resource”, 1981)

A thinking question…

• What is the Law of Supply? Give an example of how this law applies in the business world. What is the relationship between price and quantity supplied?

How do markets coordinate the independent decisions of buyers and sellers? Use a market example to explain.

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Graphing directions: label the graph, shift the curve(s) and name the determinants if applicable. Indicate the effect on price and quantity.

����Sunk costs have �already been incurred and are not recoverable.Therefore they should be ignored.

provide an example.

Da Vinci painting sells for record $450 million at auction

Leonardo da Vinci's painting of Jesus Christ, "Salvator Mundi" ("Savior of the World"), sold at Christie's in New York City for $450 million, including the auction house premium, after a 20-minute bidding war Wednesday night. The sale smashed the record for the most expensive art work to ever sell at auction, previously $179 million for Picasso's "Les Femmes d'Alger" ("Women of Algiers"). The painting was commissioned by France's King Louis XII more than 500 years ago, and was presumed lost until early this century; in 2005, an art dealer purchased "Salvator Mundi" at an estate sale in the United States, and had it restored, authenticated, then unveiled at London's National Gallery in 2011. Christie's said it did not immediately know whether the buyer would make his or her identity public.

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The Fleurburger

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$5000

Fleur Burger 5000.�Fleur Restaurant, Las Vegas.�Hubert Keller's FB 5000 comes loaded with Wagyu, foie gras, and truffle, serving it with a bottle of '95 Chateau Petrus, which is apparently "good".

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The Fleurburger

• 1. An increase in demand; a decrease in supply.

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• 2. A decrease in supply; decrease in demand

The Fleurburger

• 3. A decrease in demand; an increase in supply

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• 4. An increase in supply; an increase in demand.

Royal Mile Edinburgh,

Scotland

The Fleurburger

• http://www.luxist.com/2008/05/14/theres-a-5-000-burger-in-las-vegas/

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HL S and D Functions

The Demand Function

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Qd = a – bP

a = quantity demanded if price is zero (Q intercept)

Determinants change a

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b = the change in Qd resulting from a change in price (slope of the D curve)

`P represents the Price of the item

• To find two points on the D curve, set P = 0; this is the Q intercept

Set Qd = 0 to find the P intercept

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Shifting the D curve

• If a increases, the D curve shifts right; if a decreases, the D curve shifts left.

Changing the steepness of the D curve

• b is the slope (ΔQd/ΔP)
• The larger the absolute value of the slope, the flatter (more elastic) the D curve

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• Note that the slope here is “run over rise” due to the reversal of the axes of the dependent and independent variables.

The Supply Function (or equation)

Qs= c +dP

c= Qs if the price is zero (Q intercept)

Determinants change C

d = the rate at which a change in price will cause the Qs to increase (the slope of the S curve)

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d is always positive

P represents the price of the item

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• To find two points on the S curve, set P = 0; this is the Q intercept

Set Qs = 0 to find the P intercept

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• If the value of c is negative (Qs = -6 +3P), then setting P =0 will give Q < 0 (not in the permissible range of the S curve).

Shifting the supply curve

• If c increases the S curve shifts right
• If c decreases the S curve shifts left

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• The larger the value of the slope (d), the flatter the S curve. The smaller the value of the slope (d) the steeper the supply curve

Market Equilibrium

Market Equilibrium

Equilibrium exercises: The Market for Bread

• Solve for P and Q; create a table to show the S and D schedule for prices of 0, $3, $5, $7 and $9.

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• Qs = 100+10P; Qd = 300 – 30P
• State the equilibrium P and Q.
• A new D curve is Qd = 350 – 30P. Add a column to determine Qd at the 5 prices.
• Calculate the excess demand (shortage) at the original price

126

Total Surplus

Coff

Gasoline

Market Equilibrium in Linear Demand and Supply Equations

If we plot the demand and supply curves on the same axis, the intersection of the two curves should confirm our calculations of equilibrium price and quantity.

Notice:

• If the price were anything other than $4, the quantities demanded and supplied would not be equal.
• If the quantity were anything other than 400, the marginal social benefit (demand) and marginal social cost (supply) would not be equal.

$4 is the market clearing price and 400 is the allocatively efficient level of output.

Market Equilibrium

(A)

(B)

Market Equilibrium

Market Equilibrium

If we graph these two equations, we can see the new equilibrium price and quantity

• Demand has decreased and becomes steeper, indicating that consumers are less responsive to price changes, yet consume a smaller quantity overall.
• The equilibrium price is lower (P3.43 instead of P4) and the quantity is lower (314 instead of 400)

Whenever either demand or supply change, the market equilibrium will adjust to a new market clearing price and quantity!

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• [Hayek's] point: that the market system, paradoxically, makes use of far more information than anyone involved in it – or any agency – can actually grasp.  That information is collected, processed, summarized and delivered to everyone who needs it through the price system, which is an information and processing network that spreads out into the entire market system and updates itself moment by moment.  No agency, even one with many local offices, could ever collect and process so much information….
• The key information that drives the market order is not information that is physical, public and organized, like the information that exists in ledgers and libraries.  It is the inherently personal information of what people value; and it is producers’ understanding of those values, their skill at reading changing market events, their knowledge of their own customers and their experience of how a particular market works.

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Firms and Production�

• Short run production is about Law of Diminishing Returns*

TP, MP and AP

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• Long run production is about economies of scale and the LRATC.

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*Law of Diminishing Marginal Product

SR vs LR

• Short run: the period of time where firms can’t acquire land or capital, but can make changes to the quantity of Labour (variable resource)

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• Long Run: firms are able to acquire and put all factors of production into production… or exit the market. In the long run all resources are variable.

• A firm wishes to maximize the productivity of its resources in order to minimize its costs.

The Law of Diminishing Returns (SR)

• States that as successive amounts of a variable (labour) are added to a fixed amount of other resources, the contribution to the production process first rises and will eventually decline.

Total, Average and Marginal Product�(also called Total, average and marginal output)

• Total product is the output produced by all employed workers
• Average is the Total Product divided by the number of workers
• Marginal product is the additional output generated by the the additional worker.

As labor usage increases from L₁ to L₂, total output (measured vertically in the top graph) increases by the amount shown. But if labor usage is increased by the same amount again, output goes up by less, implying diminishing marginal returns to the use of labor as an input. The marginal product of labor (measured vertically in the bottom graph) is diminishing everywhere to the right of point A.

What is the relationship between marginal product and average product?

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How does this relate to your GPA (your average grade in a course and the additional assessment score from this week…..)

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How do marginal’s “drive” averages?

• FC: the cost of the fixed factors of production for a firm such as land, capital and entrepreneurship
• VC: the cost of the variable factor of production such as labor

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Fixed or variable costs?

• Advertising expenditures, fuel, interest on company issued bonds, shipping charges, payments for raw materials, real estate taxes, executive salaries, insurance premiums, wage payments, sales taxes, rental payments on leased office equipment
• Explain: There are no fixed costs in the long run.

Marginal cost

the additional cost of producing one more unit

The Law of Diminishing Returns

SR and LR

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MP and TP

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MC and TC

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Marginal Product: the additional unit produced

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Marginal Cost: the cost of the additional uit produced.

At higher prices there is a greater incentive to produce more. This profit motive is a driving force for the producer.

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The marginal cost of a product increases as output increases, therefore the producer must receive a higher price (due to the law of increasing opportunity costs).