MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 1
Lecture 7 (2005.10.8)
Class today
p57-67
MB MC
Supply and Demand:
An Introduction
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 3
Overview 1
Chapter 3 introduces markets and provides
an overview of the supply and demand
model,It begins by comparing central
planning and the market as alternative
methods of allocating resources,
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 4
Overview 2
It includes a brief history of economic thought
regarding markets and prices,Emphasizing a core
principle of the book,the chapter next discusses
the concept of equilibrium,It explains how
market forces bring the price and quantity back to
equilibrium in the case of surpluses and shortages
and includes discussion of price controls (price
ceilings and floors),Finally,the chapter explains
how to use the supply and demand model to
explain changes in prices and quantities.
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 5
Two examples:
Food delivery system
Rental housing market
Supply and Demand,An Introduction
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 6
Supply and Demand,An Introduction
Market 1
How do consumers get the goods and
services they want in the right quantities
and qualities?
Some goods and services are allocated by
the market forces of supply and demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 7
Supply and Demand,An Introduction
Market 2
Why do some goods and services have
shortages or surpluses and others do
not?
Some good and supplies services are
regulated by government
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 8
What,How,and for Whom?
Central Planning Versus the Market
Three Problems All Economic Systems
Must Address
What should be produced?
How should it be produced?
For whom will it be produced?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 9
What,How,and for Whom?
Central Planning Versus the Market
Centralized Economic Organizations
Agrarian society
Former Soviet Union
Cuba,North Korea
China
Bureaucracy
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 10
What,How,and for Whom?
Central Planning Versus the Market
A small number of individuals address
What
Establish production targets for factories and
farms
How
Plan how to achieve the goals
For Whom
Distribute the goods and services produced
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 11
What,How,and for Whom?
Central Planning Versus the Market
Free-Market or Capitalist Economic
Systems
Individual choices determine
Which careers to pursue
Which products to produce or buy
When to start and shut-down a business
Who gets what,which is decided by individual
preferences and purchasing power
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 12
Buyers and Sellers in Markets
A Market
Consists of all buyers and sellers of a good
or service
What do you think?
What determines the price of pizza,
gasoline,a car wash,or other goods and
services?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 13
# Alfred Marshall
-------(British economist)
Buyers and Sellers in Markets
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 14
Buyers and Sellers in Markets
The Demand Curve
A schedule or graph that tells us the quantity of a
good that buyers wish to buy at each price
A Property of Demand
As price of a good or service goes down the
quantity consumers wish to buy will increase
Therefore,the demand curve is downward-
sloping
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 15
The Daily Demand Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 16
Buyers in Markets
The Demand Curve
Why do buyers purchase a greater quantity
at lower prices and vice-versa?
The substitution effect
The income effect
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 17
Buyers in Markets
The Substitution Effect
The change in the quantity demanded of a good
that results because buyers switch to substitutes
when the price of the good changes
The Income Effect
The change in the quantity demanded of a good
that results because a change in the price of a
good changes the buyer’s purchasing power
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 18
Buyers in Markets
Price
($ per slice)
Quantity
(1000s of slices per day)
Demand
8 12 16
The buyers reservation price:
The largest dollar amount the
buyer would be willing to pay for
a good
4
2
3
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 19
Buyers in Markets
The Cost-Benefit Principle
The reservation price is the benefit the
buyer receives from the good
The cost of the good is its market price
If the reservation price (benefit) exceeds
the market price (cost) the consumer will
purchase the good
At higher prices,benefit will exceed cost
for a smaller quantity than at lower prices
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 20
Buyers in Markets
* Horizontal Interpretation
Price determines
quantity demanded
Price
($ per slice)
4
2
3
8 12 16
Demand
Quantity
(1000s of slices per day)
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 21
Buyers in Markets
* Vertical Interpretation
Quantity measures the
marginal buyer’s
reservation price
Price
($ per slice)
4
2
3
8 12 16
Demand
Quantity
(1000s of slices per day)
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 22
Sellers in Markets
The Supply Curve
A curve or schedule showing the quantity
of a good that sellers wish to sell at each
price
Upward-sloping with respect to price
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 23
The Daily Supply Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 24
Seller’s Reservation Price
The smallest dollar amount for which a
seller would be willing to sell an additional
unit,generally equal to marginal cost
Sellers in Markets
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 25
The Daily Supply Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
* Horizontal Interpretation
Shows the
quantity produced
for each price
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 26
The Daily Supply Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
* Vertical Interpretation
Shows the marginal
cost (reservation
price) for producing
each additional unit
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 27
Market Equilibrium
Equilibrium
A system is in equilibrium when there is no
tendency for it to change
Market Equilibrium
Occurs in a market when all buyers and
sellers are satisfied with their respective
quantities at the market price
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 28
The Equilibrium Price and Quantity of Pizza in
Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
Demand
Equilibrium at $3
Quantity Demanded =
Quantity Supplied
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 29
Market Equilibrium
Equilibrium Price and Equilibrium
Quantity
The values of price and quantity for which
quantity supplied and quantity demanded are
equal
What Do You Think?
Would buyers prefer a lower price than the
equilibrium price?
Would sellers prefer a higher price than the
equilibrium price?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 30
Excess Supply
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
Demand
Excess supply = 8,000 slices per day
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 31
Excess Demand
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 16
Excess demand = 8,000
slices per day
Supply
Demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 32
Excess supply
Excess demand
Market Equilibrium
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 33
Points Along the Demand and Supply Curves of a
Pizza Market
Demand for pizza Supply of pizza
Price
($/slice)
Quantity demanded
(1000s of slices/day)
Price
($/slice)
Quantity supplied
(1000s of slices/day)
1 8 1 2
2 6 2 4
3 4 3 6
4 2 4 8
Example 3.1
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 34
Graphing Supply and Demand and
Finding the Equilibrium Price and Quantity
Price
($per slice)
Quantity
(1000s of slices per day)
5
2
3
4
1
4
102
Demand
0 6 8
Supply
2.50
5
The Equilibrium Price = $2.50
The Equilibrium Quantity = 5
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 35
Market Equilibrium
What Do You Think?
Is the market
equilibrium always
an ideal outcome
for all market
participants?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 36
Homework
Review,p57-67
Review questions,
1;4
Preview,p67-78
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 37
Lecture 8 (2005.10.11)
Class today
p67-78
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 38
An Unregulated Housing Market
Monthly Rent
($/apartment)
Quantity
(Millions of apartments/day)
1600
2
Supply
Demand
What Do You Think?
Is $1600 more than some
people can afford?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 39
Rent Controls
Monthly Rent
($/apartment)
Quantity
(Millions of apartments/day)
1600
2
Supply
Demand
2400
Controlled = 800
1 30
Excess demand = 2 million
apartments per month
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 40
Market Equilibrium
Rent Controls Reconsidered
Other consequences of rent controls
Maintenance will decline and housing quality
will fall
Illegal payments
Creation of co-ops and conversion to
condominiums
Reduction in household mobility
Discrimination
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 41
Market Equilibrium
What do you think?
How can we make
housing affordable
for poor people
without using rent
ceilings?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 42
Rent Controls
Monthly Rent
($/apartment)
Quantity
(Millions of apartments/day)
800
2
Supply
Demand
1200
1 30
What is the impact of a rent
control set at $1,200/month?
Exercise 3.3
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 43
Price Controls in the Pizza Market
Price
($ per slice)
Quantity
(1000s of slices per day)
Supply
Demand
Excess demand = 8,000 slices per day
4
Price ceiling = 2
3
8 12 16
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 44
Market Equilibrium
Pizza Price Controls?
Market responses to a pizza price ceiling
Long lines
Preferential treatment to selected customers
Alternative pricing strategies
Poorer quality ingredients
Black-market pizzas
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 45
Predicting and Explaining Changes in Prices and
Quantities
Distinguishing Between
A change in the quantity demanded
A movement along the demand curve that
occurs in response to a change in price
A change in demand
A shift of the entire demand curve
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 46
An Increase in Quantity Demanded vs,an Increase in Demand
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
4
1
4
122
6
0
D
D Increase in
quantity
demanded
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 47
An Increase in Quantity Demanded vs,an Increase in
Demand
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
1
4
12
6
0
Increase in demand
D
D
D’
D’
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 48
An Increase in Quantity
Demanded vs,an Increase in Demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 49
Predicting and Explaining Changes in Prices and
Quantities
Change in the quantity supplied
A movement along the supply curve that
occurs in response to a change in price
Change in supply
A shift of the entire supply curve
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 50
An Increase in Quantity Supplied
vs,an Increase in Supply
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
4
1
4
102
6
0 6 8
S
S
Increase in
quantity supplied
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 51
An Increase in Quantity Supplied
vs,an Increase in Supply
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
4
1
4
102
6 S
0 6 8
S
S’
S’
Increase in supply
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 52
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 53
The Effect on the Market for Tennis
Balls of a Decline in Court Rental Fees
Price
($/ball)
Quantity
(letters/month)
1.00
S
D
40
D’
1.40
58
Example 3.2
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 54
Predicting and Explaining Changes in Prices
and Quantities
Shifts in Demand
Complements
Two goods are complements in
consumption if an increase (decrease) in
the price of one cause a decrease (increase)
in the demand for the other
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 55
Effect on the Market for Overnight Letter Delivery of a
Decline in the Price of Internet Access
Price
($/letter)
Quantity
(letters/month)
P’
P
Q’ Q
S
D
D’
Example 3.3
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 56
Predicting and Explaining Changes in Prices
and Quantities
Shifts in Demand
Substitutes
Two goods are substitutes in consumption
if an increase (decrease) in the price of one
causes an increase (decrease) in the
demand for the other
Changes In Demand
An increase (decrease) in the demand for a
good will shift the demand curve to the right
(left)
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 57
Predicting and Explaining Changes in Prices
and Quantities
Exercise 3.4
What do you think?
How will a decline in
airfares affect inter-
city bus fares and
the price of hotel
rooms in resort
communities?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 58
Predicting and Explaining Changes in Prices
and Quantities
Economic Naturalist
When the Federal Government implements
a large pay increase for its employees,why
do rents for apartments near Washington
Metro stations go up relative to rents for
apartments located far away from Metro
stations?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 59
The Effect of a Federal Pay Raise on the Rent for
Conveniently Located Apartments in Washington D.C.
Rent
(dollars per month)
Conveniently
located apartments
(units per month)
D
P
Q
S
P’
Q’
D’
Income
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 60
Predicting and Explaining Changes in Prices
and Quantities
A Change In Income
Normal Good
One whose demand increases (decreases)
when the incomes of buyers increase
(decrease)
Inferior Good
One whose demand decreases (increases)
when the incomes of buyers increase
(decrease)
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 61
The Effect of the Release of Jurassic
Park on the Market for Toy Dinosaurs
Price
Toy Dinosaurs
(units per month)
P
Q
D
S
D’
P’
Q’
D’ = demand after release of movie
Preference
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 62
The Effect of a Credible Rumor on
the Market for Apple Macintosh Computers
Price
Apple Computers
(units per month)
P
Q
S
D
P’
Q’
D’
D’ = demand after rumor of cheaper
model soon to be released
Expectation
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 63
The Effect of the Increase in
the Population of Potential Buyers
Price
Housing NY City
(units per month)
P
Q
S
D
P’
Q’
D’
D’ = demand after increase in population
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 64
The Effect on the Skateboard Market
of an Increase in the Price of Fiberglass
Price
($/skateboard)
Quantity
(skateboards/month)
60
1000
S
D
80
800
S’
Raw materials
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 65
The Effect on the Market for New Houses
of a Decline in Carpenters’ Wage Rates
Price
($1000/house)
Quantity
(houses/month)
120
40
D
S
90
50
S’
Example 3.5
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 66
The Effect of Technical Change on the Market for the
Term Paper Revisions
Price
($/revision)
Quantity
(millions of revisions per year)
55
12
D
S
7.50
36
S’
Technology
Economic Naturalist 3.2
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 67
Predicting and Explaining Changes in Prices
and Quantities
Other determinants of supply
Weather
Expectations
Number of sellers
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 68
Price
Quantity
P
P’
Q Q’
S
D’D
An increase in demand will lead to an increase
in both the equilibrium price and quantity
Four Rules Governing the Effects
of Supply and Demand Shifts,I
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 69
Price
Quantity
P’
P
Q’ Q
S
DD’
A decrease in demand will lead to a decrease
in both the equilibrium price and quantity
Four Rules Governing the Effects
of Supply and Demand Shifts,II
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 70
P’
P
Q Q’
S’
D
S
Price
Quantity
An increase in supply will lead to a
decrease in the equilibrium price
and an increase in the equilibrium quantity
Four Rules Governing the Effects
of Supply and Demand Shifts,III
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 71
P
P’
Q’ Q
S
D
S’Price
Quantity
An decrease in supply will lead to
an increase in the equilibrium price
and a decrease in the equilibrium quantity
Four Rules Governing the Effects
of Supply and Demand Shifts,IV
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 72
Predicting and Explaining Changes in Prices and
Demand
Factors That Cause an Increase (rightward or
upward shift) in Demand
1,A decrease in the price of complements to the good or
service
2,An increase in the price of substitutes for the good or
service
3,An increase in income (for a normal good)
4,An increased preference by demanders for the good or
service
5,An increase in the population of potential buyers
6,An expectation of higher prices in the future
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 73
Predicting and Explaining Changes in Prices and
Demand
Factors That Cause an Increase (rightward or
upward shift) in Supply
1,A decrease in the cost of materials,labor,or other
inputs used in the production of the good or service
2,An improvement in technology that reduces the cost
of producing the good or service
3,An improvement in the weather,especially for
agricultural products
4,An increase in the number of suppliers
5,An expectation of lower prices in the future
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 74
Example,P85
problems 1
problems 2;
problems 3.
Predicting and Explaining Changes in Prices
and Demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 75
Homework
Review p57-79
Review questions
Preview p79-85
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 76
Lecture 9 (2005.10.13)
class today
Chapter 3:
P79-85
Summary
Exercises
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 77
The Effects of Simultaneous Shifts in Supply and
Demand
Price
($/bag)
Millions of bags
per month
P
Q
S
D
P’
Q’
D’
S’ S’ after reduction in price of
corn harvesting equipment
D’ after discovery that oils are
harmful to people’s health
The Market for Corn Tortilla Chips
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 78
The Effects of Simultaneous Shifts in Supply and
Demand
Price
($/bag)
Millions of bags
per month
P
Q
S
D
P’
Q’
D’
S’
D’ after discovery that oils are
harmful to people’s health
S’ after reduction in price of
corn harvesting equipment
The Market for Corn Tortilla Chips
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 79
Predicting and Explaining Changes in Prices and
Demand
Exercises 3.6
Assume
A vitamin found in corn chips helps protect against
cancer and heart disease
A swarm of locusts destroys part of the corn crop
What Do You Think?
What will happen to the equilibrium price and
quantity of corn chips?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 80
Predicting and Explaining Changes in Prices and
Demand
Economic Naturalist
Why do the prices of some goods,like
airline tickets to Europe,go up during the
months of heaviest consumption,while
others,like sweet corn,go down?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 81
Seasonal Variation in Air Travel and Corn Markets
Price
($/ticket)
1000s of
tickets
S
DS
DW
QW QS
PW
PS
High Consumption due to High Demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 82
Seasonal Variation in Air Travel and Corn Markets
Price
($/bushel)
Millions of
bushels
SW
D
QW QS
PW
PS
SS
High Consumption due to High Supply
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 83
Markets and Social Welfare
Cash On The Table
Buyer’s surplus
The difference between the buyer’s reservation
price and the price he or she actually pays
Seller’s surplus
The difference between the price received by
the seller and his or her reservation price
Total surplus
The difference between the buyer’s reservation
price and the seller’s reservation price
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 84
Markets and Social Welfare
Cash On The Table
Assume
All exchange is purely voluntary
If so
The buyer’s reservation price exceeds the
seller’s reservation price and both the buyer
and seller receive an economic surplus
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 85
Price Controls in the Pizza Market
Price
($ per slice)
Quantity
(1000s of slices per day)
S
D
3
12
4
2
8 16
Assume
Buyer’s reservation P = $4
Sellers reservation P = $2
Pizza sells for $3
Buyer’s surplus,$4 - $3 = $1
Seller’s surplus,$3 - $2 = $1
Total surplus,$4 - $2 = $2
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 86
Price Controls in the Pizza Market
Price
($ per slice)
Quantity
(1000s of slices per day)
Excess demand =
$8,000 slices/day
D
4
2
3
8 12 16
Assume price controls = $2
Quantity supplied falls to 8,000
Buyer’s reservation price ($4) is
greater than seller’s ($2)
Both would benefit from
additional production
There is CASH ON THE TABLE
S
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 87
Markets and Social Welfare
Cash On The Table
Economic metaphor
for unexploited
gains from
exchange
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 88
Markets and Social Welfare
Smart For One,Dumb For All
Socially optimal quantity
The quantity of a good that results in the
maximum possible economic surplus from
producing and consuming the good
The socially optimal quantity occurs when
MC = MB
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 89
Markets and Social Welfare
Smart For One,Dumb For All
Economic efficiency occurs when all goods
and services are produced and consumed
at their respective socially optimal levels
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 90
Markets and Social Welfare
Smart For One,Dumb For All
Achieving economic efficiency
Maximizes the economic surplus
Increases the economic pie
_______the efficiency principle
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 91
Markets and Social Welfare
Smart For One,Dumb For All
Inefficient market equilibrium
When some costs of production fall on people other than
those who sell the good or service
Example,Pollution
The market is in equilibrium,MC = MB
MC however underestimates the cost to society of
producing the good
Therefore,the market produces more than the
efficient amount and there is no incentive for
producers and consumers to alter their behavior
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 92
Markets and Social Welfare
Smart For One,Dumb For All
Inefficient market equilibrium
When some benefits from the good or service
accrue to people who did not buy the good or
service
Example,Vaccinations
The market is in equilibrium,MC = MB
MB underestimates the benefits to society of
consuming the vaccinations
The market produces less than the efficient amount
of vaccinations and there is no incentive for
producers and consumers to alter their behavior
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 93
Markets and Social Welfare
Smart For One,Dumb For All
In these markets
Buyers and sellers are behaving rationally
Market equilibrium exists
There are no unexploited opportunities for
individuals
Economic surplus is not maximized
---------The equilibrium principle
MB MC
End of
Chapter
Chapter 3 - Supply and Demand,An Introduction Slide 1
Lecture 7 (2005.10.8)
Class today
p57-67
MB MC
Supply and Demand:
An Introduction
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 3
Overview 1
Chapter 3 introduces markets and provides
an overview of the supply and demand
model,It begins by comparing central
planning and the market as alternative
methods of allocating resources,
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 4
Overview 2
It includes a brief history of economic thought
regarding markets and prices,Emphasizing a core
principle of the book,the chapter next discusses
the concept of equilibrium,It explains how
market forces bring the price and quantity back to
equilibrium in the case of surpluses and shortages
and includes discussion of price controls (price
ceilings and floors),Finally,the chapter explains
how to use the supply and demand model to
explain changes in prices and quantities.
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 5
Two examples:
Food delivery system
Rental housing market
Supply and Demand,An Introduction
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 6
Supply and Demand,An Introduction
Market 1
How do consumers get the goods and
services they want in the right quantities
and qualities?
Some goods and services are allocated by
the market forces of supply and demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 7
Supply and Demand,An Introduction
Market 2
Why do some goods and services have
shortages or surpluses and others do
not?
Some good and supplies services are
regulated by government
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 8
What,How,and for Whom?
Central Planning Versus the Market
Three Problems All Economic Systems
Must Address
What should be produced?
How should it be produced?
For whom will it be produced?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 9
What,How,and for Whom?
Central Planning Versus the Market
Centralized Economic Organizations
Agrarian society
Former Soviet Union
Cuba,North Korea
China
Bureaucracy
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 10
What,How,and for Whom?
Central Planning Versus the Market
A small number of individuals address
What
Establish production targets for factories and
farms
How
Plan how to achieve the goals
For Whom
Distribute the goods and services produced
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 11
What,How,and for Whom?
Central Planning Versus the Market
Free-Market or Capitalist Economic
Systems
Individual choices determine
Which careers to pursue
Which products to produce or buy
When to start and shut-down a business
Who gets what,which is decided by individual
preferences and purchasing power
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 12
Buyers and Sellers in Markets
A Market
Consists of all buyers and sellers of a good
or service
What do you think?
What determines the price of pizza,
gasoline,a car wash,or other goods and
services?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 13
# Alfred Marshall
-------(British economist)
Buyers and Sellers in Markets
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 14
Buyers and Sellers in Markets
The Demand Curve
A schedule or graph that tells us the quantity of a
good that buyers wish to buy at each price
A Property of Demand
As price of a good or service goes down the
quantity consumers wish to buy will increase
Therefore,the demand curve is downward-
sloping
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 15
The Daily Demand Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 16
Buyers in Markets
The Demand Curve
Why do buyers purchase a greater quantity
at lower prices and vice-versa?
The substitution effect
The income effect
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 17
Buyers in Markets
The Substitution Effect
The change in the quantity demanded of a good
that results because buyers switch to substitutes
when the price of the good changes
The Income Effect
The change in the quantity demanded of a good
that results because a change in the price of a
good changes the buyer’s purchasing power
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 18
Buyers in Markets
Price
($ per slice)
Quantity
(1000s of slices per day)
Demand
8 12 16
The buyers reservation price:
The largest dollar amount the
buyer would be willing to pay for
a good
4
2
3
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 19
Buyers in Markets
The Cost-Benefit Principle
The reservation price is the benefit the
buyer receives from the good
The cost of the good is its market price
If the reservation price (benefit) exceeds
the market price (cost) the consumer will
purchase the good
At higher prices,benefit will exceed cost
for a smaller quantity than at lower prices
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 20
Buyers in Markets
* Horizontal Interpretation
Price determines
quantity demanded
Price
($ per slice)
4
2
3
8 12 16
Demand
Quantity
(1000s of slices per day)
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 21
Buyers in Markets
* Vertical Interpretation
Quantity measures the
marginal buyer’s
reservation price
Price
($ per slice)
4
2
3
8 12 16
Demand
Quantity
(1000s of slices per day)
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 22
Sellers in Markets
The Supply Curve
A curve or schedule showing the quantity
of a good that sellers wish to sell at each
price
Upward-sloping with respect to price
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 23
The Daily Supply Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 24
Seller’s Reservation Price
The smallest dollar amount for which a
seller would be willing to sell an additional
unit,generally equal to marginal cost
Sellers in Markets
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 25
The Daily Supply Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
* Horizontal Interpretation
Shows the
quantity produced
for each price
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 26
The Daily Supply Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
* Vertical Interpretation
Shows the marginal
cost (reservation
price) for producing
each additional unit
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 27
Market Equilibrium
Equilibrium
A system is in equilibrium when there is no
tendency for it to change
Market Equilibrium
Occurs in a market when all buyers and
sellers are satisfied with their respective
quantities at the market price
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 28
The Equilibrium Price and Quantity of Pizza in
Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
Demand
Equilibrium at $3
Quantity Demanded =
Quantity Supplied
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 29
Market Equilibrium
Equilibrium Price and Equilibrium
Quantity
The values of price and quantity for which
quantity supplied and quantity demanded are
equal
What Do You Think?
Would buyers prefer a lower price than the
equilibrium price?
Would sellers prefer a higher price than the
equilibrium price?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 30
Excess Supply
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
Demand
Excess supply = 8,000 slices per day
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 31
Excess Demand
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 16
Excess demand = 8,000
slices per day
Supply
Demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 32
Excess supply
Excess demand
Market Equilibrium
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 33
Points Along the Demand and Supply Curves of a
Pizza Market
Demand for pizza Supply of pizza
Price
($/slice)
Quantity demanded
(1000s of slices/day)
Price
($/slice)
Quantity supplied
(1000s of slices/day)
1 8 1 2
2 6 2 4
3 4 3 6
4 2 4 8
Example 3.1
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 34
Graphing Supply and Demand and
Finding the Equilibrium Price and Quantity
Price
($per slice)
Quantity
(1000s of slices per day)
5
2
3
4
1
4
102
Demand
0 6 8
Supply
2.50
5
The Equilibrium Price = $2.50
The Equilibrium Quantity = 5
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 35
Market Equilibrium
What Do You Think?
Is the market
equilibrium always
an ideal outcome
for all market
participants?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 36
Homework
Review,p57-67
Review questions,
1;4
Preview,p67-78
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 37
Lecture 8 (2005.10.11)
Class today
p67-78
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 38
An Unregulated Housing Market
Monthly Rent
($/apartment)
Quantity
(Millions of apartments/day)
1600
2
Supply
Demand
What Do You Think?
Is $1600 more than some
people can afford?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 39
Rent Controls
Monthly Rent
($/apartment)
Quantity
(Millions of apartments/day)
1600
2
Supply
Demand
2400
Controlled = 800
1 30
Excess demand = 2 million
apartments per month
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 40
Market Equilibrium
Rent Controls Reconsidered
Other consequences of rent controls
Maintenance will decline and housing quality
will fall
Illegal payments
Creation of co-ops and conversion to
condominiums
Reduction in household mobility
Discrimination
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 41
Market Equilibrium
What do you think?
How can we make
housing affordable
for poor people
without using rent
ceilings?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 42
Rent Controls
Monthly Rent
($/apartment)
Quantity
(Millions of apartments/day)
800
2
Supply
Demand
1200
1 30
What is the impact of a rent
control set at $1,200/month?
Exercise 3.3
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 43
Price Controls in the Pizza Market
Price
($ per slice)
Quantity
(1000s of slices per day)
Supply
Demand
Excess demand = 8,000 slices per day
4
Price ceiling = 2
3
8 12 16
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 44
Market Equilibrium
Pizza Price Controls?
Market responses to a pizza price ceiling
Long lines
Preferential treatment to selected customers
Alternative pricing strategies
Poorer quality ingredients
Black-market pizzas
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 45
Predicting and Explaining Changes in Prices and
Quantities
Distinguishing Between
A change in the quantity demanded
A movement along the demand curve that
occurs in response to a change in price
A change in demand
A shift of the entire demand curve
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 46
An Increase in Quantity Demanded vs,an Increase in Demand
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
4
1
4
122
6
0
D
D Increase in
quantity
demanded
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 47
An Increase in Quantity Demanded vs,an Increase in
Demand
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
1
4
12
6
0
Increase in demand
D
D
D’
D’
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 48
An Increase in Quantity
Demanded vs,an Increase in Demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 49
Predicting and Explaining Changes in Prices and
Quantities
Change in the quantity supplied
A movement along the supply curve that
occurs in response to a change in price
Change in supply
A shift of the entire supply curve
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 50
An Increase in Quantity Supplied
vs,an Increase in Supply
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
4
1
4
102
6
0 6 8
S
S
Increase in
quantity supplied
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 51
An Increase in Quantity Supplied
vs,an Increase in Supply
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
4
1
4
102
6 S
0 6 8
S
S’
S’
Increase in supply
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 52
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 53
The Effect on the Market for Tennis
Balls of a Decline in Court Rental Fees
Price
($/ball)
Quantity
(letters/month)
1.00
S
D
40
D’
1.40
58
Example 3.2
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 54
Predicting and Explaining Changes in Prices
and Quantities
Shifts in Demand
Complements
Two goods are complements in
consumption if an increase (decrease) in
the price of one cause a decrease (increase)
in the demand for the other
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 55
Effect on the Market for Overnight Letter Delivery of a
Decline in the Price of Internet Access
Price
($/letter)
Quantity
(letters/month)
P’
P
Q’ Q
S
D
D’
Example 3.3
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 56
Predicting and Explaining Changes in Prices
and Quantities
Shifts in Demand
Substitutes
Two goods are substitutes in consumption
if an increase (decrease) in the price of one
causes an increase (decrease) in the
demand for the other
Changes In Demand
An increase (decrease) in the demand for a
good will shift the demand curve to the right
(left)
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 57
Predicting and Explaining Changes in Prices
and Quantities
Exercise 3.4
What do you think?
How will a decline in
airfares affect inter-
city bus fares and
the price of hotel
rooms in resort
communities?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 58
Predicting and Explaining Changes in Prices
and Quantities
Economic Naturalist
When the Federal Government implements
a large pay increase for its employees,why
do rents for apartments near Washington
Metro stations go up relative to rents for
apartments located far away from Metro
stations?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 59
The Effect of a Federal Pay Raise on the Rent for
Conveniently Located Apartments in Washington D.C.
Rent
(dollars per month)
Conveniently
located apartments
(units per month)
D
P
Q
S
P’
Q’
D’
Income
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 60
Predicting and Explaining Changes in Prices
and Quantities
A Change In Income
Normal Good
One whose demand increases (decreases)
when the incomes of buyers increase
(decrease)
Inferior Good
One whose demand decreases (increases)
when the incomes of buyers increase
(decrease)
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 61
The Effect of the Release of Jurassic
Park on the Market for Toy Dinosaurs
Price
Toy Dinosaurs
(units per month)
P
Q
D
S
D’
P’
Q’
D’ = demand after release of movie
Preference
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 62
The Effect of a Credible Rumor on
the Market for Apple Macintosh Computers
Price
Apple Computers
(units per month)
P
Q
S
D
P’
Q’
D’
D’ = demand after rumor of cheaper
model soon to be released
Expectation
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 63
The Effect of the Increase in
the Population of Potential Buyers
Price
Housing NY City
(units per month)
P
Q
S
D
P’
Q’
D’
D’ = demand after increase in population
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 64
The Effect on the Skateboard Market
of an Increase in the Price of Fiberglass
Price
($/skateboard)
Quantity
(skateboards/month)
60
1000
S
D
80
800
S’
Raw materials
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 65
The Effect on the Market for New Houses
of a Decline in Carpenters’ Wage Rates
Price
($1000/house)
Quantity
(houses/month)
120
40
D
S
90
50
S’
Example 3.5
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 66
The Effect of Technical Change on the Market for the
Term Paper Revisions
Price
($/revision)
Quantity
(millions of revisions per year)
55
12
D
S
7.50
36
S’
Technology
Economic Naturalist 3.2
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 67
Predicting and Explaining Changes in Prices
and Quantities
Other determinants of supply
Weather
Expectations
Number of sellers
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 68
Price
Quantity
P
P’
Q Q’
S
D’D
An increase in demand will lead to an increase
in both the equilibrium price and quantity
Four Rules Governing the Effects
of Supply and Demand Shifts,I
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 69
Price
Quantity
P’
P
Q’ Q
S
DD’
A decrease in demand will lead to a decrease
in both the equilibrium price and quantity
Four Rules Governing the Effects
of Supply and Demand Shifts,II
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 70
P’
P
Q Q’
S’
D
S
Price
Quantity
An increase in supply will lead to a
decrease in the equilibrium price
and an increase in the equilibrium quantity
Four Rules Governing the Effects
of Supply and Demand Shifts,III
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 71
P
P’
Q’ Q
S
D
S’Price
Quantity
An decrease in supply will lead to
an increase in the equilibrium price
and a decrease in the equilibrium quantity
Four Rules Governing the Effects
of Supply and Demand Shifts,IV
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 72
Predicting and Explaining Changes in Prices and
Demand
Factors That Cause an Increase (rightward or
upward shift) in Demand
1,A decrease in the price of complements to the good or
service
2,An increase in the price of substitutes for the good or
service
3,An increase in income (for a normal good)
4,An increased preference by demanders for the good or
service
5,An increase in the population of potential buyers
6,An expectation of higher prices in the future
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 73
Predicting and Explaining Changes in Prices and
Demand
Factors That Cause an Increase (rightward or
upward shift) in Supply
1,A decrease in the cost of materials,labor,or other
inputs used in the production of the good or service
2,An improvement in technology that reduces the cost
of producing the good or service
3,An improvement in the weather,especially for
agricultural products
4,An increase in the number of suppliers
5,An expectation of lower prices in the future
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 74
Example,P85
problems 1
problems 2;
problems 3.
Predicting and Explaining Changes in Prices
and Demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 75
Homework
Review p57-79
Review questions
Preview p79-85
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 76
Lecture 9 (2005.10.13)
class today
Chapter 3:
P79-85
Summary
Exercises
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 77
The Effects of Simultaneous Shifts in Supply and
Demand
Price
($/bag)
Millions of bags
per month
P
Q
S
D
P’
Q’
D’
S’ S’ after reduction in price of
corn harvesting equipment
D’ after discovery that oils are
harmful to people’s health
The Market for Corn Tortilla Chips
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 78
The Effects of Simultaneous Shifts in Supply and
Demand
Price
($/bag)
Millions of bags
per month
P
Q
S
D
P’
Q’
D’
S’
D’ after discovery that oils are
harmful to people’s health
S’ after reduction in price of
corn harvesting equipment
The Market for Corn Tortilla Chips
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 79
Predicting and Explaining Changes in Prices and
Demand
Exercises 3.6
Assume
A vitamin found in corn chips helps protect against
cancer and heart disease
A swarm of locusts destroys part of the corn crop
What Do You Think?
What will happen to the equilibrium price and
quantity of corn chips?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 80
Predicting and Explaining Changes in Prices and
Demand
Economic Naturalist
Why do the prices of some goods,like
airline tickets to Europe,go up during the
months of heaviest consumption,while
others,like sweet corn,go down?
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 81
Seasonal Variation in Air Travel and Corn Markets
Price
($/ticket)
1000s of
tickets
S
DS
DW
QW QS
PW
PS
High Consumption due to High Demand
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 82
Seasonal Variation in Air Travel and Corn Markets
Price
($/bushel)
Millions of
bushels
SW
D
QW QS
PW
PS
SS
High Consumption due to High Supply
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 83
Markets and Social Welfare
Cash On The Table
Buyer’s surplus
The difference between the buyer’s reservation
price and the price he or she actually pays
Seller’s surplus
The difference between the price received by
the seller and his or her reservation price
Total surplus
The difference between the buyer’s reservation
price and the seller’s reservation price
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 84
Markets and Social Welfare
Cash On The Table
Assume
All exchange is purely voluntary
If so
The buyer’s reservation price exceeds the
seller’s reservation price and both the buyer
and seller receive an economic surplus
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 85
Price Controls in the Pizza Market
Price
($ per slice)
Quantity
(1000s of slices per day)
S
D
3
12
4
2
8 16
Assume
Buyer’s reservation P = $4
Sellers reservation P = $2
Pizza sells for $3
Buyer’s surplus,$4 - $3 = $1
Seller’s surplus,$3 - $2 = $1
Total surplus,$4 - $2 = $2
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 86
Price Controls in the Pizza Market
Price
($ per slice)
Quantity
(1000s of slices per day)
Excess demand =
$8,000 slices/day
D
4
2
3
8 12 16
Assume price controls = $2
Quantity supplied falls to 8,000
Buyer’s reservation price ($4) is
greater than seller’s ($2)
Both would benefit from
additional production
There is CASH ON THE TABLE
S
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 87
Markets and Social Welfare
Cash On The Table
Economic metaphor
for unexploited
gains from
exchange
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 88
Markets and Social Welfare
Smart For One,Dumb For All
Socially optimal quantity
The quantity of a good that results in the
maximum possible economic surplus from
producing and consuming the good
The socially optimal quantity occurs when
MC = MB
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 89
Markets and Social Welfare
Smart For One,Dumb For All
Economic efficiency occurs when all goods
and services are produced and consumed
at their respective socially optimal levels
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 90
Markets and Social Welfare
Smart For One,Dumb For All
Achieving economic efficiency
Maximizes the economic surplus
Increases the economic pie
_______the efficiency principle
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 91
Markets and Social Welfare
Smart For One,Dumb For All
Inefficient market equilibrium
When some costs of production fall on people other than
those who sell the good or service
Example,Pollution
The market is in equilibrium,MC = MB
MC however underestimates the cost to society of
producing the good
Therefore,the market produces more than the
efficient amount and there is no incentive for
producers and consumers to alter their behavior
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 92
Markets and Social Welfare
Smart For One,Dumb For All
Inefficient market equilibrium
When some benefits from the good or service
accrue to people who did not buy the good or
service
Example,Vaccinations
The market is in equilibrium,MC = MB
MB underestimates the benefits to society of
consuming the vaccinations
The market produces less than the efficient amount
of vaccinations and there is no incentive for
producers and consumers to alter their behavior
MB MC
Chapter 3 - Supply and Demand,An Introduction Slide 93
Markets and Social Welfare
Smart For One,Dumb For All
In these markets
Buyers and sellers are behaving rationally
Market equilibrium exists
There are no unexploited opportunities for
individuals
Economic surplus is not maximized
---------The equilibrium principle
MB MC
End of
Chapter
