The Market

Exchange Supply & Demand Supply & Demand Elasticities Fitting demand and supply
Economics - Lecture 8
The Market
Demand and Supply Analysis
Anna D’Ambrosio
Polytechnic of Turin
Chapter 2, Besanko & Braeutigam, Microeconomics, 4th Edition
October 22, 2017
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The market
Outline
1 Exchange
2 Supply & Demand
3 Supply & Demand Elasticities
4 Fitting demand and supply
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Themes of Microeconomics
Prices
How are prices determined?
Centrally planned economies – governments control prices
Market economies – prices determined by interaction of
market participants
In modern societies, individuals are typically involved in the
production of a range of goods that is substantially smaller
than the one that corresponds to her pattern of consumption.
Hence, EXCHANGE is necessary.
The economic places where these interactions take place are
called markets – collection of buyers and sellers whose
interaction determines the prices of goods
(not the only possible ones: e.g. public administration,
agricultural communities, intra-firm exchanges)
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Markets
China Sveden UK
Hungary USA
Cuba Italy Japan
Planned Market
Economy Economy
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The market
1 Exchange
2 Supply & Demand
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What is a Market?
Markets
Collection of buyers and sellers who, through their actual or
potential interaction, determine the prices of products
Buyers: consumers purchase goods, companies purchase labor

and inputs
Sellers: consumers sell labor, resource owners sell inputs, firms
sell goods
Exchange is voluntary: we not only choose among

alternatives, but also which alternatives.
Even if the exchange is subject to regulations, the choice to
enter the exchange relationship must be free
=⇒ Within the limits of her knowledge at the time of the exchange,
no party will damage her own position through the exchange.
=⇒ The realization of the exchange implies that none of the
parties will be harmed by the exchange (necessary and
sufficient condition)
=⇒ However, one can gain more than the other
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Fundamental theorem of the exchange
if all transactions are voluntary (any party has the power to

oppose to the realisation of the transaction)
if all stakeholders are involved in the transaction itself
if the terms of the transactions are known to all parties so
that they can decide on whether it is convenient to participate
or not
if all parties are protected from extortion
then, through market exchange, individuals achieve their own
objectives without harming others.
Notice:
=⇒ Legal protection and guarantee of the enforceability of the contract are
not enough: there needs to be full information
=⇒ Terminology must be publicly known; goods and services must be
standardized
=⇒ Market mechanism relies essentially on trust among participants 7 / 72
Why exchanging?
To demonstrate the fundamental theorem of the exchange, we
need to understand why people find it profitable to associate with
others:
An individual can specialize in those tasks at which she is
better able and exchange her production with the product of
others’ work
In many instances, joint efforts of many individuals produce
results that outperform those attained in isolation.
Once recognized that specialisation and division of labour are
economically convenient, we need a method to distribute the
goods produced: this method is the voluntary exchange in a
capitalistic system.
To this end, we need to introduce some key underlying concepts in
economics: opportunity cost, comparative advantage and
Pareto optimality
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Some terminology: Opportunity cost
Consider a decision maker that must choose among a set

of mutually exclusive alternatives, each of which entails a
particular payoff;
The opportunity cost of a particular alternative is
the value associated with the best of the
alternatives that are not chosen
The concept applies widely to most economic decisions (e.g. consumption,
production, exchange)
Intuition:
A student faces the choice between studying and having a break at two different times
of the day.
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particular payoff;
Intuition:
of the day.
At 9:30, she knows that she is able to study 20 pages/hour.
At 13:00, she is so tired that she cannot study any pages in one hour.
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particular payoff;
Intuition:
of the day.
At 13:00, she is so tired that she cannot study any pages in one hour.
The opportunity cost of half an hour break at 9:30 is the 10 pages that she will not
study; at 12:30, it is the 1,5 pages that she will not study. At 13:00, the opportunity
cost of having a break is zero. What time should she choose to have her break? 9 / 72
Opportunity cost, comparative advantage and

specialisation
An application (I)
Consider two individuals, Anna and Paola, who are able to produce
two goods, e.g. food and clothing.
The opportunity costs of producing food is measured in
terms of units of clothing: how much clothing does she have to
give up producing, in order to produce an additional unit of food?
Suppose that, in one hour:

Anna produces 10 t-shirts or 2 pizzas.
Paola produces 6 t-shirts or 6 pizzas.
To produce an additional pizza,
Anna gives up 10 t-shirts every 2 pizzas = 10/2= 5 t-shirts
Paola gives up 6 t-shirts every 6 pizzas= 6/6 = 1 t-shirt
=⇒ Who should specialise in producing food?
To produce an additional t-shirt,
Paola gives up 6 / 6 = 1 pizza
Anna gives up 2 / 10= 1/5 pizzas
=⇒ Who should specialise in producing clothes?
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Different opportunity costs between two individuals imply that one

has a comparative advantage over another.
Paola has a comparative advantage over Anna in the

production of food if her opportunity cost in producing food is
lower than Anna’s.
Anna has a comparative advantage over Paola in the
production of clothes, as her opportunity cost in producing
clothing is lower than Paola’s.
How many pizzas will be produced if Anna and Paola specialize in

the production of the good in which they have a comparative
advantage?
Per hour, 6 pizzas and 10 t-shirts.
How many will be produced if both Anna and Paola operate in
isolation (assume each devotes half an hour to each production)?
Per hour, (1+3)=4 pizzas and (5+3)=8 t-shirts
=⇒ There are gains from specialization
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Graphically:
T-shirts
16
production possibility frontier
Specialization
10
Self-sufficiency
8
4 6 8 Pizzas
The set of all possible efficient production levels that an economic

system can attain with a given amount of resources (given the
technical knowledge and production endowments available to
agents) is called production possibility fronteer
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Some terminology: Pareto optimality

A combination of two goods such that, for a given production level
of one, maximizes the production of the other, is an efficient level
of production for the economic system.
By self-sufficiency, the output level is not efficient: by introducing
some kind of specialisation scheme, it is possible to increase the
production of one good without decreasing the other one.
More generally:
If we can find a way to make some people better off

without making anybody else worse off, we have a
Pareto improvement.
If an allocation allows for a Pareto improvement, it is
called Pareto inefficient; a Pareto inefficient allocation
has the undesirable feature that there is some way to
make somebody better off without hurting anyone else.
if an allocation is such that no Pareto improvements
are possible, it is called Pareto efficient, or Pareto
optimal.
The concept applies widely to all economic decisions (e.g.

consumption, production, exchange)
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Self-sufficiency
Self-‐sufficiency
Anna Paola
T-shirts T-shirts
10
9
6
5
1/5 2 1 6
Pizzas Pizzas
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Specialization and voluntary exchange - case 1

Consider the following cases of voluntary exchange by specialisation comparing
them with self-sufficiency: will the exchange be realized? Why?
Specialization
Case 1: Anna offers two t-‐shirts in exchange for one pizza
T-shirts Anna T-shirts Paola

10
8
6
1 2 6
Pizzas Pizzas
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Specialization
Case 2: Anna offers three t-‐shirts in exchange for two pizzas
T-shirts Anna T-shirts Paola

10
7 6
2 4 6
Pizzas Pizzas
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Specialization
Case 3: Anna offers one t-‐shirt in exchange for two pizzas
Anna Paola
T-shirts T-shirts
10
9
2 4 6
Pizzas Pizzas
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Specialization
Case 4: Anna offers one t-‐shirt in exchange for one pizza
Anna Paola
T-shirts T-shirts
10
9
1 2 5 6
Pizzas Pizzas
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Specialization
Case 5: Paola offers one pizza in exchange for six t-‐shirts
Anna Paola
T-shirts T-shirts
10
1 2 6
Pizzas Pizzas
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What is implied?
Recall that the opportunity cost of producing pizzas was 1 t-shirt
for Paola, and 5 t-shirts for Anna
Case Exchange ratio* Deal?
Anna Paola
1) T-shirts for one pizza 2/1=2 Yes Yes
2) T-shirts for one pizza 3/2=1.5 Yes Yes
3) T-shirts for one pizza 1/2=0.5 Yes No
4) T-shirts for one pizza 1/1=1 Yes ?
5) T-shirts for one pizza 6/1=6 No Yes
* aka: the t-shirt price of pizzas
The buyer will accept the deal as long as the price of the good
(implied by the exchange ratio) is less than the opportunity cost
of producing that good.
The seller will accept the deal as long as the price of the good
(implied by the exchange ratio) is greater than the opportunity
cost of producing that good.
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Exchange and welfare (I)
Hence, the exchange will take place if the exchange ratio is

comprised between the two opportunity costs:
The exchange will only take place if

cseller < pizza price of t-shirts < cbuyer
Where cseller denotes the opportunity cost of producing t-shirts (in terms of
pizzas) for the seller, Anna; and cbuyer the opportunity cost of producing
t-shirts (in terms of pizzas) for the buyer, Paola
Hence, the fundamental theorem of the exchange:

Trade is mutually beneficial. Voluntary exchange increases
net benefits for all parties involved
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Exchange and welfare (II)

But notice:
We can answer what, how, who produces, but not for whom:
Those who are willing and able to pay the highest price, will
get the good.
Hence, a market economy is ultimately a system of prices,
i.e. a system where the price is the variable guiding the
allocation of resources.
On the other hand, what agents are able to buy depends on
their income, hence on their initial endowments.
Hence, it is possible that the initial distribution of wealth is
such that not all of them are able to take part in the market.
This is a matter of distributional justice and not of efficiency.
In itself, a perfectly competitive market economy does not
ensure that the final distribution of goods is equitable. This is
the main ground for the intervention of the State in the
economy.
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The market
1 Exchange
2 Supply & Demand
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Market functioning
Many of the most interesting questions in economics concern the
functioning of markets
Why are there a lot of firms in some markets and not in
others?
Firms choose the combination of production factors that allow
them to maximize their profits. To this end, firms must
produce those goods that consumers want to purchase and
they also have to produce them at the lowest possible costs.
Are consumers better off with many firms?
In a market economy, consumers choose, among the goods
accessible to them, those that best satisfy their preferences
subject to their capacity to pay for them. The more firms will
be competing in the market, the better-off the consumers:
firms will have to minimize production costs and therefore
prices will be lower.
Should the government intervene in markets?
When the above conditions are not met, we talk about market
failures. Then there is a natural scope for the government to
intervene
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Market definition
Setting boundaries to the markets: product exchanged, time,

geography.
What time frame is considered? enough to adjust the
production flow and vary the stocks given the existing plants
and equipment used or enough to change the plants?
Which buyers and sellers should be included in a given market?
E.g. Market for housing in New York or Indianapolis; market

for all cameras or digital cameras
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Types of Markets I: Perfectly competitive markets
Because of the large number of buyers and sellers, no

individual buyer or seller can influence the price
Firms and consumers are price takers
Competition - three elements:
1 Automatic: no direct intervention of anyone
2 Invisible: individuals taking part in the market do not know the
ultimate consequences deriving from their own choices and of
their impact on the functioning of the system as a whole
3 Anonymous: to function, a market needs a diversity of
perspectives (if a buyer and a seller are both convinced that
the price of the good will decrease, the market will never clear)
Example: Most agricultural markets
Fierce competition among firms can create a competitive
market even by a small number of firms
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Types of Markets II: Noncompetitive Markets
Markets where individual producers can influence the price:

Producers are price makers
Three main types of non-competitive markets:
Monopoly: only one producer in the market
Monopolistic competition: many firms competing in the
market for a differentiated good, each enjoying some monopoly
power on a specific variety of the good
Oligopoly: only a few producers in the market =⇒ any
producer must act strategically and must take into
consideration the other producers’ choices
Cartels – groups of producers who act collectively
Example: OPEC dominates with world oil market
In this course, we will mainly focus on competitive markets (unless

specified otherwise)
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Competitive markets
Let us have a look at the vagaries of prices in a competitive
market
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The Demand Curve

The demand curve shows the highest price that the market “will
bear” for a given quantity of output, holding non-price factors
constant
The quantity demanded is expressed as a function of price:
QD = QD (P ) (but axes are inverted in the graphical representation)
Changing the price, we move along the curve
Price
($ per unit)
The inverse relationship

between quantity and price
is called the
LAW OF DEMAND
Quantity
(units/time period)
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The Demand Curve
Non-price determinants of Demand:

Income
Consumer Tastes
Price of Related Goods
Substitutes
Complements
Changing their values will induce shifts in the curves
In the case of linear demand curves, non-price determinants of
demand affect the intercept of the demand curve
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Demand shifts
Income Increases
At P1 , demand Q2
At P2 , demand Q1
Demand Curve shifts right
More purchased at any price on D 0 than on D
P D D’
P2
P1
Q0 Q1 Q2 Q
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The Supply curve

The supply curve shows the minimum price at which producers are
willing to sell a given quantity of output, holding constant other
factors that might affect quantity supplied
The quantity supplied is expressed as a function of price:
QS = QS (P ) (again, axes are inverted in the graphical
representation)
Changes in prices lead to movements along the curve
Price
($ per unit) S
P2
The supply curve slopes upward:
P1 at higher prices firms
will increase output
Q1 Q2 Quantity
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The Supply curve
Non-price Determining Variables of Supply

Costs of Production Factors:
Labor
Capital
Raw Materials
Production of related goods
Changing their values will induce shifts in the curves
In the case of linear supply curves, non-price determinants of
supply affect the intercept of the supply curve
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Supply shifts
The cost of raw materials falls
At P1 , produce Q2
At P2 , produce Q1
Supply curve shifts right to S 0
More produced at any price on S’ than on S
P
S S’
P1
P2
Q0 Q1 Q2 Q
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The Market Mechanism

Characteristics of the equilibrium or market clearing price:
QD = QS
No shortage
No excess supply
No pressure on the price to change as long as exogenous variables
don’t change
Price
($ per unit) S
The curves intersect at

equilibrium, or market-
clearing, price. At P0 the
quantity supplied is equal
P0
to the quantity demanded
at Q0 .
Q0 Quantity
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A Shortage
The market price is below equilibrium:

There is a shortage
Producers have an incentive to raise prices
Quantity demanded decreases and quantity supplied increases
The market continues to adjust until the new equilibrium price
is reached.
Price
($ per unit) S
Assume the price is P2 , then:

1) Qd : Q2 > Qs : Q1
2) Shortage is Q1:Q2.
P3 3) Producers raise price.
4) Quantity supplied increases
and quantity demanded
decreases.
P2 5) Equilibrium at P3, Q3
Shortage
D
Q1 Q3 Q2 Quantity
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A Surplus
The market price is above equilibrium:

There is excess supply
Producers lower prices
Quantity demanded increases and quantity supplied decreases
The market continues to adjust until the equilibrium price is
reached
Price
S
($ per unit)
Surplus
P1
Assume the price is P1 , then:
1) Qs : Q1 > Qd : Q2
2) Excess supply is Q1:Q2.
P2 3) Producers lower price.
4) Quantity supplied
decreases and quantity
demanded
increases.
5) Equilibrium at P2Q3
D
Q1 Q3 Q2 Quantity 37 / 72
1 Supply and demand interact to determine the market-clearing

price.
2 When not in equilibrium, the market will adjust to alleviate a
shortage or surplus and return the market to equilibrium.
3 Markets must be competitive for the mechanism to be
efficient.
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Changes In Market Equilibrium
Equilibrium prices are determined by the relative level of

supply and demand.
Supply and demand are determined by particular values of
supply and demand determining variables.
Changes in any one or combination of these variables can
cause a change in the equilibrium price and/or quantity.
Partial equilibrium analysis: we analyse prices and quantities
taking other market conditions as unchanged (Marshall)
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Raw material prices fall
S shifts to S 0
Surplus at P1
Equilibrium at (P3 , Q3 )
P
D S S’
P1
P3
Q1 Q3 Q2 Q
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Income Increases
Demand shifts to D 0
Shortage at P1
Equilibrium at (P3 , Q3 )
P D D’ S
P3
P1
Q2Q1 Q3 Q
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Changes In Market Equilibrium - An application

Suppose that the U.S. demand for aluminum is given by the
equation Q d = 500 − 50P + 10I , where P is the price of
aluminum expressed in dollars per kilogram and I is the average
income per person in the United States (in thousands of dollars per
year). Average income is an important determinant of the demand
for automobiles and other products that use aluminum, and hence
is a determinant of the demand for aluminum itself. Further
suppose that the U.S. supply of aluminum (when P ≥ 8) is given
by the equation Q s = −400 + 50P. In both the demand and
supply functions, quantity is measured in millions of kilograms of
aluminum per year.
(a) What is the market equilibrium price of aluminum when
I = 10 (i.e., $10,000 per year)?
(b) What happens to the demand curve if average income per
person is only $5,000 per year (i.e., I = 5 rather than I = 10).
Calculate the impact of this demand shift on the market
equilibrium price and quantity and then sketch the supply
curve and the demand curves (when I = 10 and when I = 5)
to illustrate this impact.
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Income Increases & raw material prices fall
The increase in D is greater than the increase in S
Equilibrium price and quantity increase to (P2 , Q2 )
P D D’ S S’
P2
P1
Q1 Q2 Q
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Shifts in Supply and Demand
When supply and demand change simultaneously, the impact on

the equilibrium price and quantity is determined by:
1 The relative size and direction of the change
2 The shape of the supply and demand models
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The market
1 Exchange
2 Supply & Demand
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Price elasticity of Demand
The extent of the change in the quantity demanded by a change in

market conditions depends on the sensitivity of demand to price,
i.e. on their elasticity:
The price elasticity of demand measures the ratio of the
relative change in quantity to the relative change in price (a
ratio of unitess numbers, hence a unitless ratio):
∆Q
Q ∗100%
eP = ∆P
P ∗100%
∆Q/Q P ∆Q
Rearranging, we get that eP = =Q
∆P/P ∆P
Useful because it offers a measure of the change in demand by
a change in price that does not depend on the unit of
measure (Marshall - Cournot)
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Interpreting the Price elasticity of Demand
Because of the inverse relationship between P and Q,

EP is negative.
If |eP | > 1, the percent change in quantity is greater than the
percent change in price. We say the demand is price elastic.
If |eP | = 1, the percent change in quantity is equal to the percent
change in price. We say the demand is unitary inelastic.
If |eP | < 1, the percent change in quantity is less than the percent
change in price. We say the demand is price inelastic.
It is a reactiveness index, hence it is ranked by the absolute values
(and not by the algebraic values)
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Price Elasticity of Demand

Elasticity and the shape of the demand curve
The flatter the curve, the more elastic the demand

Notice: comparisons among curves only make sense if we look at
the same point on different curves!
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Determinants of the price elasticity of demand
The primary determinant is the availability of substitutes.

Many substitutes =⇒ demand is price elastic
Few substitutes =⇒ demand is price inelastic
Elasticity is greater when a consumer’s expenditure on the product is
large (either in absolute terms or as a fraction of total expenditures)
Elasticity is smaller when a the product is perceived as a necessity,
greater when it is perceived as a luxury
Elasticity is greater, the greater the price level of the good
! Do not confuse market-level vs. brand-level price elasticities of demand!
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Business relevance of the price elasticity of demand
Useful information for firms that are deciding how to price

their products and services: it affects revenues PQ by a
change in price:
|e| > 1 =⇒ , the quantity reduction will outweigh the benefit
of the higher price
|e| < 1 =⇒ , the quantity reduction will not be too severe
and revenue will increase
An important determinant of the structure and nature of the
competition within industries,
An important factor affecting the impact of government
interventions.
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Determinants of the price elasticity of demand
Some examples
Category Estimated eP
Airline travel, leisure -1.52
Rail travel, leisure -1.40
Airline travel, business -1.15
Rail travel, business -0.70
Urban transit between -0.04 and -0.34
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Elasticities along specific demand curves
Typically, the price elasticity of demand is NOT constant, as it

depends on the absolute values of price and quantity as well as on
their changes:
This is particularly true for a commonly used demand curve,
the linear demand curve
There are only 3 types of demand curves along which the elasticity
does not vary:
Perfectly elastic demand curve
Perfectly inelastic demand curve
Constant elasticity (hyperbolic) demand curve
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Price elasticity in linear demand curves

Expressing demand as Q D = a − bP, elasticity becomes eP = −bP/Q
Notice: elasticity is NOT a slope!
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Price Elasticities of Demand

Infinitely Elastic Demand
e = −∞
Price
P* D
Quantity
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Perfectly Inelastic Demand
e=0
Price
Q* Quantity
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Constant Elasticity Demand
Define the demand function as Q D = aP −b ;
For an arbitrarily small change in P, we can compute the point elasticity

of demand: dQ dP Q
P
Since dQ
dP = −baP −(b +1) , the point elasticity of demand is e = −b
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Other Demand Elasticities

The Income elasticity of demand measures the % change in
quantity demanded resulting from a one % change in income.
It is: EI = ∆Q/Q I ∆Q
∆I /I = Q ∆I : positive for “normal” goods
Cross elasticity of demand measures the percentage change in the
quantity demanded of one good that results from a one percent
change in the price of another good.
e.g. butter and margarine, Coca-Cola and Pepsi
∆Qb /Qb ∆Qb
The cross elasticity of demand is: EQb Pm = ∆P m /Pm
= PQmb ∆Pm
The cross elasticity for substitutes is positive, while that for
complements is negative.
An example
Elasticity Coca-cola Pepsi
Price elasticity of demand -1.47 -1.55
Cross-Price elasticity of demand 0.52 0.64
Income elasticity of demand 0.58 1.38
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Price elasticity of Supply
Price elasticity of supply measures the percentage change in

quantity supplied resulting from a 1 percent change in price.
The elasticity is usually positive because price and quantity
supplied are directly related.
Factors affecting the elasticity of supply:
stocks of goods available to potential sellers
conservation and transportation costs of the good
production costs of goods
price expectations
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Short-Run Versus Long-Run Elasticities
Price elasticity of demand varies with the amount of time

consumers have to adjust to a price change.
Usually, in the long run, people will have had the time to
adjust their demand to the price change:
Long-run demand curves are usually more elastic than
short-run demand curves
(e.g. gasoline)
Similar considerations apply to short and long-run elasticities
of supply :
Long-run supply curves are usually more elastic than short-run
supply curves
(e.g. semiconductors)
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Gasoline: Short-Run and Long-Run Demand Curves
Price DSR
People tend to
drive smaller and
more fuel efficient
cars in the long-run
Gasoline DLR
Quantity
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Short-Run Versus Long-Run Elasticities: Durable goods
The opposite is true for durable goods:

Higher prices discourage the substitution of durable goods for
more expensive new goods in the short run;
However, in the long run, the old goods have to be replaced:
the price change does not affect demand very much
For durable goods, long-run demand curves are usually less
elastic than short-run demand curves
(e.g. planes, automobiles)
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Automobiles: Short-Run and Long-Run Demand Curves
Price DLR
People may put
off immediate
consumption, but
eventually older cars
must be replaced.
Automobiles DSR
Quantity
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An application: Hurricane Katrina and the price of Gasoline
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An application: Hurricane Katrina and the price of Gasoline
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The market
1 Exchange
2 Supply & Demand
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Fitting linear demand curves
Often, we can obtain information on the price elasticities of

demand and prices and quantities;
We can approximate the demand curve as a linear function
We can then derive the equation of linear demand functions,
e.g. QD = a − bP
Then we can determine numerically how a change in a
variable will cause demand to shift and thereby affect the
market price and quantity.
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Fitting linear demand curves
Available Data:
Equilibrium Price, P ∗
Equilibrium Quantity, Q ∗
Price elasticity of demand, eQ ,P .
Note that P ∗ and Q ∗ must be on the demand curve

Recall that eQ ,P = −bP/Q; solving for b yields b = −eQ ,P Q ∗ /P ∗
Solve for a:
∗
a = Q ∗ + bP ∗ = Q ∗ + − eQ ,P Q ∗
P ∗ P = ( 1 − e Q ,P ) Q
∗
(with the relevant info, we can do the same for the supply curve)
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Fitting linear demand
Price
Supply: Q = c + dP
a/b
ED = -bP*/Q*
P* ES = dP*/Q*
-c/d Demand: Q = a - bP
Q* Quantity
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Application: demand for chicken in the US
In 1990, the per capita consumption of chicken was 70 pounds/person;

average inflation-adjusted retail price was $ 0.70/pound. Demand for
chicken has an elasticity between -0.5 and -0.6. Thus
Equilibrium Price, P ∗ = 0.7
Equilibrium Quantity, Q ∗ = 70
Price elasticity of demand, eQ ,P = −0.55.
Applying equations above we get that

70 = 55
b = −(−0.55) 0.7
a = (1 − (−0.55))70 = 108.55
Q=108.5 - 55P
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Understanding and Predicting the Effects of Changing

Market Conditions
Application: The market for crushed stone in the US
Exogenous factors can cause shifts in the demand and supply

curves; Information about these shifts can be used to derive
demand and supply curves (“back-of-the envelope calculations”);
Suppose linear supply and demand functions.
We have info on the market for crushed stone between 2006
and 2010;
2006-2008, uneventful: market price $9/ton; 30 mln tons sold
each year.
2009, burst of highway building (Obama stimulus plan):
market price $10/ton; 33 mln tons sold.
2010, Burst ended; new union contract raised the wages of
workers : market price $10/ton; 28 mln tons sold.
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Market Conditions
Denote Q d = a − bP; Q s = f + hP b > 0, h > 0

Highway burst viewed as a rightward (parallel) shift in the
demand curve, with no corresponding shift in supply:
It identifies the supply curve: both equilibria fall on the supply
curve:
∗
h = ∆Q
∆P ∗ =
33mln−30mln = 3 mln
10−9
Rise in wages shifts the supply curve backward;
It identifies the demand curve: pre- and post-rise equilibria fall
on the demand curve:
∗
b = ∆Q
∆P ∗ =
28mln−30mln = −2 mln
10−9
Knowing that one curve shifted while the other did not
allowed us to calculate the slope of the curve that did
not shift
71 / 72

Market Conditions
We can now compute the intercepts for 2010:

28 = a − (2 ∗ 10) =⇒ a = 48; Q d = 48 − 2P
28 = f + (3 ∗ 10) =⇒ f = −2; Q s = −2 + 3P
And forecast the effect of changes in demand and supply on
the equilibrium price:
Suppose demand will increase by 15 mln through another burst
in construction:
The new equilibrium price would solve the equation
48 − 2P + 15 = −2 + 3P =⇒ P new = $13/ton; Q new =
−2 + 3(13) = 37 tons
Limitation: we cannot identify slopes if both curves shift at
the same time!
72 / 72

The Market

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The Market

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Exchange Supply & Demand Supply & Demand Elasticities Fitting demand and supply

Chapter 2, Besanko & Braeutigam, Microeconomics, 4th Edition

October 22, 2017

Buyers: consumers purchase goods, companies purchase labor

Exchange is voluntary: we not only choose among

Fundamental theorem of the exchange

if all transactions are voluntary (any party has the power to

Some terminology: Opportunity cost

Consider a decision maker that must choose among a set

Some terminology: Opportunity cost

Consider a decision maker that must choose among a set

Some terminology: Opportunity cost

Consider a decision maker that must choose among a set

Opportunity cost, comparative advantage and

Suppose that, in one hour:

Different opportunity costs between two individuals imply that one

Paola has a comparative advantage over Anna in the

How many pizzas will be produced if Anna and Paola specialize in

=⇒ There are gains from specialization

The set of all possible efficient production levels that an economic

Some terminology: Pareto optimality

If we can find a way to make some people better off

The concept applies widely to all economic decisions (e.g.

Specialization and voluntary exchange - case 1

T-shirts Anna T-shirts Paola

Specialization and voluntary exchange - case 2

T-shirts Anna T-shirts Paola

Specialization and voluntary exchange - case 3

Specialization and voluntary exchange - case 4

Specialization and voluntary exchange - case 5

Exchange and welfare (I)

Hence, the exchange will take place if the exchange ratio is

The exchange will only take place if

Hence, the fundamental theorem of the exchange:

Exchange and welfare (II)

Setting boundaries to the markets: product exchanged, time,

E.g. Market for housing in New York or Indianapolis; market

Types of Markets I: Perfectly competitive markets

Because of the large number of buyers and sellers, no

Types of Markets II: Noncompetitive Markets

Markets where individual producers can influence the price:

In this course, we will mainly focus on competitive markets (unless

The Demand Curve

The inverse relationship

The Demand Curve

Non-price determinants of Demand:

The Supply curve

The Supply curve

Non-price Determining Variables of Supply

The Market Mechanism

The curves intersect at

The Market Mechanism

The market price is below equilibrium:

Assume the price is P2 , then:

The Market Mechanism

The market price is above equilibrium:

The Market Mechanism

1 Supply and demand interact to determine the market-clearing

Changes In Market Equilibrium

Equilibrium prices are determined by the relative level of

Changes In Market Equilibrium

Changes In Market Equilibrium

Changes In Market Equilibrium - An application