Mixed economies use both the market and central planning.
The market for any good consists of all the buyers and sellers of the good.
Market price balances two forces:
➜ Value buyers derive from the good
➜ Cost to produce the good
A demand curve illustrates the quantity buyers would purchase at each possible price.
Horizontal interpretation of demand:
➜ Given a price, how much will buyers buy?
Vertical interpretation of demand:
➜ Given the quantity to be sold, what price is the marginal consumer willing to pay?
Demand curve (D) has a negative slope.
➜ Consumers buy less at higher prices
➜ Consumers buy more at lower prices
Supply curve (S) has a positive slope.
➜ Low-Hanging Fruit Principle (Buy the cheapest available)
Buyer’s reservation price is the highest price an individual is willing to pay for a good.
Seller’s reservation price is the lowest price the seller would be willing to sell for. ➜ Equals to marginal cost
Excess Supply ➜ Surplus
Each supplier has an incentive to decrease the price in order to sell more.
Lower prices decrease the surplus.
When the price decreases, the demand increases and supply decreases.
Excess Demand ➜ Shortage
Each supplier has an incentive to increase the price in order to sell more.
Higher prices decrease the shortage.
When the price increases, the demand decreases and supply increases.
Price Control
A price ceiling is a maximum allowable price, set by law.
If the controlled price is below equilibrium, then
➜ demand increases and supply decreases. ➜ A shortage results.
What will happen if price goes up?
Substitution effect: Buyers switch to substitutes.
Indirect income effect: Buyers’ overall purchasing power goes down.
Complementary Goods
If the price of renting for tennis court decreases, demand for tennis balls increases ➜ Tennis courts and tennis balls are complements.
Price changes never cause a shift in demand / supply
Cost of production affects the supply of a product.
Rules of Supply and Demand Shifts
- An {increase / decrease} in demand will lead to an {increase / decrease} in both equilibrium price and quantity.
- An {increase / decrease} in supply will lead to an {decrease / increase} in equilibrium price and a {increase / decrease} in equilibrium quantity.
Markets maximize the difference between benefits and costs (economic surplus)
Consumer’s surplus: Consumers’ reservation price — market price
Producer’s surplus: Market Price — producer’s reservation price
Total surplus = Consumer’s surplus + Producer’s surplus
No cash on the table when surplus is maximized
➜ No opportunity to gain from additional sales or purchases
Equilibrium Principle: A market in equilibrium leaves no unexploited opportunities for individuals.
Efficiency Principle: equilibrium price and quantity are efficient if:
Sellers pay all the costs of production
Buyers receive all the benefits of their purchase
Efficiency is about society making optimal (best) use of scarce resources.
➜ Marginal cost == Marginal benefit
Economic efficiency means all goods are produced at their socially optimal level.
