Economics Chapter 1: Markets and Prices

Introduction to Economics

• Economics studies how societies allocate scarce resources to produce and distribute valuable commodities.
• Microeconomics focuses on individual units (consumers and producers) and their interactions.
• Macroeconomics analyzes aggregate issues like economic growth, inflation, and unemployment.

Key Concepts in Microeconomics

• Limited resources versus unlimited wants lead to trade-offs in resource allocation.
• Optimal trade-offs involve consumer theory, worker impact, and firm theories.

Market Dynamics

• Markets are defined as geographic areas where buyers and sellers interact to determine product prices.
• Industries represent the supply side of markets.
• The concept of arbitrage involves buying low in one market and selling high in another.

Market Types

• Competitive markets have many buyers and sellers, preventing any single entity from influencing prices.
• Non-competitive markets allow individual producers to impact pricing, often leading to price variability.

Market Extent and Definition

• Market parameters include geographic boundaries (e.g., different cities) and ranges of products (different gasoline types).
• Example markets include prescription drugs, which can be clearly defined or ambiguous based on their therapeutic use.

Scarcity and Society's Choices

• Scarcity necessitates choices between goods since not all wants can be satisfied.
• Producers, consumers, and governments address three fundamental economic questions: what to produce, how to produce, and who consumes.

Factors of Production

• Natural resources: assets provided by nature (land, water, minerals).
• Labor: physical and mental efforts of workers.
• Physical capital: man-made objects used in production (machines, buildings).
• Human capital: knowledge and skills acquired through education and experience.
• Entrepreneurship: the coordination of production and risk-taking in business ventures.

Production Possibilities Frontier (PPF)

• PPF illustrates possible combinations of goods/services produced when resources are fully and efficiently utilized.
• Points on the PPF indicate efficient production; points inside indicate inefficiency, while points outside are unattainable.

Price Concepts

• Nominal price refers to the current dollar price, while real price adjusts for inflation using the Consumer Price Index (CPI).
• Real prices allow for analysis of relative prices across time.

Supply and Demand Dynamics

• The supply curve indicates how much of a product producers are willing to sell at various prices.
• Non-price determinants of supply include production costs, labor, and raw materials.
• The demand curve reflects how much consumers are willing to purchase at different prices.
• Non-price determinants of demand involve income levels, consumer preferences, and the prices of related goods (substitutes and complements).

Summary of Supply and Demand

• Changes in supply are shown by shifts in the supply curve due to costs or other factors.
• Changes in quantity supplied occur along the supply curve as prices change.
• Demand shifts occur due to income changes or varying consumer tastes, affecting overall market demand.### Market Equilibrium and Mechanism
• Changes in quantity demanded are indicated by movements along the demand curve.
• Equilibrium occurs when quantity demanded (QD) equals quantity supplied (QS).
• At equilibrium, there are no shortages or excess supply, and no pressure to change price.
• If market price is above equilibrium, a surplus results, leading producers to lower prices, increasing quantity demanded and decreasing quantity supplied until equilibrium is restored.
• If market price is below equilibrium, a shortage occurs, prompting producers to raise prices, which decreases quantity demanded and increases quantity supplied until equilibrium is established.

Changes in Market Equilibrium

• Equilibrium prices fluctuate based on levels of supply and demand, influenced by changes in determining variables.
• A decrease in raw material prices shifts the supply curve right, resulting in a new equilibrium with lower prices and increased quantity.
• Conversely, an increase in raw material prices shifts the supply curve left, causing a shortage and prompting a new higher equilibrium price.
• Increases in income generally shift the demand curve right, leading to higher equilibrium prices and quantities for normal goods, while the opposite is true for inferior goods.

Simultaneous Shifts in Supply and Demand

• The outcome on equilibrium price and quantity from simultaneous shifts depends on the magnitude and direction of the changes as well as the shape of the curves.

Case Studies: Eggs and College Education

• The real price of eggs fell significantly due to increased supply from better farming techniques, despite a decrease in demand linked to health concerns.
• The price of college education rose due to a decrease in supply from higher operational costs and increased demand from more students attending college.

Long-Run Behavior of Natural Resource Prices

• Demand for copper has surged while real prices have remained stable, indicating increased supply has offset demand growth.

Factors Influencing Demand Shift

• Increases in income for normal goods lead to a rightward shift in demand, raising both equilibrium price and quantity.
• Conversely, decreases in income for inferior goods can increase demand, shifting the curve rightward too.

Factors Influencing Supply Shift

• Rising resource prices decrease supply, shifting the curve left and raising equilibrium prices while decreasing quantities.
• Technological improvements boost supply, shifting the supply curve right and reducing prices while increasing quantities.

Price Elasticity of Demand

• Price elasticity of demand assesses sensitivity of quantity demanded to price changes, calculated as the percentage change in quantity demanded divided by the percentage change in price.
• Demand is elastic if the percentage change in quantity exceeds the percentage change in price, and inelastic when the opposite is true.
• Availability of substitutes is crucial in determining elasticity; more substitutes result in more elastic demand.

Visualization of Demand Curves

• The price elasticity varies along the demand curve; lower sections typically exhibit less elasticity compared to upper sections.### Elasticity Concepts
• Price Elasticity of Demand (Ep): Measures responsiveness of quantity demanded to price changes. Values can be:
  • Ep = -1: Unit elastic
  • Ep < -1: Elastic demand
  • Ep > -1: Inelastic demand
• Linear Demand Equation: Q = a - bP
  Example: Q = 8 - 2P
• Types of Demand Elasticity:
  • Infinitely Elastic Demand: Any price change leads to infinite change in quantity demanded (Ep = -∞).
  • Completely Inelastic Demand: No change in quantity demanded regardless of price changes (Ep = 0).

Income Elasticity of Demand

• Definition: Measures percentage change in quantity demanded from a 1% change in income. Formula:
  [ EI = \frac{∆Q/Q}{∆I/I} ]
• Types of Goods Based on Income Elasticity:
  • Normal Goods: 0 < EI < 1
  • Superior Goods: EI > 1
  • Inferior Goods: EI < 0 (negative elasticity).

Cross Elasticity of Demand

• Definition: Measures percentage change in quantity demanded of one good due to a 1% change in the price of another good.
• For Substitutes: Cross elasticity is positive (e.g., butter and margarine).
• For Complements: Cross elasticity is negative.

Price Elasticity of Supply

• Definition: Measures percentage change in quantity supplied resulting from a 1% change in price. Supply elasticity is usually positive.
• Formula:
  [ EP = \frac{P \cdot ∆Q}{Q ∆P} ]

Elasticity Calculations Example

• Elasticity of demand when price is $80: Ep = -0.40 (inelastic).
• Elasticity of supply when price is $80: Ep = 0.50 (elastic).

Market for Wheat (1981)

• Supply Curve: QS = 1,800 + 240P
• Demand Curve: QD = 3,550 - 266P
• Equilibrium Price: $3.46/bushel at Q = 2,630 million bushels.

Short-run vs Long-run Elasticities

• Demand Elasticity: Short-run elasticities are typically less than long-run elasticities for most goods, such as gasoline and automobiles.
• Example for Gasoline: Consumers adapt to higher prices over time by choosing smaller vehicles (long-run demand more elastic).

Consumer Behavior

• Consumer Choice Process: Involves preferences, budget constraints, and determining the best combination of goods for maximizing satisfaction.
• Three Assumptions About Preferences:
  • Completeness
  • Transitivity
  • More is preferred to less.

Indifference Curves

• Indifference curves represent combinations of goods providing the same satisfaction.
• They slope downward, indicating a trade-off between goods.
• An indifference map consists of multiple indifference curves illustrating consumer preferences.

Additional Notes

• Demand for Gasoline: Price elasticity increases over time, indicating consumers become more responsive to price changes.
• Market Dynamics: weather in Brazil significantly impacts coffee prices due to supply elasticity; demand shifts result in price volatility.

This quiz covers the fundamentals of markets and prices, exploring key concepts such as supply and demand, and elasticity. It includes multiple-choice questions and scenarios to test your understanding of consumer behavior and market dynamics. Ideal for students studying introductory economics.