Unit 3
Markets: not just for
fleas and stocks!
Specialization and
Voluntary Exchange
Specialization

Specialization: people/companies learn and
practice a small set of skills then work with
others with different skills to produce
something

The assembly line idea
Why does specialization work?

Skills are developed at a deeper level


people become “experts” in their field
Costs are cut because time needed to produce
is decreased
Training can be more focused and in-depth
Remember: People, Stores & industries specialize

Examples of specialization

Doctors – cardiologists, dermatologists,
dentists, podiatrists, rhinologists
Examples of specialization

Teachers – grade level, subject, coaches

Stores at the mall – food court, hats,
electronics, shoes, clothes

Write two examples of specialization in each
of these areas:

Restaurant
Movie
Courts
How does specialization relate
to voluntary exchange?



Because we specialize, we rely on others for
the things we don’t produce
In an exchange, BOTH sides are looking to
gain something
BOTH sides gain in VOLUNTARY, NON-
FRAUDULENT EXCHANGE
How does each side gain in
these potential transactions?
LAWYER
Circular Flow
GPS



SSEMI1 The student will describe how
households, businesses, and governments are
interdependent and interact through flows of
goods, services, and money.
Illustrate by means of a circular flow diagram, the
Product market; the Resource market; the real flow
of goods and services between and among
businesses, households, and government; and the
flow of money.
Explain the role of money and how it facilitates
exchange.
Components of the circular flow








Product market
Factor (resource) market
Households
Businesses
Government
Money
Goods/services
Resources
Taxes
Taxes
GOVERNMENT
Goods and Services
Explaining the Circular Flow
diagram


Imagine a family wants to have some popcorn to eat
during movie night. The family would be represented by
the “Households” box on the left. Rather than do
everything themselves to produce the popcorn someone
in the household will just go to a grocery store and buy
the popcorn. The grocery store is the “Product Market,”
where people pay money (“Expenditures”) to get the
goods they need (“Products” like popcorn).
Where did the family get the money to pay for the
popcorn? Very likely, someone worked at a job in return
for a salary. In the diagram, the working family member of
the household provided labor (a “Productive Resource”)
at a “Factor Market” (also called a “Resource Market”) in
return for “Income,” or money.
Explaining the Circular Flow
diagram (continued)


That explains the left side of the diagram, showing how the family
demanded popcorn and then acquired it. The right side of the
diagram shows how the popcorn was supplied. To be a successful
popcorn “Business,” a company must secure kernels of corn; these
are the primary “Resource” needed to produce popcorn. In the
diagram, the “Resource” can be paid for by “Wages, Interest, Net
Profit.” This just illustrates that there is a variety of ways a business
can pay for its resources. If the popcorn company owns its own
farm, it would pay “Wages” to its employees to harvest the
“Resource.” If it doesn’t own its own farm, it might pay money (“Net
Profit”) to some independent farmer in order to purchase corn, its
“Resource.”
Once the business has its kernels of corn, it’s time to package them
and prepare them for sale in the grocery store. These bags of
popcorn are the “Goods” that travel to the “Product Market.” Of
course, the popcorn company doesn’t give its popcorn away; the
grocery store must pay the popcorn maker money, which is shown
as the “Revenue” arrow.
Supply and Demand
GPS



SSEMI2 The student will explain how the
Law of Demand, the Law of Supply,
prices, and profits work to determine
production and distribution in a market
economy.
Define the Law of Supply and the Law of
Demand.
Describe the role of buyers and sellers in
determining market clearing price.
Demand

amount of a good or service that consumers
are willing and able to purchase at various
prices

this can be represented by a graph or by a table

DIFFERENT THAN QUANTITY DEMANDED

QUANTITY DEMANDED – amount a consumer is
willing and able to purchase at a SPECIFIC price
Demand Graph


Demand line = D
Essential components


Y axis = prices of good
X axis = quantity of good



Price (P)
AXES MATTER!
$2
Demand line = D
At $2, there is a
QUANTITY DEMANDED
of 5
D
5 Quantity (Q)
Law of Demand
THERE IS AN INVERSE RELATIONSHIP
BETWEEN PRICE and QUANTITY
DEMANDED
Why?



the more expensive something becomes, the more
likely people are to find a substitute
diminishing marginal utility
The demand curve shows the amount of goods
or services that buyers are able and willing to
purchase at different prices.
Supply

amount of a good or service that producers
are willing and able to sell at various prices

this can be represented by a graph or by a table

DIFFERENT THAN QUANTITY SUPPLIED

QUANTITY SUPPLIED – amount a producer is
willing and able to sell at a SPECIFIC price
Supply Graph

Essential components





Price (P)
Y axis = prices of good
X axis = quantity of good
Supply line = S
At a price of $2, there
is a QUANTITY
SUPPLIED of 3
S
$2
Supply line = S
3
Quantity (Q)
Law of Supply
THERE IS A DIRECT RELATIONSHIP
BETWEEN PRICE AND QUANTITY
SUPPLIED
Why?


the higher the price, the more likely the chance for
a greater profit to be made
The graph shows the firm’s supply, the quantity
of goods or services that someone is able and
willing to supply at different prices.
Price

IF ALL THAT CHANGES IS PRICE,
then ONLY QUANTITY DEMANDED
or SUPPLIED CHANGES!!!!!!!!
P
P1
P2
D
Q1
Q2
Q
Supply and Demand
Explaining Supply and
Demand


At equilibrium, the demand exactly equals
supply, which is why P is called the
equilibrium price and Q is called the
equilibrium quantity. If a firm produces Q*
at a price of P*, they should be able to sell all
that they make. This is very efficient, and
efficiency is good for a business.
Equilibrium price is also called market
clearing price
GPS





SSEMI2 The student will explain how the Law of
Demand, the Law of Supply, prices, and profits
work to determine production and distribution in
a market economy.
Define the Law of Supply and the Law of Demand.
Describe the role of buyers and sellers in
determining market clearing price.
Illustrate on a graph how supply and demand
determine equilibrium price and quantity.
Explain how prices serve as incentives in a market
economy.
GPS




SSEMI3 The student will explain how markets,
prices, and competition influence economic
behavior.
Identify and illustrate on a graph factors that cause
changes in market supply and demand.
Explain and illustrate on a graph how price floors
create surpluses and price ceilings create
shortages.
Define price elasticity of demand and supply.
DEMAND SHIFTS (IRDL)

Market for Diamond Rings

P

$200

$100

D
100
150
Assume that a diamond ring
costs $200
At $200 buyers are buying
around 100 a day
If the price were $100, buyers
would be buying 150 a day
What happens if people’s
income doubles?
Now, at $200, people want
150 rings.
D2 What about at $100?
WillQ
people want more or
less?
Determinants of Demand
(Things that shift the entire line!)
(*All statements work in reverse as well!)
 R elated goods (Complements and Substitutes)
•Complements – if price of complement increases, demand for
the other good decreases
•Substitutes – if price of substitute increases, demand for other
good increases.
 Income – income increases, demand increases
 Preferences – preferences increase, demand increases
 E xpectations – expect higher prices in future, current
….
demand increases
umber of buyers – # of buyers increase, demand increases
N
Shifting Demand (RIPEN) not
price
Determinants of Supply (Entire Line)

G overnment decisions
•Taxes – taxes increase, supply decreases
•Subsidies – subsidies increase, supply increases
•Regulation – regulations increase, supply decreases

R esource prices or availability *prices have an inverse relationship,
*availability has a direct relationship
 Expectations – expect to sell more, supply increases; expect
to sell at higher prices, immediate supply decreases.

N umber of producers – direct relationship to supply

Technology or training – direct relationship to supply
Shifting Supply (GRENT) not
price
Price ceilings lead to
shortages

This figure illustrates the shortage that occurs when a price ceiling is
imposed on suppliers. Consumers demand QD while Suppliers are only
willing to supply QS.
Price Floors lead to surpluses:
Market for Wheat
Why does a price floor lead to
a surplus?

“Price Floors in Wheat Markets” shows the market
for wheat. Suppose the government sets the price of
wheat at PF. Notice that PF is above the equilibrium
price of PE. At PF, we read over to the demand
curve to find that the quantity of wheat that buyers
will be willing and able to purchase is W1 bushels.
Reading over to the supply curve, we find that
sellers will offer W2 bushels of wheat at the price
floor of PF. Because PF is above the equilibrium
price, there is a surplus of wheat equal to (W2 −
W1) bushels. The surplus persists because the
government does not allow the price to fall.
Define Price elasticity

economists occasionally talk about price
elasticity. Elasticity refers to the percentage
change in quantity divided by the percentage
change in price, and it can refer to both
supply and demand. The main idea is to track
how much a change in price affects a change
in quantity, and vice versa.
Illustration of inelastic demand
Explanation for case 1

In Case 1, price increases greatly, from P1 to
P2. However, consumers still desire the good
provided, so while quantity demanded is
diminished, it is only a small drop from Q1 to
Q2. As the change in price is greater than the
change in quantity demanded, the demand
curve for this good is said to be inelastic.
Illustration of elastic demand
Explanation for case 2

A small change in price in Case 2 leads to a
great decrease in the quantity demanded.
Since this good is very sensitive to changes
in price, this good has a demand curve that is
elastic.

Elasticity in supply curves work under the same principle as elasticity in demand
curves. In Case 1, a larger change in price leads to a smaller change in quantity, so
the supply curve in Case 1 is inelastic. In Case 2, a smaller change in price leads to
a greater change in quantity, showing that the supply curve in Case 2 is price
elastic.
Market Structures
GPS


SSEMI4 The student will explain the
organization and role of business and
analyze the four types of market
structures in the U.S. economy.
Identify the basic characteristics of monopoly,
oligopoly, monopolistic competition, and pure
competition.
Competitive Markets
2 Major Types of Competitive
Markets

Pure Competition

Monopolistic Competition
PURE COMPETITION


No single buyer or seller controls supply,
demand, or prices
There are 4 conditions for PC




Many Buyers and Sellers
Identical Products
Informed Buyers
Easy Market Entry and Exit
1. Many Buyers/Sellers


Each company or producer accounts for a
small portion of goods
Everyone acts INDEPENDENTLY, little or no
teamwork among competitors
2. Identical Products
Buyers choose goods almost SOLELY
based on price, not quality
 Consumers are highly informed about
product

3. Informed Buyers


Buyers will decide if prices
are acceptable
This is possible because all
the products are nearly
identical

Offers easy comparison
between competitors
4. Easy Market Entry

Extremely easy to enter the market and make
a profit


Low start-up costs, few regulations
Easy to switch between goods if you’re
already in the market
Real World PC?


Pure Competition is a model
AGRICULTURE is closest to pure
competition


Many farmers, food is very similar, buyers
are informed
Commodities also are close

Gold, silver, dairy, etc
MONOPOLISTIC
COMPETITION

Similar to pure competition in some areas



Many producers
Fairly easy to enter market
Primary difference between pure competition
is sellers try to DIFFERENTIATE their
products through advertising
Monopolistic Competition
(cont’d)

Competition based on things other than price


Quality, size, perks, color…
Advertising differences is key
Differences other than Price
Differences other than Price
What are these companies
selling?
Problem with Profits

MC and PC face problem of non-sustainable profits
 2 major problems

1. No real control over price



If price goes too high, consumers purchase from
someone else
If profits are extremely large, other firms enter the
industry because it’s easy to get in
2. In MC, advertising constantly changes the
playing field


Consumers change back and forth from one brand to
another based on their preferences
SHORT RUN profits are possible with differentiation
Journal #?

Identify 3 different categories of goods
(shoes, hamburgers, etc)


For each category of good, identify 3 different
brands
Explain what each brand has that the other two
don’t have
Imperfect Competition
Imperfectly Competitive
Markets
Unlike competitive markets,
firms in imperfectly competitive
markets may be able to set
prices or production
- 2 types: Oligopoly and
Monopoly
-
3 Conditions for Oligopoly
1. Few LARGE sellers
- top 3-4 companies/sellers handle 75% of
demand
2. Identical or VERY similar products
- producers less willing to take chances
3.
Difficult market entry
- Large firms have already paid start-up costs
Oligopolies at Work

Typically try to use non-price
competition

T.V. Stations, Cars, Movie studios
Oligopolies At Work

INTERdependent pricing
 Firms set prices based on other
firms
 Price leaders: largest seller sets a
price and others follow
Oligopolies at Work

Collusion: when the major sellers
set a price or production level
 Typically the price is above
equilibrium, but there are no
cheaper substitutes
Oligopolies at Work

Cartels: an open form of collusion
where production levels or prices
are announced
 OPEC or DeBeers
 Usually short-lived because of
greed/self-interest
3 Conditions for Monopolies

1. Single Seller


2. No reasonable substitutes


Total control of production and price setting
Forces demand for good, even if prices are too
high
3. Difficult or Impossible Market Entry

Too high start-up costs or too technical field
Examples of Monopolies or
near Monopolies
•Currently under
investigation.
NFL
–
•Potentially trying
Convicted
to form a of
being
an in the
monopoly
•Standard
Oil,
Used Video
illegal
upmarket.
in but
Game
monopoly
in
•Had competition frombroken
Livenation,
1911
1980
are currently under negotiations
to
• Claiming
ebay/amazon as
buy Livenation
competition
Not all Monopolies are “bad”
•The cost to build
more rail lines
would be
tremendous just
for someone to
make a little bit of
profit
•Fayette county
water authority is a
“natural monopoly”
•The costs to
society of having
another competitor
are too great
Why not charge outrageous
prices?



1. Consumer Demand: Increase in price
of too much would cause demand of zero
2. Potential Competition: Startup costs
are extremely high, but if prices got high
enough, entrepreneurs would have
incentive to enter
3. Government Regulation
Business Organizations
GPS


SSEMI4 The student will explain the
organization and role of business and
analyze the four types of market
structures in the U.S. economy.
Compare and contrast three forms of
business organization—sole proprietorship,
partnership, and corporation.
Business Organizations

3 basic business structures





Sole Proprietorship – one person owns/manages
Partnership – 2 or a small group
Corporation – a group of shareholders
Each has various costs and benefits
All types must deal with 4 general issues

Liability, life expectancy, financial options, and taxes
Sole Proprietorships





Advantages
Low start-up costs
Keeps all profits
Full control
Can respond to market
quickly
Easy to discontinue

Disadvantages
100% Owner liability



Legal, debt, taxes, etc
Life expectancy of
company
Limited access to
resources
Partnerships



Advantages
Low startup costs
Take advantage of
specialization
Larger pool of capital


Disadvantages
Potential for conflict
Unlimited liability

General partnership vs.
limited liability
Corporations




Advantages
Limited liability
Much larger pool of
capital
Take advantage of
specialization
Prestige

Disadvantages
Difficulty of startup


Double taxation



corporate charter, stocks
The corporation is a
SEPARATE individual
from the people who run
it.
Loss of control
More regulation
25000
20000
15000
Non farm
proprietorships
Partnerships
10000
Corporations
5000
0
Total receipts (in
billions)
# of firms (in
thousands)
What’s On the Test

Specialization/Voluntary
Exchange



Circular Flow



Which direction do the arrows
flow?
What are the components?
Market Structures



Why do people trade?
Why do we specialize?
What are the characteristics of
the 4?
How does each structure
affect prices/profits?
Business Organizations

Pros/Cons of each type of
Organization

Supply/Demand





How are prices set in a
market?
Law of Supply/Law of
Demand
RIPEN/GRENT
What happens to
equilibrium price/quantity
when supply/demand
shift
Price Floors/Ceilings
Sample Questions for Unit 3
A corporation MOST often seeks to
increase its profit and expand the size of
its operations by
A issuing stock
B joining an oligopoly
C becoming a monopoly
D controlling the money supply

Answer to sample question


Answer: A Standard: Types of businesses
and market structures
Choices B and C are types of market
structures and have no relationship to
strategies that a corporation can use to
increase its profit or size of operation. A
corporation cannot control the money supply,
choice D. The Federal Reserve controls the
money supply. Choice A is the correct
answer.
Organizers of many high-interest sporting
events such as the Super Bowl and the World
Series usually set ticket prices lower than the
equilibrium price, citing fairness to the public as
their reason. What names do economists give to
the resulting set price and disequilibrium
situation?
A price ceiling; surplus
B price ceiling; shortage
C price floor; shortage
D price floor; surplus

Answer to sample question


Answer: B Standard: Markets and prices
Setting ticket prices below the equilibrium
price creates a price ceiling. This eliminates
choices C and D. Price ceilings create a
shortage of a good, so choice B is the correct
answer.
In the graph below, lines D and S1 show the demand and
supply schedules for the Anaxos Fruit Shake company in its
last month of operation.
Anaxos just upgraded its capital equipment by buying a
machine that makes fruit shakes faster and cheaper
than the original machine. What effect should this have
on the graph?
Price
A Rises
B Drops
C Rises
D Drops
Quantity
Rises
Rises
Drops
Drops
Answer to sample question


1. Answer: B Standard: The laws of supply
and demand
The new machine makes shakes faster and
cheaper. This allows the supplier to reduce
the price, which eliminates choices A and C.
Since the price is lower, the number
produced can increase to meet the demand
(on the same curve). This eliminates choice
D. Therefore the correct answer is choice B.
Use the graph to answer the
question.
When the income in households increases,
what is the likely result?
A The supply curve will shift to the left.
B The supply curve will become vertical.
C The demand curve will shift to the left.
D The demand curve will shift to the right.
Answer to sample question

Answer: D Standard: Markets and prices
Houses can be considered normal goods,
since people tend to increase their
consumption of housing (by buying a bigger
house) as their income increases. In the short
term, this increased demand will lead the
demand curve to move to the right, so the
answer is choice D.