SV151, Principles of Economics
K. Christ
5 – 9 December 2011
The Circular Flow Model and Some Basic Definitions
Market:
Foreign Market
Participants
potential
Goods and Services
Output (or Goods) Markets
Payments
Business
Sector
Household
Sector
Factor Payments
Input (or Factor) Markets
Factors of Production (or Production inputs)
Foreign Market
Participants
Competitive Market:
Basic demand concepts…
Quantity Demanded
The specific amount of a good or service that buyers are
willing and able to purchase under given conditions.
Demand
A general summary of the amounts of a good or service
that buyers are willing and able to purchase, determined
by prices, income, tastes, expectations, and potentially
many other influences.
Law of Demand
The claim that, other things being equal, there will be an
inverse relationship between quantity demanded and price.
The demand schedule and demand curve
55
50
45
40
Qd Qd
50 1
45 2
40 3
35 5
30 7
25 9
20 12
15 15
10 20
5
6
7
9
11
13
16
19
24
35
Price
P
30
25
20
15
10
5
0
0
2
4
6
8
10
12
14
16
Quantity Demanded
18
20
22
24
Basic supply concepts …
Quantity Supplied
The specific amount of a good or service that sellers are
willing and able to sell under given conditions.
Supply
A general summary of the amounts of a good or service
that sellers are willing and able to sell, determined
by prices, technology, expectations, time, and potentially
many other influences.
Law of Supply
The claim that, other things being equal, there will be a
positive relationship between quantity supplied and price.
The supply schedule and supply curve
55
50
45
40
50
45
40
35
30
25
20
15
10
Qs
17
16
15
13
11
9
6
3
0
Qs′
21
20
19
17
15
13
10
7
4
35
Price
P
30
25
20
15
10
5
0
0
2
4
6
8
10
12
14
Quantity Supplied
16
18
20
22
Equilibrium: a moving target?
Some market state, often defined in terms of prices and quantities, toward
which a market will evolve given a certain set of market conditions.
55
50
45
40
Qd Qd Qs
50 1
45 2
40 3
35 5
30 7
25 9
20 12
15 15
10 20
5
6
7
9
11
13
16
19
24
17
16
15
13
11
9
6
3
0
35
Price
P
30
25
20
15
10
5
0
0
2
4
6
8
10
12 14
16
Quantity Demanded
18
20
22
24
Market Equilibrium: Summarizing demand and supply shifts
No Change
In Demand
An Increase
In Demand
A Decrease
In Demand
No Change
In Supply
An Increase
In Supply
A Decrease
In Supply
P
Q
P
Q
P
Q
P
Q
P
Q
P
Q
P
Q
P
Q
P
Q
same
same
up
up
down
down
down
up
ambiguous
up
down
ambiguous
up
down
up
ambiguous
ambiguous
down
Looking for the Law of Demand
The Demand for Gasoline in the United States
Monthly Data, January 2000 to December 2007 (96 Observations)
Price Per Gallon (Inflation-Adjusted)
2.80
“You have to think
hard about what else
was going on …”
2.60
2.40
2.20
2.00
1.80
1.60
1.40
1.20
1.00
32
34
36
38
40
42
Average Monthly Per Capita Usage (in Gallons)
Source: Estimating Price Elasticity of Gasoline: A How-To Guide (How Economists Measure Price Elasticity)
http://the-idea-shop.com/article/196/estimating-price-elasticity-for-gasoline-a-how-to-guide
http://chamberlaineconomics.com/2008/10/19/how-economists-measure-price-elasticity/
44
Looking for the Law of Demand
The Demand for Gasoline in the United States
Monthly Data, January 2000 to December 2007 (96 Observations)
Average Annual Personal Disposable Income
(Inflation-Adjusted)
30,000
29,500
29,000
28,500
28,000
27,500
27,000
26,500
26,000
25,500
25,000
32
34
36
38
40
Average Monthly Per Capita Usage (in Gallons)
Source: Estimating Price Elasticity of Gasoline: A How-To Guide (How Economists Measure Price Elasticity)
http://the-idea-shop.com/article/196/estimating-price-elasticity-for-gasoline-a-how-to-guide
http://chamberlaineconomics.com/2008/10/19/how-economists-measure-price-elasticity/
42
44
Looking for the Law of Demand
The Demand for Gasoline in the United States
Monthly Data, January 2000 to December 2007 (96 Observations)
DEC
12
NOV
11
10
OCT
SEP9
Month
AUG8
JUL7
JUN6
MAY5
APR4
MAR3
FEB2
JAN1
32
34
36
38
40
Average Monthly Per Capita Usage (in Gallons)
Source: Estimating Price Elasticity of Gasoline: A How-To Guide (How Economists Measure Price Elasticity)
http://the-idea-shop.com/article/196/estimating-price-elasticity-for-gasoline-a-how-to-guide
http://chamberlaineconomics.com/2008/10/19/how-economists-measure-price-elasticity/
42
44
Looking for the Law of Demand
The Demand for Gasoline in the United States
Monthly Data, January 2000 to December 2007 (96 Observations)
An Empirically Estimated Demand Function:
Quantity Demanded = 22.3271 – 1.0399*Price + 0.0007*DPI + Monthly Effects
Estimating Demand Using Average Values of IVs:
Quantity Demanded = 22.3271 – 1.0399*1.8018 + 0.0007*26,717
- 4.6071 FEB = 34.5581 Gal.
or
+ 1.6886 AUG = 40.8438 Gal.
P
A Demand “Curve”:
Qd = 22.3271 – 1.0399*Price + 0.0007*26,717
Qd = 41.9290 – 1.0399*Price
40.32
An Inverse Demand Curve:
Price = 40.3202 – 0.9616 Qd
AUG
FEB
41.93
Qd
Demand Theory: Demand Functions and Demand Curves
Demand function:
If
dQ x
 0 , then goods x and y are substitutes.
dPy
If
dQ x
 0 , then goods x and y are complements.
dPy
( - )

Q  Dx  P x , Py , I ,


d
x
If dQ x  0 , then goods x is a normal good.
dI
If dQ x  0 , then goods x is an inferior good.
dI
Demand curve:
 
Q  Dx  P x   Qx  a  bPx
 
d
x
(-)
Inverse Demand curve:
a 1
Px   Qx    Qx
b b
The intercept term, a, captures
the effects of all non-price
factors of demand. Hence,
changes in any of these factors
are modeled as shifts of a
demand curve.
Supply Theory: Supply Functions and Supply Curves
Supply function:
Price of production alternatives.
(  )

Q  S x  P x , Py , w,


s
x
Input prices.
Supply curve:


Qxs  S x  P x   Qx  c  dPx


()
Inverse Supply curve:
c 1
Px    Qx    Qx
d d
The intercept term, c, captures
the effects of all non-price
factors of supply. Hence,
changes in any of these factors
are modeled as shifts of a
demand curve.
What’s Wrong With Price Gouging?
October 2, 2001 | Jefferson City, Mo.
Forty-eight gasoline retailers
from around the state are going
to pay $60,043.51 in penalties
and costs for violating Missouri's
rules and regulations on price
gouging in the wake of the Sept.
11 terrorist attacks, Attorney
General Jay Nixon announced
today.