David Youngberg ECON 202—Montgomery College LECTURE 04: ANATOMY OF SUPPLY AND DEMAND I. II. III. What is our goal? a. Efficiency—Maximizing output with a given amount of input. i. Also known as minimizing waste. b. Efficiency seems like a dry, heartless concept but it isn’t. i. By being able to do more with less, we can use what’s saved to do other things—in effect we lower our opportunity cost and do the things we would normally forgo. ii. These other things are not just consumer items. Innovation, art, education, meditation, music, socializing, and traveling are all things we can do. iii. Indeed the history of humanity includes more of these higher pursuits as people save the time and money to not just make these things but appreciate them. Efficiency helped bring about the works of Mozart, Shakespeare, Aristotle, and Confucius— people don’t ponder art and philosophy when they’re struggling to survive. Perfect Competition a. Assumptions of perfect competition i. Homogenous products (identical goods) ii. Perfect information iii. Freedom of entry and exit iv. A large number of buyers and seller b. Thus, everyone is a price taker—that is no one can deviate from the market price and no one can influence it. The anatomy of the analysis a. Understanding surplus on the diagram. i. We take all prices as uniform across a particular market, such as socks, but people will value supplying or consuming that unit differently. We can note the difference as surplus, assuming the transaction took place. ii. Reservation price is the most a person will pay for something or the minimum a person is willing to sell something for. Supply and demand curves are made up of reservation prices. iii. The difference between the most you would buy something for and what you did buy it for is your consumer surplus. iv. The difference between the least you would sell something for and what you did sell it for is your producer surplus. Price S Total Consumer Surplus Pe Total Surplus Producer Surplus D Quantity Surplus Qe v. While individual consumer surplus is Reservation Price – Market Price, total consumer surplus is all the reservation prices, or the demand curve, minus Market Price. To calculate total consumer surplus, remember the formula for a triangle. vi. Similarly, there is a difference between individual producer surplus and total producer surplus. b. Understanding movements along a curve. i. When the world changes, people respond to that change by adjusting the quantity they consume or sell. The move along the supply or demand curve reflects a change in the quantity demanded or supplied. ii. Movements along the curves tend toward equilibrium. Price Change in Quantity Demanded S Pe Change in Quantity Supplied Qe D Quantity IV. A Quick Note on the Supply of labor a. The supply of labor is much like a standard supply curve. The more people are paid, the more hours they are willing to work. i. For individuals this is not always the case, since supplying something requires time and effort (something people prefer using for their own ends). If you are paid $1,000 an hour to mow lawns, you would probably work only an hour a day. At some point, an individual’s supply curve bends backwards. ii. But for the market, the supply of labor slopes up. If lawn mowing is being paid so much an hour, many people would leave their current job and enter the market for lawn mowing.