Personal Finance
Scott Wentland
wentlandsa@longwood.edu
434-395-2160
Longwood University
201 High Street
Farmville, VA 23901
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Markets
Part 1 – What are markets?
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Individuals and Value
• Where does value really come from?
– Individuals (last lecture)
• Looked at how individuals determine value for
themselves (subjective value for goods we consume)
• Individuals think “on the margin”
– Diamonds are more valuable than water, because an additional
diamond makes us much happier than an additional bottle of
water (assuming we’re not in desert)
– But this story is incomplete…
• Diamonds would be valuable to you, even if you didn’t
like diamonds…
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Markets and Value
• Even if you didn’t like diamonds, you could
always sell a diamond on the market…
– Markets (this lecture)
• Markets are made up of individuals (consumers and
producers) who trade with one another
– Buying/selling is the market’s way to address scarcity
– Prices help buyers and sellers make good decisions and help
make the market “efficient”
• Markets can be best understood by understanding the
laws of supply and demand
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What is a market?
• Markets are everywhere and anywhere, where
people buy and sell something for a price
– This is a VERY general definition
– Examples:
•
•
•
•
•
Stock market
Shopping mall or flea market
Grocery store
Street corner (illegal or black markets are still markets)
Ebay or Amazon (markets don’t have to even be a physical
place)
• Labor market (selling your services…wage = price)
– Prices don’t even have to be in cash, they can be barter exchanges
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Why markets?
• Why do we have markets?
– We don’t live in a world where everyone begins
with everything he or she will ever want/need
– We learn this at lunch in grade school
• Mom packed pudding, I want chips
• Joe’s mom packed chips, Joe wants pudding
– I trade my pudding for Joe’s chips
– We’re both happier  a more efficient allocation
• Markets help us allocate resources efficiently
– (This is just one of many things markets do…)
• Why is resource allocation important?
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Scarcity
• We live in a world of scarcity
– Humans have infinite wants and needs
• Our resources are finite.
– In economics, scarcity is the idea that our
wants/needs exceed our resources
• Even if our physical resources were infinite, we would
still be constrained by time  we cannot escape scarcity
• Markets help us get the most out of what
we’ve got
– Also provide incentives for advancement (more on
this later)
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Markets vs. Central Planning
• An economy that lets markets (i.e. buyers/sellers)
produce, control, and allocate resources is a
market economy.
– Goods and services are freely traded at mutually
agreeable prices
– Factors of production (land, labor, capital) or inputs
are primarily owned privately (not by government)
– Low government involvement in the day-to-day
economy
– Also called capitalism, free market capitalism, or
laissez faire capitalism
• Are markets the only way to allocate resources?
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Markets vs. Central Planning
• Planned (or command) economy
– The government (or “The People”):
• Decides what to produce, who produces it, and who gets
it
• Decide how resources are allocated
• Own the factors of production (land/natural resources,
labor, capital) and plan how they are used
• Buying and selling in markets are largely prohibited
– Also called central planning or communism
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A Spectrum of Economies
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A Spectrum of Economies
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A Spectrum of Economies
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A Spectrum of Economies
Also called “mixed economies”…most economies are “mixed”
Next lecture: how do markets work?
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Markets
Part 2 – How do markets work?
A (very brief) intro to supply & demand
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How do markets work?
• Supply and demand
– Supply  represents the sellers
• In a pure free market  many sellers
– Demand  represents the buyers
• In a pure free market  many buyers
• In markets, buyers and sellers come together to
exchange
– For any given good, a price emerges as a market
price, as a result of negotiations between them
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Demand
• Consumer have a limited income and want to
maximize utility (or happiness)
– Buyers always want the lowest price they can get
– When something becomes cheap, consumers tend
to buy more
– When something becomes expensive, consumers
economize and cut back on quantity of that
• Common sense, right?
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Law of Demand
• Law of demand: “an increase in a product’s
price results in a decrease in quantity demanded”
holding all else constant
1. Income
2. # of buyers in the market
3. Prices of other goods
1. Substitutes
2. Complements
4. Expectations
5. Tastes
• These may “shift demand” if they change
– More about that in a full microeconomics course…
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Demand Curve
The Demand Curve for Oil is a Function Showing the Quantity of Oil
Demanded at Different Prices
Price of Oil
per Barrel
$55
$20
$5
Price
Quantity
Demanded
$55
5
$20
25
$5
50
Demand
5
25
50
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Quantity of Oil (MBD)
Supply
• Producers/sellers want to maximize profit
– Profit margin = Price – Average Cost
• They always want the highest price they can get
– When something becomes more expensive,
businesses want to supply/sell more of their
product
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Law of Supply
• Law of supply: “an increase in a product’s price
will result in an increase in quantity supplied by
the market” holding all else constant
• Holding what else constant?
1. Technological Innovations
2. Input Prices
3. Taxes and Subsidies
4. Expectations
5. Entry or Exit of Producers
6. Changes in Opportunity Costs
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Supply Curve
The Supply Curve for Oil is a Function Showing the Quantity of Oil
Supplied at Different Prices
Price of Oil
per Barrel
Supply Curve for Oil
$55
$20
Price
Quantity
Supplied
$55
50
$20
30
$5
10
$5
Quantity of Oil (MBD)
10
30
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50
Equilibrium
• Buyers want the lowest price
• Sellers want the highest price
– When they come together, they generally meet
somewhere in the middle
– They work out mutually beneficial exchanges and
a market price emerges
• Supply = Demand
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Equilibrium
Price is Determined by Supply and Demand
Price of Oil
per Barrel
Supply Curve
Equilibrium
Price $30
Demand Curve
65
Equilibrium Quantity
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Quantity of Oil
(MBD)
In Equilibrium
• An optimal price emerges out of buyers and
sellers interacting in the market
• Why is this price optimal or efficient?
# Supplied = # Demanded (at the equilibrium price)
– The lowest cost, most efficient sellers are the ones
who supply at that price
– The highest valued buyers are the ones who buy at
that price
– All possible mutually beneficial trades have taken
place at that price
• There are no sellers left who want to sell at a price that
another buyer would agree to.
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In Equilibrium
• If we were to design an allocation of stuff at
the beginning we would want:
– The people who are best, lowest cost producers
to make stuff
• We don’t want people in Alaska to grow oranges 
wasteful and inefficient
– The people who have the highest value for stuff to
get it and consume it
• We don’t want people who don’t like oranges to get
them  wasteful and inefficient
• Markets get us this efficient outcome, without
anyone planning it
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Equilibrium
• An equilibrium will emerge in any free market
– Check Ebay for the price of a specific product
• Buyers bid until a price settles on some equilibrium price
• If a similar item goes up for auction, it sells for about the
same amount (assuming nothing else has changed)
– Compare travel sites for any given flight
• Equilibrium price is very close
• That equilibrium may change, as other things that
affect supply and demand change
– Supply and demand conditions constantly change
– Markets are dynamic  prices change
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Value
• Back to our diamond/water paradox…
– Diamonds are also valuable because they have a high
market price as a result of supply and demand
• In the last lecture, we talked about from an individual buyer’s
perspective
• Here, we take the entire market perspective
– Diamonds have a:
• Low supply
– very rare, hard to find, labor intensive, few sellers
• High demand
– Many uses, many buyers want them relative to supply
• High price.
– Water’s low market price is largely due to high supply
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Conclusions
• Understanding markets through supply and
demand helps us understand
– Value and prices in a market economy
– How market economies allocate resources
efficiently
• Full microeconomics course
– Learn a lot more about supply and demand
• How to use supply and demand to understand markets
better
• Predict prices based on particular events
• Predict how certain government policies (e.g. minimum
wage) affects markets
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Thank You
http://en.wikipedia.org/wiki/Scarcity
http://en.wikipedia.org/wiki/Market_economy
http://en.wikipedia.org/wiki/Social_market_economy
http://en.wikipedia.org/wiki/Planned_economy
http://en.wikipedia.org/wiki/Factors_of_production
http://en.wikipedia.org/wiki/Supply_and_demand
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