Lecture 3

• Microeconomics


  The study of the economic behaviour of individual consumers, firms, and industries
• Course outline


  • 1 Introduction
  • 2 The basic market forces: Supply and demand A
  • 3 The basic market forces: Supply and demand B
  • 4 Quantitative analysis of supply and demand: Elasticities
  • 5 Background to demand: The theory of consumer choice A
  • 6 Background to demand: The theory of consumer choice B
  • 7 Background to supply: The theory of the firm A
  • 8 Background to supply: The theory of the firm B
  • 9 Market structures A: Perfect competition
  • 10 Market structures B: Monopoly and monopolistic competition
  • 11 Market structures C: Oligopoly
  • 12 Introduction to game theory
  • 13 Market failure and the role of the government
  • 14 Exam preparation
• Market equilibrium


  A combination of price and quantity for a certain good that is determined by the interaction of market demand and market supply, such that quantity demanded and quantity supplied are balanced, which means that there is neither a shortage nor a surplus (in terms of the good's quantity) in the market, which implies that neither consumers nor firms have an incentive to change their behavior
• Demand


  • Demand curve
  • Demand shifters
  • Demand function
• Supply


  • Supply curve
  • Supply shifters
  • Supply function
• Price and quantity in a competitive market


  The point where the demand curve and the supply curve intersect
• Controls on prices


  Price ceilings (an upper limit) and price floors (a lower limit)
• Comparative static analysis


  1. Determine whether the event shifts the demand curve, the supply curve, or both

  2. Determine whether the respective curve shifts to the left or to the right

  3. Use a supply and demand diagram to determine the impact of the event on market equilibrium
• In markets in which price adjusts quickly, disequilibrium occurs only for brief periods of time
• In markets with "sticky prices" or "price controls", disequilibrium can last longer or exist continuously
• In markets in which demand or supply shifts frequently, the equilibrium also shifts frequently and may never be exactly reached
• Price ceiling


  A legal maximum on the price at which a good can be sold
• Price floor


  A legal minimum on the price at which a good can be sold
• An increase (decrease) in demand

  Leads to a higher (lower) equilibrium price and a higher (lower) equilibrium quantity
• An increase (decrease) in supply


  Leads to a lower (higher) equilibrium price and a higher (lower) equilibrium quantity
• A simultaneous increase (decrease) in demand and supply

  Leads to a higher (lower) equilibrium quantity, but the effect on price is ambiguous
• Possible combinations of changes in supply and demand

  • Supply: No change
  • Supply: Increase
  • Supply: Decrease
• Example on slide 15

  • Example on slide 15
• Example on slide 16

  • Example on slide 16
• Example on slide 17

  • Example on slide 17
• Market equilibrium


  • Demand curve
  • Demand shifters
  • Demand function
  • Supply curve
  • Supply shifters
  • Supply function
  • Price and quantity in a competitive market
  • Controls on prices
  • Comparative static analysis
• The concepts from this lecture apply primarily to competitive markets ("perfect competition"). A more detailed analysis of this market structure will follow in lecture 9.
• Study chapters 3 and 7 in our textbook "Economics" by Mankiw and Taylor.
• Shifters and comparative static analysis

  Consider the market for hoodies with the logo of a certain business school. The school got a star to wear such a hoodie on TV – good advertising! Draw a diagram to show this event's effect on the market for the hoodies. What happens to the equilibrium price and quantity?
• Advertising is a demand shifter


  The demand curve shifts to the right. The equilibrium price and quantity rise.
• Shifters and comparative static analysis

  Suppose the local cafeterias offer a dish based on strawberries and beef. The weather was good, and the price of strawberries falls. Draw a diagram to show this event's effect on the market for the dish. What happens to the equilibrium price and quantity?
• Strawberries are an input in producing the dish


  The supply curve shifts to the right. The equilibrium price falls, the equilibrium quantity rises.
• Shifters and comparative static analysis

  Suppose the government urges students to buy a calculator and, at the same time, drops all import tariffs on calculators. Draw a diagram to show these two events' effect on the market for calculators. What happens to the equilibrium price and quantity?
• The government's campaign is similar to advertising

  The demand curve shifts to the right.
• The reduction of tariffs is similar to a lower input price


  The supply curve shifts to the right.
• The equilibrium quantity rises. The effect on price is ambiguous: It depends on the relative magnitude of the shifts.
• Shifters and comparative static analysis

  Suppose that because of tensions in the Middle East, oil production is down by 4.6 million barrels per day – a five percent reduction in the world's supply of crude oil. What is the likely impact of this event on the market for crude oil, the market for gasoline, the market for new gasoline-powered cars, and the market for used gasoline-powered cars?
• Oil production is down


  The supply curve for crude oil shifts to the left. The equilibrium price of crude oil rises, quantity falls.
• Oil is an input in producing gasoline and the price of this input has risen


  The supply curve for gasoline shifts to the left. The equilibrium price of gasoline rises, quantity falls.
• Gasoline and new gasoline-powered cars are complements and the price of gasoline has risen


  The demand curve for new gasoline-powered cars shifts to the left. The equilibrium price and quantity of new gasoline-powered cars fall.
• The demand curve for used gasoline-powered cars shifts to the left


  The supply curve for used gasoline-powered cars shifts to the right, as people have an incentive to sell more of their old cars. The equilibrium price of used gasoline-powered cars falls. The effect on quantity is ambiguous.
• Market equilibrium


  Demand and supply in a competitive market are given by Qd = 60 - 2P and Qs = 5P - 10. Determine the equilibrium price and quantity. Find the inverse demand and supply functions. Determine the equilibrium price and quantity, using the inverse functions.
• Equilibrium price Pe = 10, Equilibrium quantity Qe = 40
• Inverse demand function


  Qd = 60 - 2P ➔ P = 30 - 0.5Qd
• Inverse supply function


  Qs = 5P - 10 ➔ P = 0.2Qs + 2