Eco Models: Supply-Demand Basics

summarize: Introduction and Supply and Demand What is Microeconomics Study of how individuals and firms make decisions in a condition of scarcity Constrained optimization exercises People try to make themselves as well off as possible given constraints Trade offs Given that you are constrained how do you trade off things to make yourself as well off as possible Opportunity cost Every action or inaction has a cost and you could have been doing something else instead The dismal science - economics - called because nothing is free there is always an opportunity cost Paul Samelson wrote textbook on microeconomics, from MIT Supply and Demand Model What is a model Description between any two or more economic variables In economics tractability is making things simpler to be able to describe in a model not perfectly All models are wrong but some are useful Three levels of understanding Intuitive Explain well enough you can explain Graphical Mathematical Least important Supply and Demand Model Adam Smith 1776 Wealth of Nations Water Diamond paradox Water is important and essential Diamonds are frivolous Yet water is free and diamonds are expensive Why? We demand lots of water demand fewer diamonds Water is almost infinite but diamonds are limited in supply Supply and demand scissors You have to explain them together Marrket for Roses Supply curve Demand curve Quantity x Price y Demand curve Represents price of good versus how much people want it Downward sloping Supply curve How much firms are willing to supply at a given price As price goes up you are willing to supply more If you can make something and sell it at a higher price you are likely to make more of it Market equilibrium is where supply and demand curve meet Where suppliers and consumers are willing to produce the number and price Where both suppliers and consumers are happy Positive vs Normative analysis Positve analysis is the study of how things are Normative is how things should be Ebay Auctions Auctions are text example of competitive market The higher the price the fewer people bid Supply is how many are listed Kidney Why did the price go so high? Limited supply High demand Positive what happens if you do Normative should you do so Why would you want to stop selling a kidney? Market failures Reasons why the market does not work as it should fraud Imperfect information Equity or fairness Only rich people would get kidneys Behavioral economics People don’t always make rational decisions sometimes make mistakes Positve analysis is needed to analyze the framework first then you can evaluate normative Economic at its core is a right wing science Markets know what to do and governments get in the way How freely should the economy function Capitalistic economy firms and individuals decide what to do Tremendous growth Inequality Command Economy government makes all production and consumption decisions Ensured equity In practice does not work well due to corruption Adam Smith The invisible hand Individuals and firms will do what is best for society Most stuff gets produced and consumed Can lead to unfair outcomes How do individuals and firms acting in self interest created most productive economy How do consumers decide what to demand Utility Optimization function How do firms decide what to produce Competitive markets versus monopoly markets Market equilibrium How there are market failures

### Introduction and Supply and Demand #### What is Microeconomics? - Microeconomics studies how individuals and firms make decisions under scarcity. - It involves constrained optimization, where people aim to maximize their well-being within given limits. - Decisions involve trade-offs, meaning every choice incurs an opportunity cost—the cost of forgoing the next best alternative. - Economics, often called the dismal science, highlights that nothing is free due to opportunity costs. - Paul Samuelson, an influential economist from MIT, authored a significant textbook on microeconomics. #### Supply and Demand Model - **Model Definition:** A simplified description of the relationship between economic variables, aiming for tractability despite being imperfect. - **Levels of Understanding:** 1. Intuitive 2. Graphical 3. Mathematical (least important) - **Historical Context:** Adam Smith’s "Wealth of Nations" (1776) introduced key concepts like the Water-Diamond paradox, illustrating the supply and demand principle. - Water is essential but cheap due to its abundance. - Diamonds are less essential but expensive due to their scarcity. - **Supply and Demand Curves:** - **Demand Curve:** Shows the relationship between the price of a good and the quantity demanded by consumers, typically downward sloping. - **Supply Curve:** Shows how much producers are willing to supply at different prices, typically upward sloping. - **Market Equilibrium:** The point where the supply and demand curves intersect, indicating the price and quantity where both consumers and producers are satisfied. #### Positive vs. Normative Analysis - **Positive Analysis:** Examines how things are, describing and predicting economic phenomena. - **Normative Analysis:** Evaluates how things should be, incorporating ethical considerations and value judgments. - **Example:** eBay auctions reflect a competitive market where price influences the number of bidders and items listed. - High kidney prices due to limited supply and high demand illustrate market dynamics. #### Market Failures and Economic Systems - **Market Failures:** Occur due to reasons like fraud, imperfect information, and equity issues (e.g., only the wealthy affording kidneys). - **Economic Systems:** - **Capitalist Economy:** Individuals and firms make production and consumption decisions, leading to growth but also inequality. - **Command Economy:** Government controls economic decisions, aiming for equity but often resulting in inefficiency and corruption. - **Adam Smith’s Invisible Hand:** Suggests that self-interested actions by individuals and firms can lead to societal benefits, though it may also cause unfair outcomes. #### Decision-Making in Microeconomics - **Consumers:** Optimize utility to decide what to demand. - **Firms:** Decide what to produce based on market conditions (competitive vs. monopoly markets). - **Market Equilibrium and Failures:** The interaction of supply and demand determines equilibrium, but various factors can lead to market failures.