Modern principles of economics

1. Prof. dr. Maarten Pieter Schinkel
Principles of Economics & Business
Monday Lecture 2
September 12th 2022
‘Choices’ – with Willemijn van Dolen

2. 1

3. 2
“The master-economist must possess a rare combination of gifts ....
He must be mathematician, historian, statesman, philosopher—in
some degree. He must understand symbols and speak in words. He
must contemplate the particular, in terms of the general, and touch
abstract and concrete in the same flight of thought. He must study
the present in the light of the past for the purposes of the future. No
part of man's nature or his institutions must be entirely outside his
regard. He must be purposeful and disinterested in a simultaneous
mood, as aloof and incorruptible as an artist, yet sometimes as near
to earth as a politician.”
John Maynard Keynes (1924)

4. 3
Agenda
• Demand and Consumer Surplus
• What can shift a Demand Curve?
• Supply and Producer Surplus
• What can shift a Supply Curve?
• Market Equilibrium and how it comes about
• Free market maximizes the gains from trade

5. 4
Demand Curve:
A function that shows the quantity demanded at different prices.
Quantity Demanded:
The quantity that buyers are willing and able to buy at a particular price.

6. 5
Demand for Crude Oil

7. 6
‘The Law of Demand’
• A demand curve is (typically) negatively sloped:
The lower the price, the greater the quantity demanded
• Demand summarizes how consumers choose to use a good, given their
preferences and the possibilities for substitution

8. 7
Demand reflects value in different uses

9. 8
Consumer Surplus:
The consumer’s gain from exchange, or the difference between the
maximum price a consumer is willing to pay for a certain quantity and
the market price.
Total Consumer Surplus:
The area beneath the demand curve and above the price.

10. 9
Consumer Surplus

11. 10
Shifts in the Demand Curve

12. 11
Demand Shifters
• Tastes
• Income
• Population
• Price of substitutes
• Price of complements
• Expectations

13. 12
Tastes
• What people like underlies their demand
• Changes in tastes caused by fads, fashions, and
advertising can all increase or decrease demand –
important role of marketing

14. 13
Income
• When people get richer, they buy more stuff
• When an increase in income increases the demand for a good, it is a
normal good
• Most goods are normal goods
• When an increase in income decreases the demand for a good, it is an
inferior good

15. 14
Population
• An increase in population will increase demand
generally
• A shift in subpopulations will change the demand for
specific goods and services – e.g. an aging population

16. 15
Price of Substitutes
• A substitute is a good that can be consumed instead of another
good
• A decrease in the price of a substitute will decrease demand
for the other good
• New substitutes becoming available decrease demand

17. 16
Prices of Complements
• Complements are things that go well together
• A drop in the price of a complement increases demand for the
complementary good
• New complements becoming available increase demand

18. 17
Expectations
• New expectations of a reduction in future supply increases the demand today
• Changed expectations of future demand can in- or decreases demand today

19. 18
Supply Curve:
A function that shows the quantity supplied at different prices.
Quantity Supplied:
The quantity that sellers are willing and able to sell at a particular price.

20. 19
Supply of Crude Oil

21. 20
‘The Law of Supply’
• A supply curve is (typically) positively sloped:
The higher the price, the greater the quantity supplied
• Supply summarizes how producers choose to offer a good, given their
technologies and cost of production factors

22. 21
Supply reflects (marginal) cost of production
Top photo: Dan Lamont/Corbis Bottom: Bettmann/Corbis

23. 22
Producer Surplus:
The producer’s gain from exchange, or the difference
between the market price and the minimum price at which a
producer would be willing to sell a particular quantity.
Total Producer Surplus:
The area above the supply curve and below the price.

24. 23
Producer Surplus

25. 24
Shifts in the Supply Curve

26. 25
Supply Shifters
• Technological innovations and changes in the price of inputs
• Taxes and subsidies
• Expectations
• Entry or exit of producers
• Changes in opportunity costs

27. 26
Technological Innovations
• Improvements in technology can reduce costs, thus
increasing supply
• A reduction in input prices also reduces costs and thus
has a similar effect

28. 27
Taxes and Subsidies
• A tax on output has the same effect as an increase in costs
• A subsidy is the reverse of a tax

29. 28
Expectations
• Suppliers who expect prices to increase will store
goods for future sale and sell less today
• The expectation of a future price increase therefore
decreases current supply
• Supply curve today shifts to the left
• Yet it increases future supply – supply curve
tomorrow shifts to the right

30. 29
Entry or Exit of Producers
• The entry of new producers increases supply, shifting the curve down and
to the right

31. 30
Changes in Opportunity Costs
• An increase in opportunity costs reduces supply
• With the new legal option to grow hemp, the
opportunity cost of growing wheat increases
• Some farmers will shift away from producing
wheat, and will start growing hemp
• Supply curve of wheat shifts to the left

32. 31
Market Equilibrium
The price at which the quantity demanded is equal to the quantity supplied.
• Intersection of the demand and supply curves
• Equilibrium price and quantity are the only ones that are stable in a free
market
• At any other point, ‘economic forces’ push prices and quantities back
toward equilibrium

33. 32
Market Equilibrium
Price
Quantity
Supply
Demand
700
$60
//
Equilibrium

34. 33
Demand/Supply and Quantity Demanded/Supplied
• There is a big difference between demand/supply and quantity
demanded/supplied
• A change in demand/supply is a shift of the entire demand/supply curve
• A change in quantity demanded/supplied is a movement along a fixed
demand/supply curve
• First look at changes in the quantities demanded/supplied

35. 34
Price
Quantity
700
$60
$75
500
//
900
Supply
Demand
Price Above Equilibrium
Disequilibrium Price Adjustment: Surplus

36. 35
Price
Quantity
700
$60
$75
500
//
900
Supply
Demand
QD = 500 QS = 900
SURPLUS
QS > QD
Disequilibrium Price Adjustment: Surplus

37. 36
Price
Quantity
700
$60
$75
500
//
900
Supply
Demand
Price is driven down
towards equilibrium
Disequilibrium Price Adjustment: Surplus

38. 37
Price
Quantity
700
$60
$55
500
//
900
Supply
Demand
Price Below Equilibrium
Disequilibrium Price Adjustment: Shortage

39. 38
Price
Quantity
700
$60
$55
500
//
900
Supply
Demand
QS = 500 QD = 900
SHORTAGE
QD > QS
Disequilibrium Price Adjustment: Shortage

40. 39
Price
Quantity
700
$60
$55
500
//
900
Supply
Demand
Price is driven up
towards equilibrium
Disequilibrium Price Adjustment: Shortage

41. 40
Oil Market Disequilibrium Price Adjustments

42. 41
Equilibrium and Gains From Trade
• A free market maximizes the gains from trade:
1. Available goods are bought by buyers with the highest willingness to pay
2. Goods are sold by the sellers with the lowest costs
3. Between buyers and sellers, there are no unexploited gains from trade or any
wasteful trades
• These three conditions imply that the gains from trade are maximized

43. 42
Buyers are
willing to pay
$90
Unexploited Gains From Trade
Price
Quantity
Supply
Demand
70
$70
//
Suppose quantity is less
than equilibrium quantity
(say 50)
50 90
$50
$90
Sellers are willing to
supply for $50

44. 43
Buyers are
willing to pay
$90
Unexploited Gains From Trade
Price
Quantity
Supply
Demand
70
$70
//
50 90
$50
$90
Sellers are willing to
supply for $50
Any trade between $50
and $90 will make both
parties better off
Unexploited gains from
trade

45. 44
Wasted Resources
Price
Quantity
Supply
Demand
70
$70
//
Suppose quantity is greater
than equilibrium (say 90)
50 90
$50
$90
Sellers are willing to
supply for $90
Buyers are only willing
to pay $50

46. 45
Wasted Resources
Price
Quantity
Supply
Demand
70
$70
//
50 90
$50
$90
Sellers are willing to
supply for $90
Buyers are only willing
to pay $50
Sellers are losing money
on these units
Waste of resources

47. 46
Concluding Remarks
• Choices are behind demand and supply
• Price can equilibrate a market – Friedrich von Hayek
• Free market maximizes the gains from trade
For the Friday Lecture:
• Demand/supply versus quantity demanded/supplied
• Supply and demand plans change, changing the market equilibrium
• Two types of dynamics; which one is faster?