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In a market economy, prices are key to determine the allocation of resources.
–Other mechanisms (central planning) no longer considered viable.
- Much of microeconomics is concerned with how prices are determined within a market (‘price theory’).
- The supply-and-demand model is the most important tool for this.
- Here: a quick introduction to supply-and-demand analysis.
- Rest of the course:
–Understand where demand and supply come from.
Explore the limits of the basic supply-and-demand model
Demand and Supply
- The supply-and-demand model states that prices and quantities are determined by supply and demand.
- Demand for a good (say, bread) depends on
–Prices of related goods (croissants, butter)
–Income (positive or negative influence?)
–Other factors (information, tastes, government regulation …)
- The supply-and-demand model focuses on a good’s price, holding all other factors constant.
–A ‘ceteris paribus’ assumption.
–Exogenous vs endogenous variables.
–Yields a ‘demand schedule’ or ‘demand curve’.
- Supply of a good (bread) depends on
–Prices of inputs (labour, flour …)
–Conditions of production (e.g., technology)
–Other factors (e.g., government regulation)
Intersection of demand and supply determines the equilibrium price Pe and quantity Qe.
–What happens if we are below Pe (‘excess demand’)?
–What happens if we are above Pe (‘excess supply’)?
–What happens if something changes?
- The price of butter goes up.
- ‘Comparative statics’ analysis.
- Central role of prices
–Prices convey information.
–Prices ration scarce resources.
–Prices determine incomes.
Consider the market for bread in the UK. Which of the following changes will not be associated with a shift of the demand or supply curves?
A.An increase in the price of bread leads to a decrease in the quantity of bread demanded.
B.The price of raspberry jam falls, leading to an increase in bread consumption.
C.The UK Government introduces stricter hygiene standards for bread production.
D.Lower import tariffs induce more foreign companies to export bread to the UK.
E.Both answers A) and D) are correct.
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