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Buyers and Sellers Determine Prices

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Goals of Buyers and Sellers

BUYERS

Make a transaction

Zero price

SELLERS

Infinite Price

Make a transaction

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The Process of Price Determination

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COMPETITION IS THE REGULATOR

It constrains buyers and sellers.

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Competition is the Regulator

“If he charges too much for his wares, or if he refuses to pay as much as everybody else for his workers, he will find himself without buyers in the one case, and without workers in the other.”

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Buyers want the lowest possible price, but....

• For

• Sale

•DEMAND

•Price

•Quantity

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they have to compete against all other buyers.

• For

• Sale

•Price

•Quantity

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Sellers want to charge the highest price possible, but ......

• For

• Sale

•Price

•Quantity

•Supply

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they have to compete against all other sellers.

• For

• Sale

•Price

•Quantity

•Supply

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Competition determines the Equilibrium Price

• For

• Sale

•SUPPLY

•Demand

•Price

•Quantity

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How are prices determined?• Buyers competing against each other

drive the price up

• Sellers competing against each other drive the price down

• Equilibrium Price is determined by the impersonal forces of supply and demand

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About the buyers

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Influences on the sellers

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Reservation Prices

• Sellers – Supply price– The lowest price that a seller is willing and able to

accept for a particular quantity of a particular product

• Buyers– Demand price– The highest price that a buyer is willing and able to

pay for a particular quantity of a particular product

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At the equilibrium price• Buyers who are able and willing to pay the

price get the goods and services they desire

• Sellers who are able to produce at that price sell all that they wish

• There are neither surpluses nor shortages• Not all prospective buyers or sellers are

satisfied

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Relative Prices

•$20

•$10

•$40

•Income = $30,000

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Relative Prices Have Not Changed

•$20

•$10

•$40

•Income = $30,000•Income = $60,000

•$20

•$40

•$80

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Supply – a relationshipPrice Quantity

Supplied$10 5$9 4$8 3$7 2$6 1$5 0$4 0$3 0$2 0$1 0

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The Law of Supply

• Once all other factors have been considered, the quantity supplied of a product varies directly with the price of the product.

• If the price rises, the quantity supplied will rise; if the price falls, the quantity supplied will fall.

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Demand – a relationshipPrice Quantity

Demanded$10 0$9 0$8 1$7 2$6 3$5 4$4 5$3 6$2 7$1 8

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The Law of Demand

• Once all other factors have been considered, the quantity demanded of a product varies inversely with the price of the product.

• If the price rises, the quantity demanded will fall; if the price falls, the quantity demanded will rise.

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Price Elasticity of Demand

• Measure of the strength of buyers’ reactions to price changes

• If buyers don’t react very strongly, inelastic

• If buyers react strongly, elastic

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Determinants of Price Elasticity of Demand

• availability of substitutes• percentage of income • time

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Price Elasticity of Supply

• Strength of seller’s response to price change

• Determinants– time– use of easily transferable resources– divisibility of inputs.

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Equilibrium Price and Quantity Exchanged

Price Quantity Supplied

Quantity Demanded

$10 5 0$9 4 0$8 3 1$7 2 2$6 1 3$5 0 4$4 0 5$3 0 6$2 0 7$1 0 8

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The Equilibrium Price

• Quantity supplied equals quantity demanded

• No shortages or surpluses• The market clears• Scarcity is not eliminated• The measure of relative scarcity

Some questions

• How tall are you? Feet and inches• How much do you weigh? Pounds• How far is LA from here? Miles• What is the temperature? Degrees • What is the humidity? %• How scarce is the coffee you just

bought? Dollars and cents

Price – A Unit of Measurement

• Scarcity is a general concept about our goals and resources

• Relative scarcity, as indicated by the price of a particular resource, good, or service is indicates HOW scarce that particular resource, good or service is compared to all others.

Relative Scarcity• What determines the price of footballs?• What determines the price of cashmere

sweaters?• What determines the price of music

downloads?• What determines the price of Ipods?• The answer to all of these questions is:

buyers and sellers (Demand and Supply)

Relative Scarcity• The relationship between supply and demand for

footballs is different than the relationship for cashmere sweaters or music downloads or IPods.

• The price of any particular product is the indication of the relationship between demand and supply for one product compared to all others.

• The relative price is the unit by which the market measures HOW scarce one item is compared to all others.

Relative Scarcity• An item with high supply and low demand is

not very scarce; its price will be low reflecting the low scarcity.

• An item with low supply and high demand is very scarce; its price will be high reflecting the high scarcity

• Workers with low human capital are in low demand and high supply; their wage will be low reflecting their low scarcity.

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Relative Price: unit by which we measure relative scarcity

(Units on the Scarcometer)

How scarce are these?

•Fighting Uncle Sam•Rubber Ducky•Econ Ruler

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Order these products in terms of relative scarcity (7 being most scarce, 1 being least scarce)

yacht candy bardinner for one at MacDonalds a nice dinner for two in LA laptop computer Toyota mini truck ticket to a world series game

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Main Points

• The Law of Demand states that a higher price will cause a decrease in the quantity demanded and a lower price will cause an increase in the quantity demanded.

• A demand schedule is a relationship between prices and quantities demanded.

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Main Points

• The Law of Supply states that a higher price will cause an increase in the quantity supplied and a lower price will cause a decrease in the quantity supplied.

• A supply schedule is a relationship between prices and quantities supplied.

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Main Points

• Price elasticity of demand is the strength of the buyers’ response to price changes.

• The determinants of price elasticity of demand are availability of substitutes, percentage of income, and time.

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Main Points

• Price elasticity of supply is the measure of the strength of seller’s response to a price change

• The determinants of price elasticity of supply are time, use of easily transferable resources, and divisibility of inputs.

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Main Points• Buyers and sellers (demand and supply) determine

equilibrium price and quantity exchanged. • At the equilibrium price, the number of items that

sellers are willing and able to offer for sale equals the number of items that buyers are willing and able to purchase.

• Relative scarcity is the relationship of supply and demand for one product compared to that relationship for all others.

• Relative price is the measure of relative scarcity