II. How Do Markets Help Economies Grow

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• II. How Do Markets Help Economies Grow?
• Book
• Ch. 2 (pp. 47-53) Chapter 3
• (Ch. 3 not on the exam)
• B. Prices
• - survey Of the prices of goods and services
  that you buy, what percent are set or controlled
  by the government?

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Answer
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• Yep the government sets hardly any prices
• some utility prices and some medical prices are
  set or controlled by the govt.
• prices of everything else you buy set by
  markets gas, food, concert tickets, etc. free
  to move up and down
• thinking of other regulations?
• Thus, markets are really important (and perhaps,
  poorly understood)

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• What about the Fed influencing the inflation
  rate?
• As above, neither the govt. nor the Fed sets or
  regulates prices
• The Fed influences how much prices rise overall
  by influencing how quickly the economy grows
• ex say the U.S. grows at 5/year
• not sustainable productivity, K, L
  dont grow fast enough (3 is sustainable)
• businesses try to get supplies they
  bid up prices inflation accelerates
• the Fed ? interest rates,
  borrowing gets more expensive, spending
  slows, inflation slows

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• B. How do markets flexible prices help
  economies grow?
• - later will describe what determines prices and
  makes them go up and down

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• But now look at the importance of prices and
  markets
• def market firms and/or individuals are free
  to buy or sell a given item or service
• typically, the price is unregulated
• def nominal (money) price how much money it
  takes to buy an item

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• money prices vary across countries
• def relative price the value of one item
  compared to another item
• ex 1 Lexus LS 6 Yaris Liftbacks (Toyota)
• LS 66,000 Yaris 11,000
• ex Faltering Family M.D.s Get Technology
  Lifeline
• Their inflation-adjusted average income
  dropped by 10 in the previous 8 years, while
  specialists income was stable.
• - relative prices influence economic decisions

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• def real price the money price of an item
  adjusted for inflation (more precisely, a money
  price adjusted for prices in general)
• ex wake up tomorrow and all prices exactly
  doubled
• inflation rate?
• nominal values of Yaris LS?
• value of Yaris to LS?
• value of Yaris to prices in general?
• calculating a real price (deflating)
• real price
• (nominal price/price index) ? 100
• converted to values in the base period of the
  price index (common reference)
• ex CPI 1982-84
• did exactly this w/ real GDP

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• ex Yaris real price (1982-84 values)
• Yaris money price 11,000
• 1/07 CPI 202.4
• Yarisreal price (11,000/202.4) ? 100
• 4,990
• ex prices double tonight
• Yaris money price 11,000 ?
  22,000
• CPI 202.4 ? 404.8
• Yarisreal price (22,000/404.8) ? 100
• 4,990
• - nominal price 2X, real price unchanged

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• Why do economists argue that the increase in gas
  prices after Katrina was a good thing?!?
• gallon of gas ? 46 in one week
• You have a hurricane, and all of a sudden you
  see prices going up like that. That has . . .
  everything to do with people trying to make money
  off the backs of this tragedy. Sen. Clinton

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Katrina Radar Deleted Due to Size
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• The resulting choices (pick one no other
  possibilities)

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• U.S. production and refining ? 5
• The choice
• - limit price increases (price ceiling)
  and get lines (did that in the 70s after oil
  supply problems)
• have a wedding to drive to?
• - higher prices
• a big incentive to drive less
• -- driving down 5
• wedding can go
• want to fish? stay home
• Got a better idea on how to coordinate the
  actions of 100M car owners in a few days?
• Prices provide incentives and transmit
  information very efficiently

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• What prices do
• Provide incentives to buyers and sellers
• ex go to college?
• ex oil production
• ex leave California
• Coordinate decisions
• ex - why have (relative) salaries ? for
  college grads?
• - companies needed more skilled workers,
  and will pay
• - thus, millions more to college
• ex - gas gets more scarce
• - how to get people to dive less and buy
  more fuel efficient cars?
• - Pgas ? gives a strong incentive

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• Provide information
• ex college is a good investment
• ex what should houses be built w/?
• More broadly, markets
• foster innovation
• ex PCs, cell phones, the Internet, iPods,
  digital cameras, and so on profits to be
  made with each often at the expense of
  existing corporations
• - creative destruction
• - technological change
• - Soviet Union not so good at these few
  incentives
• coordinate far-flung parties
• ex pencil
• ex whos in charge of feeding us?
• - All of these essential for economic growth

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• What of workers _at_ minimum wage?
• Median priced home (or Zillow)
• Syracuse 115,000
• NYC Region 464,000
• U.S. 219,000
• Monthly payments for 30 year, 5.7 loan (most
  credit-worthy)
• Syracuse 667/month
• NYC Region 2,693/month
• U.S. 1,271/month
• At the NY minimum wage, work
• Syracuse 93 hours/month
• NYC Region 376 hours/month
• U.S. 178 hours/month
• Turns out
• Moral markets matter a lot here

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• Economists argue that prices do a good job of
  reflecting the costs of producing and the value
  buyers place on an item
• salaries of surgeons
• salary of A-Rod? entertainers?
• price of gas after Katrina
• ? price of food over the last 100 years
• Needed elements for efficient markets
• not manipulated or monopolized
• ex eBay User Agreement
• prices free to move up and down
• counter ex rent control deters apartment
  building
• property rights
• ex Gleevec Section 8, Article 8
• ex private property 5th 14th

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• Role of government in markets
• correct market failures
• prevent market manipulation
• promote markets
• ex phone number portability
• otherwise, be very careful
• ex tariffs on sugar ethanol imports

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• Pro-business pro-markets
• a subtle difference
• ex phone number portability
• ex sugar and ethanol imports
• ex anti-trust policy
• Interesting uses of markets
• illustrates their ability to reflect
  decisions by many
• ex best prediction of future oil prices
  oil futures market
• ex Iowa Health Prediction Mkt.
• ex predicting political races

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• What about corporations taking advantage of us?
• surprisingly hard to do think of all the
  products some corporations dont like that others
  developed PCs, cell phones, the Internet, iPods,
  digital cameras, and so on
• - big incentive to have the next big thing
• ex Apple Computer ? Apple Inc.
• to some degree, competition is a solution
• also government antitrust policy
• still, they do look out for their
  self-interest, and so should you

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• Summary of why markets are essential for a
  growing economy
• recall very few prices or wages by govt.
• prices give signals incentives, so
  resources are put to their best use
• ex gas market after Katrina
• ex why more go to college
• ex why wood used to frame houses
• more broadly, markets provide incentives for
  new products and creative destruction
• ex new products via the Internet

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• Revisit poll of economists from the start of
  class
• The federal minimum wage in the U.S. should be
  increased more than 1 per hour.
• 17 agree (47 would eliminate)
• better ways of helping the poor EITC
• The cause of the rise of gasoline prices that
  occurred in the wake of the Iraqi invasion of
  Kuwait 1990 is the monopoly power of large oil
  companies.
• 11 agree
• that market not monopolized prices reflect
  events encourage buyers to conserve a scarcer
  commodity

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• Wage-price controls are a useful policy option
  in the control of inflation.
• 8 agree
• flexible prices very important help
  economies guide resources to their best use
• C. Where do prices come from?
• - OK, theyre important, but what determines
  them?

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• Oil Industry Ending a Year to Remember, New
  York Times, 12/26/98
• Oil prices averaged 13.13 about 60 now a
  barrel in the fourth quarter, The biggest
  United States oil companies are expected to post
  earnings declines of 32 percent to 90 percent for
  the quarter.
• Blood bath may be an understatement, said
  Douglas Terreson, senior oil analyst
• analysts expect the earnings of the smaller
  companies to fall an average of 88 percent.

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• In a market, prices set by buyers?
• No
• In a market, prices set by sellers?
• No
• - No huge surprise, prices set by both

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• - def ceteris paribus everything else held
  constant
• change one thing, and examine the consequences
• ex - as wages rise, would more or fewer
  people be willing to work?
• - dont worry yet how employers
  (buyers) will react to higher wages
  (prices)
• - def demand describes the quantity of a good
  market participants are willing to purchase under
  different situations

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• Factors Influencing Demand
• price of the good (symbol P)
• - key in graphs
• - for now a given (answer in a bit)
• tastes
• income ( its distribution)
• - normal good
• - inferior good
• prices of related goods
• - complements
• - substitutes
• population and demographics
• expected future prices
• ? not availability demand is willingness to buy
  (jump ahead) (jump ahead further) (jump
  ahead to end of demand)

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• - Law of Demand
• as P?, demand ?, ceteris paribus
• - Demand Curve graphs Law of Demand
• ex Spring Break in Cancun
• Price Quantity
• 800 20
• 400 50
• 100 150

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• - def change in quantity demanded price of the
  good (P) changes you move along the demand
  curve
• ex change in price of S. B. in Cancun

- change 1st factor, and move along
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• - def change in demand anything other than the
  price of the good changes, the curve shifts
  right or left (review)
• ex impact on demand for Spring Break in Cancun
  if student income ? 20
• Price Old Quantity New Quantity
• 800 20 30
• 400 50 70
• 100 150 200

horizontal shift
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• Some Questions
• On our graphs, ___ is on the vertical axis and
  ___ is on the horizontal axis.
• A. price, quantity
• B. quantity, price

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• For now, we assume that the price of a good is
• A. a given
• B. set by markets (i.e. supply demand)
• Factors Influencing Demand
• price of the good (symbol P)
• - key in graphs
• - for now a given (answer in a bit)

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• What would happen to the demand for bikes if
  people became more interested in exercise?
• A. move along up the curve
• B. move down along the curve
• C. shift right
• D. shift left

with more interest in exercise, at every price
of bikes, there is more willingness to buy bikes
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• What would happen to the demand for bikes if the
  price of gasoline doubled?
• A. move along up the curve
• B. move down along the curve
• C. shift right
• D. shift left

a substitute rises in price, so more demand for
bikes at a given price of bikes
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• What would happen to the demand for bikes if
  income fell?
• A. move along up the curve
• B. move down along the curve
• C. shift right
• D. shift left

bikes are likely a normal good, so less demand
for bikes at a given price of bikes
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• What would happen to the demand for bikes if the
  price of bikes rose?
• A. move along up the curve
• B. move down along the curve
• C. shift right
• D. shift left

since the price of bikes are changing (variable
on the vertical axis), we move along the
curve
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• What would happen to the demand for bikes if
  people expected the price to fall next week?
• A. move along up the curve
• B. move down along the curve
• C. shift right
• D. shift left

if buyers expect a lower price in the future,
theyll buy less now (at every current price)
review
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• def supply describes the quantity of a good
  market participants are willing to sell under
  different situations
• warning supply is harder to understand since we
  consumers are generally on the demand side
• ex If the price of cars goes up, their supply
• A. will go up.
• B. will go down.
• Answer A. will go up.
• As the price rises, car companies will have more
  incentive to produce and sell cars. Will they be
  bought? Handled elsewhere.

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• - Factors Influencing Supply
• the price of the good (P)
• - key in graphs
• - as with demand, a given for now
• price of inputs
• technological change
• prices of substitutes in production
• expected future prices
• number of suppliers in the market
• - Law of Supply
• ex - you sell model gas pumps on eBay
• - their price goes up you do what?
• - as P?, more is supplied, ceteris paribus
• ? more incentive to sell as P?

(to end of supply)
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• - Supply Curve graphs the Law of Supply
• ex your willingness to dig ditches
• Price (P) Quantity Supplied (Q)
• 10 5
• 30 50
• 90 200

anyone pay you 90 to dig ditches?
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• def change in supply anything other than the
  price of the good changes, then the curve shifts
  right or left
• def change in quantity supplied price of the
  good (P) changes you move along the supply
  curve
• saw the same with demand (likely the hardest
  thing with S D)

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• What would happen to the supply of steel if the
  price of iron ore (an input) rises?
• A. move along up the curve
• B. move down along the curve
• C. shift right
• D. shift left

if an input rises in price firms profits ?, so
they ? production of high cost items (or, sell
the same amount for a higher price)
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• Tricky thing about shifting supply curves you
  have to think of left and right, not increase or
  decrease
• ex - technology makes it easier to produce
  Boeing jetliners
• - thus, for a given price, more produced

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• What would happen to the supply of oil if its
  price rose?
• A. move along up the curve
• B. move down along the curve
• C. shift right
• D. shift left

as its price rises, there is more incentive to
produce oil from difficult areas to use
more costly technology
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• What would happen to the supply of hybrid cars
  (use batteries and gas engines) if the price of
  regular gas cars rise in price?
• A. move along up the curve
• B. move down along the curve
• C. shift right
• D. shift left

there would be an incentive to produce
more regular cars, so the production of hybrids
? for a given price of hybrids
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• What would happen to oil supply if new
  technology is found that helps produce oil ?
• A. move along up the curve
• B. move down along the curve
• C. shift right
• D. shift left

with better technology, oil companies have
an incentive to produce more oil for the same
price, so production rises
review supply
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• - Market Equilibrium
• def market equilibrium (market clears) is
  when the quantity that sellers are willing to
  sell equals the quantity that buyers are willing
  to buy
• key equilibrium determines the quantity traded
  (Q) and the market price (P)
• earlier P was given now say where from

Non-Equilibrium
Equilibrium
P
S
P
S
P1
P2
D
D
Q
Q
Qd1
Qs1
Qd2 Qs2 Q2
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• A market price is determined through the
  interaction of supply and demand (think
  scissors) to change market price, there must be
  a shift in supply /or demand
• ex P2 on the last graph is a market price
• Equilibrium is achieved through flexible prices
  market price moves up and down until Qd Qs
  (i.e. S D market clears)
• ex on last slide, P1 ? P2
• Equilibrium is a stable, if away, the market
  will move to it unless there is a govt.
  restriction (price floor or price ceiling).
• ex minimum wage a price floor
• ex anti-scalping laws (in New York)
  price ceilings
• - economists generally argue against

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• - know what influences each curve
• - know that P1 and Q1, the equilibrium
  price quantity, are determined
  by supply and demand
• Usual use
• 1. start in equilibrium
• 2. some event (or events)
• 3. curve (or curves) shift
• 4. new equilibrium
• 5. new equilibrium price and quantity

Market
P
S
P1
D
Q
Q1
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• ex What would happen in the market for bikes if
  the price of gasoline doubled?

Bike Market
P
- start in equilibrium
S
P2

• more interest in bikes,
• so D shifts right (for a
• given price of bikes,
• ceteris paribus, demand
• is larger)

P1
D2
D
Q
Q1
Q2
- new equilibrium
- new price quantity

• result more bikes produced and purchased
• (Q1 ? Q2) and the price rises (P1 ? P2)

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• More details on the bike example

Bike Market

• more bikes produced
• Law of Supply as P ?
• (A ? C)

P
S
C
P2
A
B
P1

• in net, more bikes
• bought

D2
D
change in tastes A? B
Q
Q1
Q2
some reduction with higher prices (Law of
Demand) B ? C

• prices as incentives info
• more production w/ Pgas?
• some reduction in demand
• (to other types of transport)