Ch03-Lecture+Notes - Markets and Prices A market is an...

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Markets and Prices A market is an institutional arrangement where buyers and sellers interact in order to trade a good or a service. A market does not have to be a physical location Some markets are organized, most are not We’ll study a competitive market in this chapter “Many” buyers and sellers Each buyer and seller trade an insignificant quantity of a good relative to the volume of trade in the whole market . So trades by a single buyer or a seller has no impact on the prevailing price of the good . Price of the good is determined by the total demand and supply Money Price vs Relative Price Money price is the amount of money you have to give up to get the good. It is the opportunity cost of getting one unit of the good measured by units of money Relative price of a good is the opportunity cost of getting one unit of the good measured by units of another good. Relative price can be computed from money prices. If a headphone costs $49 and a cup of coffee costs $1.75, then a headphone is worth $49/$1.75 = 28 cups of coffee. We say that the relative price of a headphone measured by coffee is 28 cups. The relative price of coffee measured by headphone is $1.75/$49 = 1/28 ≈ 0.036 headphone. If the relative price of a good in one market is different from the relative price of the good in another market, there is an arbitrage opportunity . [ ]
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Demand [ ] When you say “the demand per day for coffee at the (money) price of $1.65 per cup is 90,000 cups” it means that, at that price, people want/can afford/plan to buy that many cups of coffee per day. Typically, price ↑ (↓) quantity demanded ↓ (↑). This is called the law of demand . Substitution effect : Price is the opportunity cost. So if it goes up, you look for an alternative (a substitute). When there are lots of close substitutes, you may buy much less of the good whose price went up. If there are few alternatives, or if you are hooked on the good, you may reduce your demand only a bit, or not at all. Income effect : You have a limited budget (income). When the price of a good goes up, you can’t afford everything you used to be able to. How substitution and income effects interact. Demand for a good is affected by the prices of other goods, people’s income and for other reasons. A demand schedule for a good is a table that shows the relationship between the price of the good and the quantity demanded at a fixed set of prices of other goods, people’s income, and other relevant information. A demand curve is a visual version of the demand schedule.
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