Chapter Outline - Ch.7 - The Interaction of People in Markets - 10-24-07

Chapter Outline - Ch.7 - The Interaction of People in Markets - 10-24-07

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Microeconomics – Chapter #7 Outline – 10/24/07 THE INTERACTION OF PEOPLE IN MARKETS Invisible hand – The idea that the free interaction of people in a market economy leads to a desirable social outcome; the term was coined by Adam Smith. Competitive equilibrium model – A model that assumes utility maximization on the part of consumers and profit maximization on the part of the firms, along with competitive markets and freely determined prices. o The supply and demand model incorporates utility-maximizing consumers and profit-maximizing firms in competitive markets, we refer to it as the competitive equilibrium market . o Predicts a certain marginal benefit of consumption for each consumer and a certain marginal cost for each producer. INDIVIDUAL CONSUMERS AND FIRMS IN A MARKET A market can serve as an information-processing, coordinating, and motivating device even if it does not take place at any one location. Individual production and consumption decisions o Equilibrium price – The price at which quantity supplied equals quantity demanded. Adjustment to the Equilibrium Price o Surplus – The situation in which quantity supplied is greater than quantity demanded o Shortage – The situation in which quantity demanded is greater than quantity supplied. REVIEW Centrally coordinating and motivating is impossible Economists describe the interactions of people in the market through the competitive equilibrium model. A DOUBLE-AUCTION MARKET An experimental market is much like a real-world market except that one can observe all the actions of the participants. Double-auction market – A market in which several buyers and several sellers state prices at which they are willing to buy or sell a good.
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Buyers Earn a Consumer Surplus Consumer Surplus – The difference between what a person is willing to pay for an additional unit of a good – the marginal benefit – and the market price of the good. Sellers Earn a Producer Surplus Producer Surplus – The difference between the price received by a firm for an additional item sold and the marginal cost of the items production BE SURE TO DISTINGUISH BETWEEN MARKET SURPLUS AND CONSUMER SURPLUS OR PRODUCER SURPLUS . The experimental market has been tried many times (Double-auction market), and similar results have occurred each time. o The model comes very close to predicting the outcome of the double-auction market. The double-auction market demonstrates both how a market works and how a model works at predicting the outcome of the market.
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