Banerjee Chapter 1- Markets

# Banerjee Chapter 1- Markets - Chapter 1 Markets As a segue...

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Chapter 1 Markets As a segue into the material of intermediate-level microeconomics, we begin with some familiar material from your introductory microeconomics class: market demand, supply, and equilibrium. We cover the same material but utilize algebra in addition to graphs. Then, we take up taxes and subsidies, topics which should also be somewhat familiar to you. Finally, we look at various elasticity concepts in greater detail than is usual in a principles-level class. 1.1 Market Demand and Supply Consider a single product (say, the market for steel) over a specific geograph- ical area and a relatively short time period, such as a few months. 1.1.1 Plotting a market demand function A market demand function shows how much is demanded by all potential buyers at different prices and is written generically as Q d = D ( p ) . Here, Q d is the total quantity demanded and is the dependent variable, while the per-unit price, p , is the independent variable. An example of such a market demand function may be given by the equation Q d = 120 - 2 p (1.1) where Q d is measured in thousands of tons and p in dollars per ton. The fact that the derivative dQ d / dp is negative means that this market demand 1

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2 Chapter 1 p Q d 0 50 40 30 20 10 60 100 80 60 40 20 120 Figure 1.1 Market demand embodies the so-called ‘ Law of demand ’: keep ing all other fac tors fixed, as the price of a prod uct in creases, its quan tity de manded de creases. 1 Since an independent variable is measured along the horizontal axis and the dependent variable along the vertical, the variable p ought to be on the horizontal axis and Q d on the vertical. However, economists customarily put p on the vertical axis and Q d on the horizontal axis, thereby depicting the inverse market demand by switching the variables in equation (1.1) and writing the price as a function of the quantity demanded: p = 60 - Q d 2 . (1.2) This tradition follows Alfred Marshall’s classic text, Principles of Economics , which was published in 1890 and was very influential in educating genera- tions of economists worldwide over 8 editions spanning 30 years. Marshall’s interpretation of the inverse demand is that it shows the maximum price (the dependent variable) that someone is willing to pay for a certain quantity (the independent variable). The inverse market demand given by equation (1.2) is therefore linear with a vertical intercept of 60 and slope of -0.5, 2 as shown in Figure 1.1. 1 Traditionally, the Latin phrase ceteris paribus (sometimes abbreviated as cet. par. ) is used instead to mean “keeping all other factors fixed”. 2 See section A.1.1 in the Mathematical Appendix. The units of measurement will generally be omitted from the graphs to minimize clutter.
Markets 3 Q US , Q ROW , Q d p 0 50 45 60 100 150 250 d d US demand ROW demand World demand Figure 1.2 Aggregate demand 1.1.2 Aggregating demand functions Suppose we are given the market demand curve for steel in the US as Q d US = 100 - 5 3 p , while the demand for steel in the rest of the world (ROW) is given by Q d ROW = 150 - 10 3 p .

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