Instructor: Professor Richard Holden
Decision making in markets
COMM1100 Business Decision Making
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10
Decision
Making in
Markets
Imperfect
Competition,
Economic
Surplus, and
Social Welfare
Legal Rights of
Stakeholders
in Decision
Making
Consumer
Relations
Decisions
Employee
& Supplier
Relations
Decisions
Stakeholder
Decisions Regarding
Managers
Complexity in
Business Decision
Making
11
Introduction to
Business Decision
Making
Stakeholders
and CR
11
A
SS
ES
SM
EN
TS
COMM1100 Business Decision Making
Quiz :
15%
Case study
analysis: 25%
Final
exam
50%
2 8
Decisions Related to Stakeholders
10
Decision Making Processes
5
Foundations of Business Decisions
Competitor
Relations
Decisions
6 731
Participation:
10% (in total)
Participation:
10% (in total)
Participation:
10% (in total)
Participation:
10% (in total)
Participation:
10% (in total)
Participation:
10% (in total)
Participation:
10% (in total)
Participation:
10% (in total)
Decision
Interactions
with
Government &
Broader
Society
9
Flexibility
Week
4
• The market context of business decisions
• Using models to understand context
• Comparative advantage and the incentives for
specialization
• Market analysis
• The consumer side: Demand
• The producer side: Competitive supply
• How they interact to give rise to a market equilibrium.
Chapter 1 (7 of 7)
Do benefits exceed costs?
“Or what?”
“One more?”
Everything is connected.
1. A Principled Approach to Economics
2. The Cost-Benefit Principle
3. The Opportunity Cost Principle
4. The Marginal Principle
5. The Interdependence Principle
What do you think
economics is about?
Common answers …
➢ Money, stock markets, Business
and Government policy analysis
But it goes beyond this—Economics
is a way of thinking!
True, it gives insight into why
businesses make the choices they
make, but also why you make the
choices you make in your everyday
life.
Economics is the study of
choices
➢toolkit to help you understand your
decisions and the decisions of
others.
The four core principles provide a
systematic framework for analysing
individual decisions.
Let’s look at those principles now!
Chapter 1 (3 of 7)
➢ Defining and practicing the cost-
benefit principle
➢ Willingness to pay
➢ Economic surplus
➢ Understanding and avoiding
framing effects
2. The Cost-Benefit Principle
Key Definition (1 of 6) Diving into the Definition
7
Cost-benefit principle: Costs
and benefits are the incentives that
shape decisions.
Before you make a decision …
• Evaluate the full set of costs and
benefits associated with that
choice
• Pursue that choice only if
benefits are at least as great as
the costs.
Scenario 1: You walk into a coffee
shop and have to decide whether to
buy a coffee. The coffee costs $4.
Do you decide to buy the coffee?
Dilemma: How do you compare
the benefit with the costs?
Solution: Convert costs and
benefits into dollars by evaluating
your willingness to pay
Key Definition (2 of 6)
Scenario 1 Continued
8
Willingness to pay: In order to convert
nonfinancial costs or benefits into their
monetary equivalent, ask yourself: “What
is the most I am willing to pay to get this
benefit (or avoid that cost)?”
Helpful Hint
Do not confuse “want to pay” with
“willing to pay” when doing this
conversion.
The benefit of the coffee depends on
how delicious it is to you.
Let’s say you are willing to pay up to
$5 for the coffee.
➢ Costs: $4
➢ Benefits: $5
➢ Decision: buy the coffee
Take-Away: using the cost-benefit
principle, we see the benefits exceed
the costs which is why you buy the
coffee!
Evaluating the FULL set of costs and benefits
Using money as the measuring stick
allows you to take into account the
financial and nonfinancial costs and
benefits of a decision.
In cost-benefit analysis, money is the
measuring stick, not the objective.
➢ Cost-benefit analysis still allows
for unselfish decisions.
9
Scenario 1 (expanded upon):
Suppose your friend is also with you but doesn’t
have any money with them.
➢ Do you buy them a coffee too?
Cost-benefit analysis:
Your friend’s happiness makes you happy and
should be counted among the benefits.
If you get a lot a joy from doing nice things for your
friends, then cost-benefit analysis tells you to
purchase the coffee for your friend.
Chapter 1 (4 of 7)
Understanding opportunity
cost as the next best
alternative.
Always consider the
opportunity cost rather than
just the out-of-pocket
financial costs.
3. The Opportunity Cost Principle
Key Definition (4 of 6) Diving into the Definition
11
Opportunity cost: The true cost of
something is the next best alternative
you have to give up to get it.
Costs are not always obvious
➢ you often have to give up more
than just money to get something.
Focus on the trade-offs associated
with a particular option. What did you
give up to pursue this option?
Scenario 2: You have a one-hour
break between classes. You have
many ways you could spend this time:
➢ Hang out with friends
➢ Work on assignments
➢ Take a nap
➢ Watch something on Netflix
Whatever you choose to do, you are
implicitly choosing not to do something
else. That’s your opportunity cost!
Scenario 2 Analysis:
12
Suppose you rank the options as
follows:
1. Work on assignments
2. Hang out with friends
3. Watch something on Netflix
4. Take a nap
Given the ranking above, you choose to
work on assignments for the hour in
between classes.
What was the opportunity cost of
your choice?
What did you give up by working on
assignments in between classes?
➢Answer: hanging out with friends
HELPFUL HINT: The opportunity cost
of working on assignments is not
all the other options. Rather, the
opportunity cost is your next best
alternative (hang out with friends).
Ask yourself, “Or what?”
Should I work on assignments OR hang
out with friends?
➢ Your answer to “or what” is the
opportunity cost of the option under
consideration.
Scarcity makes trade-offs inescapable
Every choice involves a trade-off. Every choice has a cost.
Why? Because everyone deals with issues of scarcity!
Scarcity: resources are limited, therefore any resources you spend pursing one
activity leaves fewer resources to pursue others.
➢Limited money: what could I spend my money on instead?
➢Limited time: there are only 24 hours in a day (we all have a time-budget)
➢Limited attention and willpower
➢Limited production resources: what else could be produced with this machinery
and labour?
13
Calculating Opportunity Cost: You Try!
Let’s look at the costs of attending university versus continuing to work full time
(the alternative).
Attending University
Tuition costs $42,000
You quit your job
Rent and meals cost
$40,000
10 hours per day
studying
Working Full Time
You do not pay tuition
You earn $70,000
from your job
Rent and meals cost
$40,000
10 hours per day
working
Opportunity Cost
$42,000 tuition
$70,000 forgone income
No opportunity cost
No opportunity cost
$112,000 per year in
total opportunity cost
14
What counts as an opportunity cost of university?
1. Some out-of-pocket costs
The $42,000 tuition is an out-of-pocket financial
cost (let's suppose you're paying up-front, not
taking out a HECS-HELP loan), and also an
opportunity cost. She wouldn’t have had this
expense if she continued working full time.
2. Not all out-of-pocket costs
The $40,000 spent on apartment and food is
spent either way, and therefore are not an
opportunity cost of attending school.
3. Non-out-of-pocket financial
costs
The $70,000 salary you forgo by not working is
not something you pay directly but it is money that
you gave up, and is thus an opportunity cost.
4. Not all time costs (nonfinancial)
You do not count all 10 hours of study time as
an opportunity cost since your job requires 10
hours of your time. Thus, relative to your next
best alternative, the time spent studying is not
an opportunity cost of school.
15
Applying the Opportunity
Cost Principle
During the 2008 recession, the movie
business boomed. During the pandemic,
streaming services enjoyed record
profits.
Question: Why do people watch more
movies during an economic downturn?
Answer: The opportunity cost of your
time is lower! You may no longer have a
job, or you may no longer have parties
or social gathers to alternatively attend.
Thus, you watch more movies instead!
16
How entrepreneurs think about opportunity
cost
The opportunity cost principle allows entrepreneurs to evaluate whether
or not to start a business:
➢Should you start a new business, or stay in your existing job?
• If you quit your current job, you are giving up the paycheck that comes with
it.
Forgone wages are an opportunity cost.
➢Should you invest your money in this new business, or leave in the bank
(or the stock market)?
• If you take your money out of the bank (or stock market), then you will not be
earning interest on that money. This forgone interest (or the forgone
investment opportunity) is an opportunity cost associated with starting your
new business.
17
Key Definition (5 of 6)
Sunk cost: a cost that has been
incurred and cannot be reversed. A
sunk cost exists in whatever choice you
make, and hence it is not an
opportunity cost.
➢ Good decision makers ignore sunk
costs.
Do not incorporate past, irreversible
costs into your current cost-benefit
analysis.
Sunk costs are irrelevant to the
current decision at hand because
these costs are associated with every
alternative moving forward.
Sunk Cost Example
Scenario 3: You bought a movie ticket for
$15. Within the first 30 minutes you realise
the movie is horrible.
Question: Do you continue watching the
movie, or leave?
Answer: Most likely, whatever you do upon
leaving the movie theater will be a more
enjoyable use of your time, so leave!
➢ Do not let the $15 sunk cost guilt you into
staying. Whether you stay or leave, the
$15 has been spent.
18
Key take-aways: Opportunity cost
19
The opportunity cost is the most valuable alternative you had
to give up to pursue your choice.
➢Even if the choice has no direct financial cost, there is always a
cost because every choice has an opportunity cost
associated with it.
➢Scarcity makes opportunity costs (trade-offs) inescapable.
➢Good decision makers ignore sunk costs.
Chapter 8 (3 of 6)
Distinguish between absolute
advantage and comparative
advantage.
Use comparative advantage to
allocate tasks to those with the
lowest opportunity cost.
2. Comparative Advantage
Who should do what?
How to allocate tasks
21
Jamie and Helen are roommates.
They need to decide how to assign the household
tasks:
➢ Vacuuming
➢ Cooking
Jamie can also vacuum the house in four hours,
but it takes him only one hour to make a meal.
Helen can vacuum the house in four hours, or she
can make a meal in two hours.
How should they allocate the tasks?
Let’s look at some terminology to help figure this
out.
Key Definition (2 of 3)
Diving into the Definition
22
Comparative advantage: The ability to do a
task at a lower opportunity cost.
RECALL: The opportunity cost of something
is what you gave up to get that thing.
➢ Opportunity cost principle: ”Or what?”
We want to allocate each task to the lowest
cost producer.
➢ Allocate the task to the person with the
comparative advantage in that task.
➢ Who gives up relatively less to get the
job done?
To figure out the comparative
advantage…
Compare:
➢ What can you produce if assigned one
task versus the other?
➢ What can the other person produce if
assigned one task versus the other?
Advantage:
If you give up relatively less to get a
task done, then it’s more efficient for
you to do that task.
➢ You have the advantage!
Key Definition (3 of 3) Diving into the Definition
23
Absolute advantage: The ability to do a
task using fewer inputs.
Equivalent statements: hat example
You have an absolute advantage in hat-
making if…
➢ you can make 10 hats using fewer
inputs than the other person.
➢ using the same inputs, you can
produce more hats than the other
person.
Absolute advantage tells you who is
best at a task, but NOT who should do
the task.
Ludwig van Beethoven Example:
Beethoven was one of the greatest
composers in classical music.
➢ He has an absolute advantage in
composing music.
➢ Suppose he also has an absolute
advantage in tuning pianos.
But if Beethoven takes time away from
composing music to tune pianos, he
sacrifices something greatly valued by
society (his music).
➢ Thus, you don’t assign Beethoven the
task of tuning pianos.
Chapter 1 (5 of 7)
Define and practice the
marginal principle.
Use the marginal principle to
break “how many” decisions
down into a series of smaller,
or marginal, decisions. 4. The Marginal Principle
Key Definitions
Diving into the Definition
25
Marginal principle: Decisions about
quantities are best made incrementally.
You should break “how many” questions into
a series of smaller, or marginal, decision
weighing the marginal benefits and marginal
costs.
Marginal Benefit: the extra benefit from
one extra unit (of goods purchased, hours
studied, etc.).
Marginal Cost: the extra cost from one
extra unit.
Quantity Decisions:
Instead of: ”How many workers should I hire?”
Simplify to: “Should I hire one more worker?”
Apply the cost-benefit principle to this
marginal decision to answer the question
“should I hire one more worker?”
➢ What are the extra benefits of hiring one
more worker?—marginal benefit
➢ What are the extra costs of hiring one
more worker?—marginal cost
Hire the additional worker if the marginal
benefit exceeds the marginal cost.
Key take-aways: The marginal principle
26
The marginal principle tells you to break “how many” decisions into
a series of smaller, marginal decisions.
➢ If the marginal benefit exceeds the marginal cost, then buy that
additional unit.
➢ Continue to buy additional units as long as the marginal benefit
is at least as large as the marginal cost (rational rule).
➢ Stop when the marginal benefit equals marginal cost.
➢Economic surplus is maximised when marginal benefit equals
marginal cost.
Chapter 1 (6 of 7)
Defining and understanding
the interdependence
principle.
How does your decision
interact with everything and
everyone else around you?
5. The Interdependence Principle
Key Definition (6 of 6)
Diving into the Definition
28
Interdependence principle: Your
best choice depends on …
1. your other choices,
2. the choices others make,
3.developments in other markets,
4. and expectations about the future.
When any of these factors changes, your
best choice might change.
You are not making decisions in isolation.
➢ You are part of a larger network.
By deciding to take this class..
1. you can’t take other classes that
are offered at the same time.
2. there is now one less spot
available to others.
3.makes you a more attractive
intern/employee in the labour
market.
4. you fulfill a prerequisite needed for
enrollment in future classes.
1. Dependence between each of your individual
choices
29
Your own choices are all connected because you have limited resources:
➢Your decision on how much to spend on movies will impact how often you can
eat out because you have limited income.
➢Your decision on how much time to dedicate to studying economics affects
the time available for studying psychology because you have limited time.
➢Because you only have one oven (i.e., you have limited production capacity)
you may not be able to prepare the main dish, and all the side dishes for
dinner tonight.
Chapter 2 (1 of 6)
Demand and
Consumer
Choice
1. Individual Demand: What You Want,
at Each Price
2. Your Decisions and Your Demand
Curve
3. Market Demand: What the Market
Wants
4. What Shifts Demand Curves?
5. Shifts versus Movements Along
Demand Curves
Chapter 2 (2 of 6)
Defining, drawing, and
understanding an
individual’s demand curve
➢ Ceteris Paribus
➢ The Law of Demand
1. Individual Demand: What You Want, at
Each Price
Key Definition (1 of 2) Diving into the Definition
32
Individual demand curve: A
graph that plots the quantity of an
item that an individual plans to
purchase at each price.
In other words, your demand curve
visually summarises your buying
plans, and how your plans vary
with price:
➢If I walk into the grocery store
and see my favorite cookies are
now marked at a lower price, then
I plan to buy more cookies at this
new, lower price
Individual: We are referring to
one person (as opposed to many
people)
Demand: We are examining
buying decisions (as opposed to
selling decisions)
Curve: We are graphing things
(sometimes these curves are straight
lines)
Let’s create our first individual
demand curve!
Creating Darren’s Demand Curve
33
The quantity Darren plans to buy depends on
the price: the lower price, the higher the
quantity demanded.
Quantity of petrol demanded
(litres per day)
Price per litre Quantity
$1.80 per litre 5 litres
$1.60 per litre 10 litres
$1.40 per litre 15 litres
$1.20 per litre 25 litres
$1.00 per litre 35 litres
Connect the various
quantities demanded to get
Darren’s demand curve
$1.80
$1.60
$1.40
$1.20
$1.00
0 5 10 15 20 25 30 35
Price of petrol
($ per litre)
Individual demand curve: Ceteris paribus
“holding other things constant” (Latin: ceteris paribus)
Every time you draw an individual’s demand curve, you are drawing this person’s buying
plans given current economic conditions.
➢ If something important changed (like Darren lost his job), then Darren’s buying plans
would change, which means his individual demand curve would change.
Economists know that many factors other than price can influence your demand.
➢ But first, understand what happens when the price (and only the price) changes.
➢ Push these other factors aside for the time being when drawing an individual’s
demand curve.
➢Then, later, bring other factors into consideration separately.
34
The Law of Demand
35
As a consumers, think about how you react to
high versus low prices:
➢ As the price falls lower and lower…
➢ your quantity demanded gets higher
and higher.
This pattern is so commonly seen among
consumers that it has its own name.
Law of demand: The tendency for quantity
demanded to be higher when the price is
lower.
This law implies that demand curves slope
down:
➢ When drawing a demand curve, think:
“Demand, down to the ground”
Key take-aways: Individual demand
36
The individual demand curve plots the quantity a person
plans to buy at each price, holding all other factors constant
(ceteris paribus).
➢ Other factors that impact a person’s buying plans will
be assessed later.
The Law of Demand: As price falls, the quantity
demanded rises.
➢ Or, equivalently, as price rises, the quantity
demanded falls.
Apply the core principles of
economics to make good
demand decisions.
The Rational Rule for Buyers.
Demand and marginal benefit
are one and the same.
Chapter 2 (3 of 6)
2. Your Decisions and Your Demand Curve
Do the Economics:
Choosing the Best Quantity to Buy
Do the Economics:
Choosing the Best Quantity to Buy
Should Darren buy the first can of petrol?
• Yes. The marginal benefit of $9 is greater
than the $7 it would cost him.
Should Darren buy the second can of petrol?
• Yes, the marginal benefit of $8 is still greater
than the marginal cost of $7.
Should Darren buy the third can of petrol?
• Yes, the marginal benefit of $7 is still slightly
greater than the marginal cost which is
actually $6.995.
Should Darren buy the fourth can of petrol?
• NO! It’s not worth spending $7 to get a
marginal benefit of $6.50.
Result: Darren buys 3 cans of petrol total.
38
paoarqi/Stock Editorial/Getty Images
Applying the core principles to make good buying decisions
Marginal Principle: Break down the question
of ”how many cans of petrol to buy?” into a
series of smaller marginal choices.
Cost-Benefit Principle: For each marginal
choice, buy the additional can of petrol if the
benefits exceed the costs.
Opportunity Cost Principle: “Or what?” To
accurately assess the marginal benefits
of each can of petrol, Darren always makes a
comparison to his next best alternative:
➢ shopping at the corner store; catching the
bus, calling his parents instead of seeing
them in person, etc.
39
The Rational Rule for the Buyer: Buy
more of an item if the marginal benefit of
one more is greater than (or equal to) the
price.
➢ Keep buying until Price = Marginal
Benefit
Following this rule maximises your
economic surplus as a buyer!
➢ Why?
➢ Because each purchase you make in
accordance with this rule will boost
your total benefits more than it
boosts your total costs.
Demand and Marginal Benefit
Your demand curve is also your marginal
benefit curve!
➢ Recall: price = marginal benefit
➢ Demand illustrates the price at which
you are willing to buy each quantity.
➢ The price you are willing to pay for
each unit is informed by the marginal
benefit you associated with that unit.
Thus, the marginal benefit and demand
curves are one and the same.
40
Diminishing marginal benefit: Each
additional item yields a smaller marginal
benefit than the previous item.
Example: The first slice of pizza is delicious!
The second slice is still good. With the third
slice you are full. The fourth slice would
make you uncomfortably full.
Because each unit yields a smaller marginal
benefit, your willingness to pay for each
additional unit declines.
➢ Hence, your demand (and marginal
benefit) curve is downward sloping.
Key take-aways: Your decisions and your demand curve
41
The Rational Rule for the Buyer: Buy more of an item if the
marginal benefit of one more is greater than (or equal to) the
price.
➢ Keep buying until Price = Marginal Benefit
Your demand curve and your marginal benefit curve are one
and the same.
Diminishing marginal benefit: Each additional item yields a
smaller marginal benefit than the previous item.
➢ The next slice of pizza, while still yummy, tastes a little
less delicious than the previous slice.
Chapter 2 (4 of 6)
Building the market
demand curve from
individual demand curves.
Tracing out movements
along the demand curve.
3. Market Demand: What the Market Wants
Key Definition (2 of 2)
Diving into the Definition
43
Market demand curve: A graph plotting
the total quantity of an item demanded
by the entire market, at each price.
The market demand gives business
owners a sense of how much business is
up for grabs:
➢How many customers want your
restaurant’s pizza
➢How many applicants for a university
➢How many donations for a nonprofit
➢How many followers on Instagram
Individual demand curves are the
building blocks of market demand:
➢ At each price, the total quantity of
petrol demanded is the sum of the
quantity that each potential
customer will demand at that price.
➢ The market demand curve visually
summarises these purchasing
decisions across the various price
points.
Let’s explore the four-step process
you can use to estimate the market
demand for a given product!
Estimating Market Demand (1 of 4)
The Four-Step Process to
Estimate Market Demand:
1. Survey: Ask each person the
quantity they will buy at each
price.
2. For each price, add up total
quantity demanded by all
customers.
3. Scale up the quantities to
represent the whole market.
4. Plot the total quantity
demanded at each price.
44
STEP 1: Suppose you survey a
representative sample of 200 potential
customers, asking each person about their
petrol purchasing plans at various price
points
Estimating Market Demand (2 of 4)
The Four-Step Process to
Estimate Market Demand:
1. Survey: Ask each person the
quantity they will buy at each
price.
2. For each price, add up total
quantity demanded by all
customers.
3. Scale up the quantities to
represent the whole market.
4. Plot the total quantity
demanded at each price.
45
STEP 2: Add up how many litres of petrol each of
your 200 customers want to buy at each and
every price.
Caution: Do not add up the price each individual
pays at each quantity. Instead, the correct
approach is to add up the quantities at each price.
Key take-aways: Market Demand
46
Market demand curve: The total quantity demanded by the entire
market at each price.
➢ Four-step process to estimate market demand.
➢ Add up the quantities from each consumer at each price.
When the price of the good changes, you simply move along the
existing demand curve to that new price point.
➢ Move from one point to another point.
➢ This price change triggers a change in the quantity demanded
(not a change in demand).
Chapter 2 (5 of 6)
Visualising increases and
decreases in demand.
Naming and understanding
the six factors that shift
the demand curve.
4. What Shifts Demand Curves?
Shifts in the Demand Curve
48
Increase in demand: a shift of the demand
curve to the right.
Movie Example: If Netflix does not have any
good shows this month, then I will demand
more movie tickets at each and every price.
Decrease in demand: a shift of the demand
curve to the left.
Movie Example: If Netflix does have good
shows this month, then I will demand fewer
movie tickets at each and every price.
Quantity
of movie tickets
per month
Price
$14
$12
$10
$8
$6
1 2 3 4 5
Quantity
of movie tickets
per month
Price
$14
$12
$10
$8
$6
1 2 3 4 5
old demand curve new demand curve
old demand curve
new demand curve
The Interdependence Principle and Shifting Demand Curves
Recall
The interdependence principle
says that everything is connected.
➢ Your best choice depends on many
other factors beyond price. When
these other factors change, so might
your demand decisions.
49
The six factors that shift the market
demand curve:
1. Income
2. Preferences
3. Prices of related goods
4. Expectations
5. Congestion and network effects
6. The type and number of buyers
... but not a change in price.
Key take-aways: What shifts a demand curve?
50
Increase in demand: a shift of the demand curve to the right.
➢ An increased quantity is demanded at each and every price.
Decrease in demand: a shift of the demand curve to the left.
➢ A decreased quantity is demanded at each and every price.
Six factors shift the demand curve.
➢ Be Careful: The effect of changing income depends on whether the
good is normal or inferior.
➢ Be Careful: The effect of changing the price of a related good
depends on whether the two goods are complements or
substitutes.
Chapter 2 (6 of 6)
Summarising key points:
➢ Shifts versus
movements
➢ Change in quantity
demanded versus
change in demand
5. Shifts versus Movements Along
Demand Curves
Shift versus Movement Along Demand
52
If the only thing changing is the
price of the good itself, then you
are thinking about a movement
along the demand curve. This is a
change the quantity
demanded.
But when other factors change,
you need to think about a shift in
the demand curve (recall the six
factors). This is a change in
demand itself.
Changes in price cause
changes in quantity
demanded
Quantity
Price
Changes in other factors
cause shifts in demand.
Price
Demand
curve
Quantity
Original Demand
increased
demanddecreased
demand
Chapter 3 (1 of 6)
Supply:
Thinking like
a Seller
1. Individual Supply: What You Sell, at
Each Price
2. Your Decisions and Your Individual
Supply Curve
3. Market Supply: What the Market Sells
4. What Shifts Supply Curves?
5. Shifts versus Movements Along
Supply Curves
Chapter 3 (2 of 6)
Defining, drawing, and
understanding an
individual business’
supply curve
➢ Ceteris Paribus
➢ The Law of Supply
1. Individual Supply: What You Sell, at
Each Price
Suppliers come in all
shapes and sizes
55
Can you name a seller?
➢ Amazon
➢ Target
➢ Netflix
You are also a seller!
➢ Sold furniture on Facebook
Marketplace or eBay.
➢ Sold your tickets to an event.
➢ If you have a job, you sell your
labour in return for a wage.
Key Definition (1 of 2) Diving into the Definition
56
Individual supply curve: A
graph plotting the quantity of an
item that a business plans to sell at
each price.
In other words, the supply curve
visually summarises the selling
plans of a business, and how those
plans vary with price:
➢Suppose you work part-time as a
tutor. How many hours are you
willing to tutor someone if they pay
you $25 per hour? What if the rate
increases to $50 per hour?
Individual: We are referring to one
business (as opposed to many businesses)
Supply: We are examining selling
decisions (as opposed to buying decisions)
Curve: We are graphing things
(sometimes these curves are straight lines)
Let’s create our first individual business’
supply curve!
Creating BP's Individual Supply Curve for Petrol
The quantity of petrol BP plans to sell
depends on the price they will receive for the
petrol: the higher price, the higher the
quantity supplied.
57
Quantity of petrol supplied
(millions of litres per week)
Connect the various quantities
supplied to get BP's supply curve
$1.80
$1.60
$1.40
$1.20
$1.00
0 50 100 130 160 190 220
Price of petrol
($ per litre)
$0.5
Price per litre Quantity
(millions of litres per week)
$1.80 per litre 220m litres
$1.60 per litre 190m litres
$1.40 per litre 160m litres
$1.20 per litre 130m litres
$1.00 per litre 100m litres
Below $1.00 per
litre
0 litres
An individual supply curve holds other things constant
Recall, ‘Ceteris Paribus’
(Latin phrase for 'holding other things constant')
Every time you draw an individual’s supply
curve, you are drawing this person’s selling
plans holding other things constant.
➢ If something important changed, like the
wage of oil refinery workers fell, then BP’s
selling plans would change, which means
their individual supply curve would
change.
58
Economists know that many factors other
than price can influence selling plans.
➢ But first, understand what happens
when the price (and only the price)
changes.
➢ Push these other factors aside for the
time being when drawing an individual’s
supply curve.
➢Then, later, bring other factors into
consideration separately.
The Law of Supply
59
As a seller, think about how you would react
to high versus low prices:
➢ As the price rises higher and higher…
➢ Your quantity supplied gets higher
and higher.
This pattern is so commonly seen among
sellers that it has its own name.
Law of supply: The tendency for quantity
supplied to by higher when the price is
higher.
This law implies that supply curves slope
upward:
➢ When drawing a supply curve, think:
“Supply to the Sky!”
© Worth Publishers
Key take-aways: Individual supply
60
The individual supply curve plots the quantity a person
plans to sell at each price, holding all other factors
constant (ceteris paribus).
➢ Other factors that impact a person’s selling plans will
be assessed later.
The Law of Supply: As price rises, the quantity supplied
rises.
➢ Or, equivalently, as price falls, the quantity supplied
falls.
Chapter 3 (3 of 6)
Being a seller in a perfectly
competitive market setting
➢ Sellers are price-takers
Examining Marginal Benefits
and Marginal Costs
The Rational Rule for Sellers
2. Your Decisions and Your Supply Curve
NOTICE! We have been discussing an individual’s selling plans, given the price.
Why isn’t BP choosing their own price?
➢ Because there are many other petrol
companies who can provide the same
product!
BP, just like many businesses, operates in a
perfectly competitive market:
➢ Markets in which 1) all firms in an
industry sell an identical good; and 2)
there are many buyers and sellers,
each of whom is small relative to the
size of the market
62
Because there are many small firms, all selling the
same product, an individual seller cannot set their
own price.
Example: If the prevailing market price for petrol
is $1.60 per litre, you could charge…
• $1.70, but would sell nothing
• $1.60 and sell whatever quantity you want
• $1.50 and sell whatever quantity you want
Outcome: You decide to charge the prevailing
market price and sell as much as you want.
➢ You are a price-taker
Not all Markets are Perfectly Competitive
Most markets have some degree of
imperfection:
➢Only a few buyers and/or sellers
➢Selling a unique product
➢Product has loyal customers
Result: Buyers and sellers may no
longer be price-takers.
So why start with prefect competition?
➢Nearly all markets have some degree of
competition.
➢Simplifies analysis
➢Build an analytical foundation
63
Applying the core principles to make good selling decisions
Marginal Principle: Break down the question of
”how many litres of petrol to sell?” into a series of
smaller marginal choices.
➢ “Should I supply one more litre of petrol?”
Cost-Benefit Principle: For each marginal
choice, sell the additional litre of petrol if the
benefits exceed the costs.
➢ Is the price for which you can sell the extra
litre of petrol at least as much as it costs to
make (its marginal cost)?
64
Opportunity Cost Principle: “Or what?” Always
make a comparison to the next best
alternative:
➢ If my business doesn’t produce this litre of
petrol, how else could we use our
resources? (This helps you figure out what to count as
marginal costs.)
Interdependence Principle: Everything is
connected! Your best choice depends on your
other choices, the choices other makes,
developments in other markets, and expectations
about future markets.
➢ “Holding other things constant” means we
will put aside these other factors for now
and return to them later.
The Supply Curve Is Upward-Sloping
Rising marginal costs explain why the supply
curve is upward-sloping.
➢ Eventually, as you try to expand production,
there will be bottlenecks that cause marginal
costs to increase.
Marginal product: The increase in output that
arises from an additional unit of an input, like
labour.
Diminishing marginal product: The marginal
product of an input declines as you use more of
that input.
65
Diminishing marginal product can occur in the
short run when some of your inputs are fixed.
Homework Example: To increase your
production of good grades, you need to work
more on your assignments.
➢ Your first few days are very productive, but
after a while you've got a pretty good paper.
➢You could keep working on it forever, but
the improvements will get smaller and
smaller!
Thus, marginal costs of production rise, which
translates into an upward slopping supply
curve.
The Supply Curve Is Upward-Sloping
Diminishing marginal product can occur
in the long run because, despite being able
to increase all inputs (i.e., expand the
kitchen or open another restaurant)…
➢ the new location isn’t as good.
➢ the new workers are less experienced
and take longer to get things done.
➢ managing a larger workforce or
multiple restaurants creates
coordination problems.
Ultimately, adding extra inputs won’t
produce as much extra output.
➢ Thus, marginal costs rise!
66
Rising input costs also lead to rising marginal
costs.
➢ Pay time-and-a-half to get your staff to
work overtime
➢ Need to offer higher wages to attract more
workers.
➢ Harder to find workers or other inputs
➢Maybe these inputs are located farther
away, raising transportation costs
Whatever the reason, marginal costs start to
rise, and so the supply curve slopes upward.
Key take-aways: Your decisions and your supply curve
67
In perfectly competitive markets, sellers are price-takers.
The Rational Rule for the Seller: Sell one more unit if the price is greater
than (or equal to) the marginal cost
➢ Keep selling until Price = Marginal Cost
Your supply curve and your marginal cost curve are one and the same.
Diminishing marginal product sets the stage for rising marginal costs.
➢ Hence, the supply curve is upward sloping.
Chapter 3 (4 of 6)
Add up individual supply to
discover market supply.
Market Supply is upward sloping.
Movements along the supply
curve.
3. Market Supply: What the Market Sells
Key Definition (2 of 2) Diving into the Definition
69
Market supply curve: A graph plotting
the total quantity of an item supplied
by the entire market, at each price.
Individual supply curves are the
building blocks of market supply:
➢ At each price, the total quantity of
petrol supplied is the sum of the
quantity that each business will
supply at that price.
➢ The market supply curve visually
summarises these selling decisions
across the various price points.
You can use the same the four-step
process you used when estimating
market demand to estimate market
supply.
1. Survey suppliers (and potential
suppliers).
2. For each price, add up the total
quantity supplied by all sellers.
3. Scale up!
4. Plot the total quantity supplied at
each price.
Shortcut if suppliers are similar:
➢ Suppose there 10 other oil refineries that are
making the same supply decisions as BP,
then at any given price the quantity supplied
will be 10 times the quantity BP supplies.
Using the Shortcut to Estimate Market Supply
70
The Market Supply Curve Is Upward Sloping
Reason 1:
Because the market supply curve is
made from adding up individual
supply curves at each price, it
inherits many of the same
characteristics.
Law of Supply: A higher price leads
businesses to supply a larger
quantity.
71
Reason 2:
A higher price means that it’s more
profitable to be a supplier in that
industry.
• current suppliers produce more
units,
• new suppliers enter the market
Lower prices means it’s less profitable
to be a supplier.
Key Definitions Diving into the Definition
72
A change in price causes a movement
along the supply curve, yielding a
change in the quantity supplied.
Movement along the supply curve: A
price change causes a movement
from one point on a fixed supply
curve to another point on the same
curve.
Change in the quantity supplied: The
change in quantity associated with
movement along a fixed supply
curve.
When the price rises from $1.20 to $1.40 ,
the quantity supplied changes from
130m to 160m. This is a movement along
the existing supply curve.
market
supply
curve$1.40
$1.20
160m130m Quantity
Price
Key take-aways: Market Supply
73
Market supply curve: The total quantity supplied by the entire
market at each price.
➢ Four-step process to estimate market supply
➢ Add up the quantities from each supply at each price.
When the price of the good changes, you simply move along the
existing supply curve to that new price point.
➢ Move from one point to another point.
➢ This price change triggers a change in the quantity
supplied (not a change in supply).
Chapter 3 (5 of 6)
Visualising increases and
decreases in supply.
Naming and understanding
the five factors that shift
the supply curve. 4. What Shifts Supply Curves?
Supply curve discussion
thus far…
75
➢ Focus on relationship between
price and quantity, ceteris
paribus
➢ Movement from one point to
another point on the same
supply curve
Now, something new!
Shift in the supply curve: a
movement of the supply curve itself
Recall
The supply curve is just a set of selling
plans. It illustrates the quantity a
business plans to sell at various prices,
holding other factors constant (ceteris
paribus ).
If other factors change…
➢then selling plans change…
➢then the supply curve changes.
Movie Example: In one month, the
quantity of movie tickets you buy at
any given price might change if…
➢you get a pay raise
➢Netflix premiers a great new series
Shifts in the Supply Curve
Increase in supply: a shift of the supply
curve to the right.
BP Petrol Example: If BP’s engineering
team discovers a more efficient way to
refine crude oil into petrol, then BP will
increase their supply of petrol.
Decrease in supply: a shift of the
supply curve to the left.
BP Petrol Example: If the chemical
additives used the refinery process get
more expensive, then BP will decrease
their supply of petrol.
76
Quantity
of petrol (millions of
litres per week)
Price
$1.6
$1.4
$1.2
$1.1
$1.0
130
Quantity
of petrol (millions of
litres per week)
Price
$1.6
$1.4
$1.2
$1.1
$1.0
130
old supply
curve
new supply
curve
old supply curvenew supply curve
160
100
The Interdependence Principle and
Shifting Demand Curves
Recall
The interdependence principle
says that everything is connected.
➢ Your best choice depends on
many other factors beyond
price. When these other factors
change, so might your selling
decisions.
77
The five factors that shift
the market supply curve:
1. Input prices
2. Productivity and technology
3. Prices of related outputs
4. Expectations
5. The type and number of sellers
... but not a change in price.
Key take-aways: What shifts a supply curve?
78
Increase in supply: a shift of the supply curve to the right.
➢ An increased quantity is supplied at each and every price.
Decrease in supply: a shift of the demand curve to the left.
➢ A decreased quantity is supplied at each and every price.
Five factors shift the demand curve.
➢ Be Careful: A change in the price does NOT shift supply.
➢ Be Careful: The effect of changing the price of a related
output depends on whether the two products are
complements or substitutes in production.
Shift versus Movement Along Supply
If the only thing changing is the
price of the good itself, then you
thinking about a movement
along the supply curve. This is a
change the quantity supplied.
But when other factors change,
you need to think about a shift in
the supply curve (recall the five
factors). This is a change in
supply itself.
Changes in price cause
changes in quantity
supplied
Changes in other factors
cause shifts in supply.
79
Quantity
Price
PriceSupply curve
Quantity
Original Supply
increased
demand
decreased
demand
Chapter 4 (1 of 4)
Equilibrium:
Where Supply
Meets Demand
1. Understanding Markets
What are markets, and how are
they organised?
2. Equilibrium
Supply equals Demand
Shortage and Surplus
3. Predicting Market Changes
Shifting demand and supply
80
Chapter 4 (3 of 4)
Equilibrium:
Where Supply
Meets Demand
2. Equilibrium
Supply equals Demand
Shortage and Surplus
81
Key Definitions: Diving into the Definition
82
Equilibrium: The point at which there is
no tendency for change. A market is in
equilibrium when the quantity supplied
equals the quantity demanded.
Equilibrium Quantity: The quantity
demanded and supplied in equilibrium.
Equilibrium Price: The price at which the
market is in equilibrium.
In equilibrium:
• Every seller who wants to sell an
item can find a buyer.
• Every buyer who wants to buy
an item can find a seller.
• This balance between the two
sides of the market is why there is
no tendency for the market price
to change from this equilibrium
point.
Visualising the Market Equilibrium
The supply-equals-demand equilibrium
occurs where the supply and demand curves
meet.
There is a surplus at $1.60 because the
quantity supplied exceeds the quantity
demanded. At $1.60, consumer is only willing
to buy 1.4 billion litres of petrol per week.
Suppliers are willing to sell 1.9 billion litres per
week.
There is a surplus of 500 million litres per
week.
There is a shortage at $1.20 because the
quantity demanded (1.8) exceeds the quantity
supplied (1.3).
83
Quantity of petrol
(billions of litres per week)
Price
of petrol Supply
Demand
1.6
$1.2
$1.4
$1.6
C
C
D
D
E
E
1.91.41.3 1.8
Examining Surplus and Shortage
At the supply-equals-demand
equilibrium there is no shortage or
surplus.
There is a SURPLUS whenever the
price is ABOVE the equilibrium price.
The higher the price is above the
equilibrium price, the larger the
surplus.
There is a SHORTAGE whenever the
price is BELOW the equilibrium price.
The lower the price is below the
equilibrium price, the larger the
shortage.
Quantity of petrol
(billions of litres per week)
Price
of petrol Supply
Demand
1.6
$1.2
$1.4
$1.6
C
C
D
D
E
E
84
A Shortage Pushes the Price Up
The Supplier’s Perspective
• At a price of $1.2 you totally sell out of petrol.
• Raising the price to $1.30 you still sell out of petrol.
• Raising the price to $1.35 you still sell all your petrol.
You can keep raising your price and sell all your petrol
(more profit for you!) as long as the shortage persists.
The Demander’s Perspective
• At a price of $1.2 you worry the petrol station will sell
out of petrol before you get the amount you want.
• You offer to pay 10 cents above the current price in
order to ensure you get all the petrol you want.
Consumers continue to push the price up as long as
the shortage persists.
When the price of petrol is BELOW the
equilibrium price level, there are too many
people chasing too little petrol, leading to a
shortage: Qd > Qs
Quantity of petrol
(billions of litres per week)
Price
of petrol Supply
Demand
$1.2
$1.4
1.3
Shortage
1.8
85
A Surplus Pushes the Price Down
The story:
At the current $1.6 price, suppliers have 500 million
litres of unsold petrol.
Petrol station owners want to sell these units and
know they can attract more customers if they lower
the price.
The falling price has two effects:
• As the price falls, the quantity demanded rises
(law of demand)
• As the price falls, the quantity supplied falls (law
of supply)
The price of petrol continues to fall until the surplus
is eliminated and the market forces are in balance at
the market equilibrium.
When the price of petrol is ABOVE the
equilibrium price level, not enough people want
to buy the petrol being sold, leading to a
surplus: Qd < Qs
Quantity of petrol
(billions of litres per week)
Price
of petrol
Supply
Demand
$1.4
$1.6
Surplus
1.91.4
86
Key take-aways: Equilibrium
87
Equilibrium: when quantity supplied equals quantity demanded
➢ Graphically, where the supply and demand curves cross
➢ At equilibrium there is no tendency for change.
Shortage: when quantity demanded exceeds quantity supplied
➢ Graphically, whenever price is below the equilibrium price
➢ A shortage pushes the price up.
Surplus: when quantity demanded is less than quantity supplied
➢ Graphically, whenever price is above the equilibrium price
➢ A surplus pushes the price down.
Chapter 4 (4 of 4)
Visualising and analysing…
➢Shifts in Demand
➢Shifts in Supply
➢Shifts in BOTH curves
3. Predicting Market Changes
Shifting demand and supply
88
Predicting Market Change:
Shifts in Demand
89
The market demand curve
summarises people’s current buying
plans, but if those plan change, then
the market demand curve will shift.
If the market demand curve shifts,
then the market moves to a new
equilibrium.
Let’s examine the market adjustment
process and the new equilibrium
outcomes!
Demand Shifters
1. Income (normal & inferior)
2. Preferences
3. Prices of complements and
substitutes
4. Expectations about the future
5. Congestion and network
effects
6. The type and number of byers
…but not a change in price
An Increase in Demand
Because demand increased, at the original
$1.4 price there is now a shortage.
This shortage kick-starts the adjustment
process that pushes the price up.
As the price rises, the quantity supplied
rises, and the quantity demanded falls.
The price stops rising when it hits $1.6, the
point at which Qd equals Qs once again.
Summary:
An increase in demand causes an increase
in both equilibrium price and quantity.
An increase in demand causes the
demand curve to shift right. Let’s analyse
the impact of this market change.
Quantity of petrol
(billions of litres per week)
Price
of petrol Supply
Old Demand
1.6
$1.4
$1.6
Increased
Demand
Shortage
1.9
90
A Decrease in Demand
Because demand decreased, at the original
$1.4 price there is now a surplus.
This surplus kick-starts the adjustment
process that pushes the price down.
As the price falls, the quantity supplied falls,
and the quantity demanded rises.
The price stops falling when it hits $1.2, the
point at which Qd equals Qs once again.
Summary:
A decrease in demand causes a decrease in
both equilibrium price and quantity.
A decrease in demand causes the
demand curve to shift left. Let’s analyse
the impact of this market change.
Quantity of petrol
(billions of litres per week)
Price
of petrol Supply
Old Demand
1.6
$1.4
$1.2
Decreased Demand
Surplus
1.3
91
Predicting Market
Change: Shifts in Supply
92
The market supply curve
summarises the current selling
plans, but if those plan change, then
the supply curve will shift.
If the market supply curve shifts,
then the market moves to a new
equilibrium.
Let’s examine the market
adjustment process and the new
equilibrium outcomes!
Supply Shifters
1. Input prices
2. Productivity and technology
3. Other opportunities and the
prices of related outputs
4. Expectations about the future
5. The type and number of sellers
…but not a change in price
Chapter 5 (1 of 5)
Elasticity:
Measuring
Responsiveness
1. Price Elasticity of Demand
2. How Businesses Use Demand Elasticity
3. Other Demand Elasticities
4. Price Elasticity of Supply
Chapter 5 (2 of 5)
Measure the responsiveness
of the quantity demanded to
price changes, using the price
elasticity of demand
1. Price Elasticity of Demand
What we know so far…
95
Law of demand tells us that when prices
fall, the quantity demanded will rise.
But, by how much?
➢ If cutting prices only leads to a few new
sales, then it was a bad strategy.
➢ If cutting prices leads to a lot more
sales, then it was a good strategy.
How responsive are buyers to prices?
Will buyers respond a lot or a little to
changing prices?
Key Definition (1 of 5) Diving into the Definition
96
Price elasticity of demand: A
measure of how responsive buyers
are to price changes. It measures the
percent change in quantity demanded
that follows from a 1% price change.
Price elasticity of demand =
% change in quantity demanded
% change in price
Scenario: If cutting the price of an Uber ride in
Sydney by 15% leads to a rise in quantity
demanded by 30%, then the price elasticity
of demand for Uber rides is…
%∆Q = +30% = |-2 | = 1.67
%∆P __ _ -15% _ __ ___________
|-2 | = 2
The price elasticity of demand is a negative
number (of course!).
➢ The negative sign gives no additional
information.
➢ To focus on the magnitude, economists
take the absolute value.