Micro review 1 for International Economics' students: the simple market model (pdf version). The notes for each slide can be read below. However, some of them were chopped off. So they are not always complete. Still, short of having a computer with PowerPoint, this is good.

1. This
video
clip
reviews
the
microeconomic
concepts
that
we’ll
be
using
in
our
course.
-­‐-­‐-­‐-­‐-­‐
Mee:ng
Notes
(1/22/12
08:53)
-­‐-­‐-­‐-­‐-­‐
In
our
interna:onal
economics
course.
1

2. The
review
includes
two
items:
(1)
the
mechanics
of
the
simple
model
of
a
compe::ve
market
that
economists
use
and
(2)
the
underpinnings
of
the
conven:onal
choice
theory
–
both
collec:ve
and
individual.
2

3. First
off,
what
is
a
market?
For
our
purposes
here,
we’ll
view
a
market
as
a
bunch
of
people
trading
a
good
on
a
voluntary
basis.
The
good
defines
the
market.
If
the
good
is
oranges,
then
it
is
a
market
for
oranges.
Markets
are
social
structures
–
people
rela:ng
to
one
another
in
certain
ways
(in
this
case,
acknowledging
and
respec:ng
their
mutual
property
and
coopera:ng
with
one
another
via
trade).
For
more
on
this,
see
my
slides
on
Coopera:on
&
Social
Structures.
At
this
point,
we
make
the
assump:on
that
this
market
is
compe::ve.
By
this
we
mean,
first,
that
the
good
is
homogeneous.
There
are
no
differences
in
the
quality
or
characteris:cs
of
the
good.
Say
it
is
oranges.
They
are
generic
oranges.
For
a
buyer,
it
doesn’t
maVer
who
supplies
the
oranges,
because
they
all
look
and
taste
and
smell
the
same.
And
second,
to
say
that
the
market
is
compe::ve
is
to
say
that
there
are
many
buyers
and
many
sellers,
so
no
par:cular
buyer
or
seller
has
“market
power”
–
i.e.
the
ability
to
manipulate
the
price
individually.
And
since
there
are
many
and
the
good
is
the
same,
the
sellers
cannot
differen:ate
the
good
or
form
coali:ons.
Neither
can
the
buyers.
Basically,
it’s
just
a
bunch
of
individual
buyers
and
sellers
trying
to
do
the
best
they
can
for
each
of
them
individually
without
regard
for
the
3

4. We
split
the
people
into
two
groups
–
one
group,
we
call
the
buyers.
These
people
have
money
and
want
the
good.
The
second
group
is
the
sellers.
These
people
have
the
good,
but
they
want
the
money.
The
two
groups
meet
and
make
the
market
by
nego:a:ng
prices
at
which
they
are
willing
to
trade.
There
will
be
a
single
price
in
this
market,
at
which
all
buyers
will
buy
the
good
and
all
sellers
will
sell
the
good.
Once
the
two
groups
agree
on
a
price
such
that
the
buyers
want
to
buy
the
same
amount
of
the
good
that
the
sellers
wish
to
sell
–
and
we
call
that
the
“market
equilibrium”
–
the
deal
is
made,
they
shake
hands,
sellers
hand
the
good
to
the
buyers,
buyers
pay
the
sellers
the
money,
and
each
group
goes
home
happier
or
at
least
not
less
happy
than
they
were
before.
Remember:
it
is
a
voluntary
transac:on.
If
people
felt
that
trading
made
them
less
happy,
then
why
would
they
do
it
voluntarily?
We
construct
the
model
in
the
following
way:
First,
we
study
the
behavior
of
buyers.
We
call
that
the
demand
side.
Second,
we
study
the
behavior
of
the
sellers.
We
call
that
the
supply
side.
Third,
we
put
the
two
together.
We
call
that
equilibrium.
Fourth,
we
study
how
equilibrium
is
aVained.
Fi]h,
we
shock
the
model
by
making
some
or
other
factor
(other
than
price)
affect
the
behavior
of
buyers
or
sellers
or
both,
and
see
what
the
model
predicts.
This
is
the
way
in
which
we
test
the
model.
If
the
predic:ons
of
the
model
match
what
we
observe
in
reality,
then
–
and
to
that
extent
–
we
deem
the
model
as
reliable
and
use
it
in
our
prac:cal
applica:ons.
4

5. Demand.
The
ques:on
we
pose
here
is:
What
makes
buyers
buy
more
(or
less)
of
a
good?
There
are
many
factors.
Let
me
limit
my
list
to
a
few
of
these
factors:
Price
is
the
first
one.
And
in
the
graphic
model
that
we
use,
this
is
the
variable
that
is
explicitly
included
in
the
analysis.
Economists
say
that
this
variable,
price,
and
the
quan:ty
traded
(demanded
and
supplied)
are
the
*endogenous*
variables.
Other
variables,
which
are
not
explicitly
visible
in
the
analysis,
are
called
*exogenous*.
It
doesn’t
mean
that
we
don’t
care
about
them.
We
have
ways
to
reflect
the
impact
of
changes
on
those
variables
on
our
market
model
–
on
price
and
quan:ty.
But
our
liVle
model
cannot
explain
*why*
they
change.
We
are
just
going
to
assume,
whenever
we
may
deem
that
convenient,
that
these
variables
change
and
then
register
the
effect
of
those
changes
on
price
and
quan:ty.
Price
maVers
here,
because
–
and
this
seems
like
a
reasonable
assump:on
to
make,
since
it
appears
to
match
what
we
observe
in
the
world
–
if
the
price
is
higher,
buyers
will
tend
to
buy
less
of
the
good.
If,
on
the
other
hand,
the
price
is
lower,
buyers
will
tend
to
buy
more.
So,
there’s
a
nega:ve
or
inverse
rela:onship
between
price
and
quan:ty
demanded
–
the
quan:ty
that
buyers
wish
to
buy
given
all
other
things.
5

6. Here’s
the
graph
of
the
demand
rela:onship.
This
graph
(the
curve
or
line)
shows
directly
the
rela:onship
between
the
quan:ty
demanded
for
the
good
and
the
price
of
the
good.
It
is
a
nega:ve
rela:onship.
That
is
why
the
slope
of
the
line
is
nega:ve.
The
line
is
downward
sloping.
Now,
for
simplicity,
I’m
drawing
it
as
a
straight
line.
Real
demand
lines,
if
we
are
able
to
es:mate
them
(and
there
are
difficul:es
to
es:mate
them
empirically),
don’t
need
to
be
straight
lines.
This
is
a
simplifica:on,
but
it
is
a
simplifica:on
that
helps
us
clarify
things
nicely.
Note
that
in
this
graph,
we
can
only
show
two
variables
explicitly
or
directly.
As
I
said,
the
two
variables
we
care
most
about
are
the
price
and
the
quan:ty
traded.
So
the
graph
only
shows
the
link
between
price
and
quan:ty
explicitly.
When
we
consider
the
change
in
the
price
of
the
good
and
then
the
reac:on
of
buyers,
then
we
say
that
we
are
“moving
along”
the
demand
line
or
demand
curve.
Let
me
note
that
we
are
drawing
the
demand
curve
as
a
straight
line
for
convenience
only.
There
is
no
reason
why
an
actual
demand
curve
would
be
linear.
6

7. When
other
factors
(not
explicitly
indicated
-­‐-­‐
the
factors
that
we
listed
before:
income,
tastes,
other
prices,
expecta:ons)…
when
those
factors
change,
that
has
an
effect
on
the
whole
demand
line.
The
demand
line
shi]s.
For
example,
suppose
that
this
is
the
market
for
oranges
and
the
price
of
apples
increases.
Then,
as
a
result,
the
en:re
demand
line
for
oranges
may
shi]
to
the
right
–
indica:ng
that
for
each
given
price,
buyers
are
willing
to
buy
more
oranges
due
to
the
higher
price
of
apples.
This
is
called
a
rightward
*shi]*
of
the
demand
line.
It
is
easy
to
see
that
the
effect
of
changes
in
the
other
variables
listed
(variables
other
than
price
and
the
quan:ty
demanded)
can
be
shown
in
this
graph
as
a
shi]
of
the
demand
line.
Now,
just
by
looking
at
the
shi]
in
the
diagram,
we
may
not
be
able
to
know
what
cause
that
shi].
So,
we’ll
need
to
add
separate
informa:on
to
our
diagram
so
that
we
know
why
the
graph,
the
demand
line
shi]ed.
7

8. Let
us
now
consider
…
supply.
This
is
the
descrip:on
of
how
the
sellers
(the
other
side
of
the
market)
behave.
The
ques:on
here
is:
What
makes
sellers
sell
more
(or
less)
of
a
good?
There
are
also
many
factors.
These
are
a
few
important
ones:
Price
is,
again,
the
first
one.
The
higher
the
price,
the
more
of
the
good
the
sellers
would
want
to
sell,
other
things
equal.
Suppose
that
the
producers
and,
more
generally,
the
sellers
of
the
good
are
business
people.
They
are
offering
the
good
for
sale,
because
they
want
to
make
a
profit.
The
profit
they
obtain
per
unit
of
the
good
is
the
difference
between
the
price
of
the
good
and
the
cost
of
the
good
for
them.
Let
us
define
here
the
cost
of
the
good
as
the
minimum
price
at
which
the
sellers
are
willing
to
sell
the
good.
Clearly,
if
the
cost
of
the
good
is
given,
the
higher
the
price,
the
higher
their
profit.
On
the
other
hand,
if
the
price
of
the
good
is
given,
then
the
lower
the
cost
of
the
good,
the
higher
the
profit.
Given
the
price
of
the
good,
its
cost
is
going
to
be
their
main
considera:on
when
deciding
how
much
of
the
good
to
sell.
What
is
the
cost:
Well,
if
they
are
the
producers,
they
need
to
assemble
the
inputs
required
to
produce
the
good
and
pay
8

9. Here’s
the
graph
of
the
supply
rela:onship.
This
graph
(the
curve
or
line)
shows
directly
the
rela:onship
between
the
quan:ty
supplied
of
the
good
and
the
price
of
the
good.
It
is
a
posi:ve
rela:onship.
The
supply
curve
or
line
is
upward
sloping.
For
simplicity,
I
draw
it
as
a
straight
line.
Real
supply
lines,
also
hard
to
es:mate
empirically,
don’t
need
to
be
straight
lines.
But
we
are
simplifying
maVers.
You
will
note
that
the
supply
curve
here
is
also
a
straight
line,
just
like
the
demand
curve
was
a
straight
line.
Again,
this
is
for
convenience
only.
There
is
no
reason
why
an
actual
demand
or
supply
curves
would
be
linear.
Now,
again,
if
we
are
studying
the
change
in
the
price
of
the
good
and
how
sellers
react
to
it,
we
are
“moving
along”
the
supply
curve.
9

10. When
the
other
factors
change,
the
supply
curve
shi]s
en:rely.
Suppose
that
this
is
the
market
for
oranges
and
the
price
of
labor
decreases
(say,
there
is
high
unemployment
in
the
area
and
workers
have
to
accept
lower
wages).
Then,
as
a
result,
the
en:re
supply
curve
to
the
right
–
indica:ng
that
for
each
given
price,
sellers
are
willing
to
sell
more
oranges
due
to
the
lower
cost
of
labor.
This
is
called
a
rightward
*shi]*
of
the
supply
curve.
And
when
any
of
the
other
factors
may
change,
we
can
do
something
similar
to
register
that
change
and
its
effect
on
the
market
in
our
diagram.
10

11. We
are
now
ready
to
put
the
demand
and
the
supply
sides
together.
In
the
diagram,
we
show
now
the
demand
and
the
supply
curves.
Demand
is
downward
sloping.
Supply
is
upward
sloping.
As
a
result,
they
cross
at
a
point.
Let
us
examine
the
point
where
they
cross.
The
demand
curve
shows
the
different
quan::es
of
the
good
that
buyers
wish
to
buy
at
different
prices
(given
the
economic
environment).
The
supply
curve
shows
the
different
quan::es
of
the
good
that
sellers
wish
to
sell
at
different
prices
(again,
given
the
economic
environment).
The
point
where
the
two
curves
cross
is
a
price
and
a
quan:ty
–
the
price
at
which
the
quan:ty
demand
and
the
quan:ty
supplied
are
equal.
At
this
price,
buyers
and
sellers
agree
on
the
quan:ty
they
wish
to
trade.
We
call
it
equilibrium,
because
if
nothing
changes
in
the
economic
environment,
then
there
is
no
reason
why
buyers
or
sellers
may
want
to
be
somewhere
else
rather
than
at
that
point.
Consider
the
case
where
the
price
is
higher
than
the
equilibrium
price
–
say
about
here.
Note
then
that
the
quan:ty
that
buyers
want
to
buy
falls
short
of
the
quan:ty
that
sellers
want
to
sell.
As
a
consequence,
there
is
no
deal.
There
is
a
gap
between
the
quan:ty
demanded
and
the
quan:ty
supplied.
Economists
call
that
gap
a
glut.
It
11

12. Let
us
now
do
the
algebra.
The
demand
equa:on
is
this
one:
P
=
12
-­‐
.8
Qd
where
12
is
the
ver:cal
intercept
and
-­‐0.8
is
the
slope.
The
intercept
or
any
price
above
it
would
discourage
buyers
from
buying
the
good.
No
buyer
would
pay
that
much
for
the
good.
The
slope
(.8)
indicates
the
drop
in
the
price
that
would
make
buyers
buy
one
extra
unit
of
the
good.
Note
that
the
ver:cal
axis
shows
you
how
much
the
buyers
value
one
unit
of
the
good.
It
indicates
how
much
they
benefit
from
it,
since
they
would
only
pay
the
price
for
it
if
they
felt
that
the
benefit
received
compensates
them
properly.
12

13. And
here
is
the
supply
equa:on:
P
=
2
+
.2
Qs,
where
2
is
the
ver:cal
intercept
and
0.25
is
the
slope.
At
the
intercept
or
any
price
below
it,
no
seller
would
sell
any
of
the
good.
The
slope
indicates
the
increase
in
the
price
that
would
lead
sellers
to
sell
one
extra
unit
of
the
good.
It
is
important
to
note
here
that
the
ver:cal
axis
also
shows
how
much
the
sellers
value
the
good.
It
indicates
how
much
the
good
costs
the
sellers,
since
they
would
only
sell
it
if
they
feel
compensated
for
such
cost.
13

14. We
have
a
system
of
two
linear
equa:ons.
The
demand
has
to
sa:sfy
the
rule
P
=
12
-­‐
.8
Qd
and
the
supply
the
rule
that
P
=
2
+
.2
Qs.
In
equilibrium,
the
price
that
buyers
pay
is
the
same
price
that
the
sellers
receive.
And
the
quan:ty
that
the
buyers
want
to
buy
is
the
quan:ty
that
the
sellers
want
to
sell.
In
other
words,
the
equilibrium
price
and
quan:ty
are
the
values
of
P
and
Q
that
solve
the
two
equa:ons
simultaneously.
Let
us
solve
the
system
algebraically
now.
Since
the
price
has
to
be
the
same
for
both
buyers
and
sellers,
then
we
can
make
the
RHS
of
these
equa:ons
equal
and
then
solve
for
Q,
which
is
also
only
one
Q,
both
quan:ty
demanded
and
quan:ty
supplied.
A]er
doing
the
algebra,
we
find
that
the
quan:ty
that
both
buyers
and
sellers
want
to
trade
is
10
units
of
the
good.
By
plugging
this
value
of
Q
in
any
of
the
original
equa:ons,
we
find
the
equilibrium
price,
which
is
$4/unit.
I
do
the
subs:tu:on
with
both
equa:ons,
demand
and
supply,
to
show
that
the
result
must
be
the
same.
…
The
equilibrium
is
a
pair
of
numbers,
a
price
and
a
quan:ty:
10
units
of
the
good
and
$4/unit.
14

15. Let
us
use
now
the
model
for
its
prac:cal
purpose.
We
need
it
to
predict
the
response
of
the
market
to
changes
in
the
economic
environment.
Say,
for
example,
that
we
want
to
know
the
effect
on
the
market
(on
its
Q*
and
P*)
of
a
new
sales
tax
by
of
$2/unit
of
the
good.
Note
that
the
same
effect
would
result
from
any
other
change
in
the
economic
environment
leading
to
a
le]ward
shi]
of
the
supply
curve
of
the
same
size.
The
result
is
a
new
equilibrium.
A
higher
price
and
a
smaller
quan:ty.
I’ll
leave
up
to
you
to
consider
what
happens
to
the
equilibrium
price
and
quan:ty
if
the
supply
curve
shi]s
to
the
right
instead.
Also,
what
happens
to
the
market
(to
Q*
and
P*)
if
the
supply
curve
does
not
move,
but
the
demand
curve
shi]s
to
the
right
and
le]?
Play
with
the
model
un:l
you
feel
comfortable
enough
understanding
its
mechanics
and
implica:ons.
15

16. Let
us
now
do
the
algebra
for
the
new
condi:ons
in
the
market.
The
demand
equa:on
stays
the
same.
But
the
supply
curve
has
a
new
–
higher
–
intercept:
The
supply
equa:on
is
now
P
=
4
+
.2
Qs.
Let
us
solve
the
new
system
for
P*
and
Q*.
Again,
since
the
price
has
to
be
the
same
for
both
buyers
and
sellers,
then
we
can
make
the
RHS
of
these
equa:ons
equal
and
then
solve
for
Q,
which
is
also
only
one
Q,
both
quan:ty
demanded
and
quan:ty
supplied.
We
find
that
the
quan:ty
that
both
buyers
and
sellers
want
to
trade
is
8
units
of
the
good.
Again,
we
plug
this
value
of
Q
in
any
of
the
original
equa:ons
to
find
the
equilibrium
price,
which
is
now
$5.6/unit.
I
do
this
subs:tu:on
in
both
equa:ons,
demand
and
supply,
to
show
again
that
the
result
is
the
same.
The
new
equilibrium
is
8
units
of
the
good
and
$5.6/unit.
16

17. 17

18. 18

19. Suppose
the
price
in
the
market
is
$4/unit.
The
amount
that
buyers
will
buy
at
that
price
is
10
units.
The
buyers’
total
benefit
(so-­‐called
“consumer”
benefit)
is
the
area
under
the
demand
curve
and
bound
by
the
quan:ty:
10
units.
Now,
the
buyers
spend
in
the
good:
P
Q
=
($4/unit)
(10
units)
=
$40.
They
receive
the
10
units
of
the
good
that
yields
for
them
the
total
benefit.
However,
a
por:on
of
the
total
benefit
–
the
rectangle
represen:ng
their
expenditure
–
is
not
free.
They
pay
for
that.
S:ll,
there
is
the
triangle
above
the
expenditure
rectangle
for
which
buyers
pay
nothing.
It
is
their
net
benefit
or
“consumer
surplus.”
It
is
the
welfare
that
buyers
receive
for
free
from
the
amount
of
the
good
they
buy
from
the
sellers.
They
receive
this
net
benefit
or
“consumer
surplus”
because
the
market
exists
–
because
there
is
another
side
to
the
market,
because
there
are
sellers
willing
to
cooperate
or
trade
with
them.
This
is
the
source
of
the
consumer
surplus.
The
consumer
surplus
is
represented
by
the
area
of
that
triangle.
To
calculate
the
area,
we
use
the
formula
(b
h)/2.
In
this
case,
the
base
is
10
units
and
the
height
is
the
intercept
of
the
demand
curve
minus
the
price
in
the
market,
which
is
$4/unit.
Therefore,
it
is
12-­‐4
=
8,
mul:plied
by
10,
that
is
80,
and
80
divided
by
2
is
40.
Note
that
the
units
are
just
dollars:
$40.
The
values
on
the
ver:cal
axis
are
prices:
$/unit.
So
$12/unit
minus
$4/unit
=
$8/unit.
Now
when
you
mul:ply
$/unit
:mes
units,
the
units
cancel
out,
and
you
obtain
$,
just
plain
dollars.
19

20. 20

21. Let
us
now
calculate
the
producer
surplus.
Again,
if
the
price
in
the
market
is
$4/unit.
The
amount
that
sellers
will
sell
at
that
price
is
10
units.
Remember
that
the
height
of
the
supply
curve
indicates
the
lowest
price
that
sellers
ask
for
one
unit
of
the
good,
and
that
is
precisely
the
cost
of
the
good
for
them.
The
sellers’
total
receipts
or
revenues
are
P
Q
=
(4)
(10)
=
$40.
That
is
represented
by
this
rectangle.
The
area
below
the
supply
curve
and
bound
by
the
quan:ty:
10
units
is
the
cost
for
the
producers.
Note
that
the
sellers’
revenues
P
Q,
$40,
are
more
than
the
sellers’
cost.
The
difference
of
R
–
C
=
profit.
The
profit
is
also
called
the
“producer
surplus.”
The
consumer
surplus
is
represented
by
the
area
of
this
triangle.
Again,
the
area
is
(b
h)/2.
In
this
case,
the
base
is
10
units
and
the
height
is
the
market
price,
$4/unit,
minus
the
intercept
of
the
supply
curve,
$2/unit.
The
height
is
then
4-­‐2
=
$2/unit.
Therefore,
the
producer
surplus
is
(10)
(2)
=
20,
divided
by
2:
$10.
So,
the
net
welfare
benefit
of
the
sellers,
their
profit
or
producer
surplus,
is
a
measure
of
the
welfare
of
sellers
in
the
market
–
something
they
receive
for
free,
because
the
market
exists.
It
is
calculated
in
dollars.
It’s
$10.
21

22. The
total
surplus
or
the
net
welfare
benefit
that
the
buyers
and
sellers
receive
altogether
is
the
sum
of
the
consumer
and
the
producer
surpluses.
22

23. In
other
words,
the
total
surplus
is
equal
to
$40
+
$10
=
$50.
To
repeat:
This
is
a
measure
of
the
net
welfare
benefits
that
both
buyers
and
sellers
together
receive
as
a
result
of
the
existence
of
the
market,
which
is
to
say,
as
a
result
of
their
coopera:ng
with
each
other.
It’s
the
fruits
of
their
coopera:on,
which
–
in
this
par:cular
case
–
takes
the
form
of
trade.
And
to
keep
the
:me
of
this
videos
short,
there’s
no
summary.
You
can
go
back
and
replay
the
parts
that
you
may
need
to
study
more
carefully.
I
hope
this
was
helpful
to
you.
I’ll
see
you
in
class.
23