Chapter 1

The Market
RMBPanti, ADMU
A. Economic Models
 Constructing a Model
Exogenous Variable

Variable taken as determined by factors not discussed in

the model

Endogenous Variable

Variable determined by factors described in the model

 Optimization and Equilibrium
Optimization Principle

People try to choose the best patterns of consumption that

they can afford

Equilibrium Principle

Prices adjust until the amount that people demand of

something is equal to the amount that is supplied.
B. The Demand Schedule
 Demand Curve
P

20
19

17

10

Q
1 2 3 7 10
 Demand Curve

Reservation Price

The highest price that a given person will accept and still
purchase the good.
 Demand Curve
P

20
19

17

10

Q
1 2 3 7 10
 Demand Curve
P

Q
 Demand Curve
Demand Schedule or Demand Curve

Relationship between the market price and quantity

bought

Law of Downward-Sloping Demand Curve

When the price of a commodity is raised (and other things

are held constant), buyers tend to buy less of the
commodity.
C. The Supply Schedule
 Supply Curve
P

19

14

8
6

Q
1 2 3 7 10
 Supply Curve
P

19

14

8
6

Q
1 2 3 7 10
 Supply Curve
P

Q
 Supply Curve

Supply Schedule or Supply Curve

Relationship between the market price and the amount of

commodity producers are willing to produce and sell,
usually upward sloping
 Supply Curve
P P

Q Q
Short Run Long Run
 Exercise
Suppose that we have 8 people who want to rent an
apartment. Their reservation prices are given below.
Person A B C D E F G H
Price 30 26 24 20 18 15 14 10

1. Plot the market demand curve in the following graph.

2. Suppose the supply of apartments is fixed at 5 units. What
is the highest price that would make the demand for
apartments equal to 5 units?
3. What is the lowest price that would make the market
demand equal to 5 units?
 Exercise
Suppose that we have 8 people who want to rent an
apartment. Their reservation prices are given below.

Person A B C D E F G H
Price 30 26 24 20 18 15 14 10

4. With a supply of 4 apartments, which of the people A - H

end up getting apartments?
5. What if the supply of apartments increases to 6 units. What
is the range of equilibrium prices?
D. Market Equilibrium
 Equilibrium
P

20
19

17

P*
10

Q
1 2 3 Q*7 10
 Supply Curve
P P

P*

Q Q
Q*
Short Run Long Run
 Market Equilibrium

• Price and quantity where the forces of supply and

demand are in balance
• Comes at the price at which quantity demand equals
quantity supplied
• Also called market clearing
 Market Equilibrium
P
S

surplus
P’

QD QS Q
 Market Equilibrium
P
S

P’
shortage
D

QS QD Q
 Market Equilibrium
P
S

P* E

Q* Q