LT2.

HOW MARKETS WORK

Assistant Professor (Dr) FAN Yi
Department of Real Estate
National University of Singapore
LECTURE STRUCTURE IN THE 1ST PART
 Today: How market works

 29 Jan: Elasticity & consumer choice

 5 Feb: Producer choice

 19 Feb: Market efficiency & economics of public sector

 9 Apr: Income inequality & redistribution

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STRUCTURE FOR EACH LECTURE
 Real estate motivation
 City story

 Revision of last lecture

 In-class practice (last lecture): 2-3MCQ, 5mins, open book
 In-class interaction via PollEverywhere/questions
 Summary of today’s lecture

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STILL HAVE QUESTIONS?

 Stay for 5-10 mins after class for Q & A

 Interact with me at PollEverywhere

 Drop me email: yi.fan@nus.edu.sg

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REAL ESTATE MOTIVATION

 Why is there trade on building materials between

companies/countries?

 What is the equilibrium price of housing

transaction?

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OUTLINE OF THIS LECTURE

• Comparative Advantage and Trade

• Pricing Mechanism: Demand, Supply, and Equilibrium

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Comparative Advantage and Trade

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 INTERDEPENDENCE
hair gel from
Every day you rely on Cleveland, OH
many people from
around the world,
cell phone
most of whom you’ve from Taiwan
never met, to provide
you with the goods dress shirt
and services you from China
enjoy.
coffee from
Kenya
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©Phil Date/Shutterstock.com
 INTERDEPENDENCE
 “Trade can make everyone better off” (Lecture 1)

 One of the Ten Principles of Economics

 Why people – and nations – choose to be interdependent?

 How they can gain from trade?

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 A PARABLE FOR THE MODERN ECONOMY
 Only two goods

 Meat

 Potatoes

 Only two people

 A cattle rancher named Ruby

 A potato farmer named Frank

 Both would like to eat both meat and potatoes

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10
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 A PARABLE FOR THE MODERN ECONOMY, PART 1
 If Ruby produces only meat and Frank produces only potatoes

 Both gain from trade

 If both Ruby and Frank produce both meat and potatoes

 Both gain from specialization and trade

 What if one person is better at producing every good?

 Still gain from trade?

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 FIGURE 1 THE PRODUCTION POSSIBILITIES FRONTIER (A)
Empty cell Minutes Minutes Amount of Amount of
needed to needed to meat potatoes
make 1 ounce make 1 ounce produced in 8 produced in 8
of meat of potatoes hours hours

Frank the 60 minutes per 15 minutes per 8 ounces 32 ounces

farmer ounce ounce
Ruby the 20 minutes per 10 minutes per 24 ounces 48 ounces
rancher ounce ounce

 Production possibilities frontier：Various mixes of output that an economy can produce

.

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
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FIGURE 1 THE PRODUCTION POSSIBILITIES FRONTIER
(b) Frank’s production (c) Ruby’s production
possibilities frontier possibilities frontier

 Both production possibilities frontiers are derived assuming that Frank and Ruby each work 8 hours per day.

 If there is no trade, each person’s production possibilities frontier is also his or her consumption possibilities frontier.

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 A PARABLE FOR THE MODERN ECONOMY, PART 2
 Specialization and trade

 Farmer Frank specializes in growing potatoes

 More time growing potatoes: 8 hours per day

 Less time raising cattle: 0 hour

 Rancher Ruby specializes in raising cattle

 More time raising cattle: 6 hours per day

 Less time growing potatoes: 2 hours per day

 Trade: 5 oz of meat for 15 oz of potatoes

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
FIGURE 2 HOW TRADE EXPANDS CONSUMPTION OPPORTUNITIES
Empty cell Frank’s meat Frank’s potatoes Ruby’s meat Ruby’s potatoes

Production and 4 ounces 16 ounces 12 ounces 24 ounces

consumption
without trade
Production with trade 0 ounce 32 ounces 18 ounces 12 ounces

Trade Gets 5 ounces Gives 15 ounces Gives 5 ounces Gets 15 ounces

Consumption with trade 5 ounces 17 ounces 13 ounces 27 ounces

Increase in Increase of 1 Increase of 1 Increase of 1 Increase of 3

consumption with gains ounce ounce ounce ounces
from trade

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
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 FIGURE 2 HOW TRADE EXPANDS CONSUMPTION OPPORTUNITIES
(a) Frank’s production (b) Ruby’s production
and consumption and consumption

 The proposed trade between Frank the farmer and Ruby the rancher offers each of them a combination of meat
and potatoes that would be impossible in the absence of trade.
 In panel (a), Frank gets to consume at point A* rather than point A.
 In panel (b), Ruby gets to consume at point B* rather than point B.
 Trade allows each to consume more meat and more potatoes.

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a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 COMPARATIVE ADVANTAGE, PART 1
 Absolute advantage

 The ability to produce a good using fewer inputs than

another producer

 In producing meat: Ruby

 Ruby needs 20 min. to produce 1 oz of meat
 Frank needs 60 minutes

 In producing potatoes: Ruby

 Ruby needs 10 min. to produce 1 oz of potatoes
 Frank needs 15 minutes

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
COMPARATIVE ADVANTAGE, PART 2
 Opportunity cost

 Whatever must be given up to obtain some item

 Measures the trade-off between the two goods that

each producer faces

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
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 COMPARATIVE ADVANTAGE, PART 3
 Opportunity cost

 Frank: 60 min. to produce 1 oz meat, and 15 min. to produce 1 oz

potatoes

 To produce 1 more oz meat, give up 4 oz potatoes

 To produce 1 more oz potatoes, give up ¼ oz meat

 Ruby: 20 min. to produce 1 oz meat, and 10 min. to produce 1 oz

potatoes

 To produce 1 more oz meat, give up 2 oz potatoes

 To produce 1 more oz potatoes, give up ½ oz meat
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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 THE OPPORTUNITY COST OF MEAT AND POTATOES

Opportunity cost of Opportunity cost of

1 ounce of meat 1 ounce of potatoes

Frank the farmer 4 ounces of potatoes 1/4 ounce of meat

Ruby the rancher 2 ounces of potatoes 1/2 ounce of meat

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 COMPARATIVE ADVANTAGE, PART 4
 Comparative advantage

 The ability to produce a good at a lower opportunity cost than

another producer
 Reflects the relative opportunity cost

 Principle of comparative advantage

 Each good should be produced by the individual that has the smaller
opportunity cost of producing that good

 Specialize according to comparative advantage

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license 21
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 COMPARATIVE ADVANTAGE, PART 5
 One person
 Can have absolute advantage in both goods
 Cannot have comparative advantage in both goods

 For different opportunity costs

 One person has comparative advantage in one good
 The other person has comparative advantage in the other good

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 22
COMPARATIVE ADVANTAGE, PART 6
 Gains from specialization and trade

 Based on comparative advantage

 Total production in economy rises

 Increase in the size of the economic pie

 Everyone is better off

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
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 COMPARATIVE ADVANTAGE, PART 7
 Trade can benefit everyone in society
 Allows people to specialize in activities in which they have a
comparative advantage
 The price of trade
 Must lie between the two opportunity costs

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distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 24
CITY STORY: APPLICATIONS OF COMPARATIVE ADVANTAGE

Should Serena Williams Mow Her

Own Lawn?

 Serena, in 2 hours
– Mow her lawn, or
– Film a TV commercial, earn $30,000

 Forest Gump, in 4 hours

– Mow Serena’s lawn “They did a nice job
with this grass.”
– Work at McDonald’s, earn $50

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Pricing Mechanism:

Demand, Supply, and Equilibrium

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 MARKET AND COMPETITION
 Supply and demand

 Words economists use most often

 The forces that make market economies work
 Refer to the behavior of people as they interact with one
another in competitive markets

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 27
WHAT IS A MARKET?
• Buyers: demand for the product
• Sellers: supply of the product
• Market: a group of buyers and sellers of a particular good or service

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 MARKETS AND COMPETITION

• Competitive market? A market in which there are many buyers and

many sellers so that each has a negligible impact on the market price

• Market price and quantity of a good are not determined by any

single buyer or seller, but by all buyers and sellers as they interact in
the marketplace

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 MARKETS AND COMPETITION

• Perfectly competitive market (highest form of competition): Buyers

and sellers in perfectly competitive markets are price takers

• Monopoly: with only one seller who sets the price

• Most markets are between perfect competition and monopoly

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PRICING MECHANISM? DEMAND & SUPPLY
• Law of demand: other things being equal, the quantity demanded of a good
(housing) falls when the price of the good rises

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 LAW OF DEMAND
• The Demand Curve: a graph of the relationship between Price of a good
and Quantity Demanded  why downward slope?

• Individual demand: an individual’s demand for a product

• Market demand: sum of all individual demands for a good or service

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 SHIFT IN THE DEMAND CURVE
price Home purchase restrictions in
Beijing
 Increase or decrease demand
in the housing market?

Influx of expatriates into

Singapore
 Increase or decrease demand
in the private housing market?

quantity

• Shift right  increase in demand; Shift left  decrease in demand

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Graph from Mankiw (2018).
FACTORS AFFECTING THE SHIFT IN DEMAND
• What if losing job one summer?

•  Income!

•  Normal good: if the demand for a good falls when income falls

•  Inferior good: if the demand for a good rises when income falls
 example?

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FACTORS AFFECTING THE SHIFT IN DEMAND
•  Prices of related goods!

•  Substitutes: two goods for which an increase in the price of one

leads to an increase in the demand for the other

•  Complements: two goods for which an increase in the price of

one leads to a decrease in the demand for the other

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FACTORS AFFECTING THE SHIFT IN DEMAND
• Tastes?
 Economics and psychology

• Expectations?
 Expectation about future income

• Number of Buyers?

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 VARIABLES THAT INFLUENCE BUYERS
Variable A change in this variable
Price of the good itself Represents a movement along the demand
curve
Income Shifts the demand curve
Prices of related goods Shifts the demand curve
Tastes Shifts the demand curve
Expectations Shifts the demand curve
Number of buyers Shifts the demand curve

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distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
SUPPLY
• Law of supply: other things being equal, the quantity supplied of
a good rises when the price of the good rises

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 SUPPLY CURVE
• The Supply Curve: Relationship between Price and Quantity Supplied
price
• Shift right  increase in supply;
• Shift left  decrease in supply

• Price of building materials falls?

Housing supply?

•  Input prices

quantity
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 SHIFT IN THE SUPPLY CURVE
price

• Shift right? Shift left?

• Building technology improves?

•  Technology

quantity

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 SHIFT IN THE SUPPLY CURVE
price
• Shift right? Shift left?

• Firms expect the housing price

to rise tomorrow? What to do
today?

•  Expectation

quantity

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 SHIFT IN THE SUPPLY CURVE
price
• Several real estate developers
are about to leave the market?

•  Number of sellers

quantity

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VARIABLES THAT INFLUENCE SELLERS
Variable A change in this variable
Price of the good itself Represents a movement along the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve

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43
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 SUPPLY AND DEMAND TOGETHER
• Equilibrium: a situation
in which the market price
has reached the level at
which quantity supplied
equals quantity
demanded

• Where the market supply

curve and market
demand curve intersect

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 SUPPLY AND DEMAND TOGETHER
• Equilibrium price
(market-clearing price):
the price that balances
quantity supplied and
quantity demanded

• Equilibrium quantity: the

quantity supplied and the
quantity demanded at the
equilibrium price

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MARKETS NOT IN EQUILIBRIUM
• Surplus: a situation in which quantity supplied is greater than the quantity demanded –
excess supply
• Shortage: a situation in which quantity demanded is greater than quantity supplied –
excess demand

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Graph from Mankiw (2018).
 EQUILIBRIUM
• Law of Supply and Demand: the price of any good adjusts to bring the
quantity supplied and quantity demanded for that good into balance

• Three Steps for Analyzing Changes in Equilibrium:

• 1. Decide whether the event shifts the supply or demand curve (or both)

• 2. Decide in which direction the curve shifts

• 3. Use the supply-and-demand diagram to see how the shift changes the
equilibrium price and quantity

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SUMMARY OF TODAY’S LECTURE
 Comparative advantage

 Trade can make everyone better off

 How markets work?

 Demand: law of demand; factors affecting shift of demand curve

 Supply: law of supply; factors affecting shift of supply curve

 Equilibrium: law of supply and demand

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REFERENCES
 Mankiw, Gregory, Principles of Economics. Chapters 3
and 4.

 Practice questions after each chapter in the textbook, and

attempt the following problems and applications (to be
covered in tutorial 1):

 Chapter 3: 2
 Chapter 4: 3, 9

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CHAPTER 3. 2

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CHAPTER 4.3

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CHAPTER 4.9

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