101+Class+06+W2008 - Principles of Economics I Economics...

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Unformatted text preview: Principles of Economics I Economics 101 Section 400 Class 6 Readings Chapter 3 Collection of newspaper articles about the auto industry Specifically 7994 CTools resources Next Class Chapter 4 Class 6 2 1/28/2007 Announcements Assignment 4 will be available this evening Please make an attempt at the questions before discussion section on Thursday and Friday Quiz 2 in discussion section Thursday/Friday Based on material from Assignment 4 Also posted later this evening selected answers from Assignment 3 1/28/2007 Class 6 3 Marginal Valuation and Demand $ P2 P1 Marginal Value Demand Curve Q2 1/28/2007 Q1 Class 6 Quantity 4 The Law of Demand As the price of a good rises, a consumer typically demands less of that good Marginal value of a good falls as consumption increases 1/28/2007 Class 6 5 What variables change the quantity consumers demand? 1. 2. 3. 4. Price of the good Prices of other goods Income "Tastes" 1/28/2007 Class 6 6 Prices of other goods An increase in PB leads to an increase in quantity of good A demanded Good B is a substitute for good A Effect from a change in relative prices An increase in PB leads to a decrease in quantity of good A demanded As PA rises, substitute away from good A consumption towards alternatives, such as good B Good A is a complement to good A Marginal value of good A decreases when quantity of good B consumed is low Class 6 7 1/28/2007 Income Typical Case: Increasing income increases the set of goods and services that can be consumed Buying the marginal unit of good A implies that more good B can be purchased when income is high than when income is low Consumer is usually willing to forego more good B to secure the marginal unit of good A, simply because higher incomes allow him to consume additional A and B If an increase in income leads to an increase in the quantity of good A demanded, we say that A is a "normal good" 1/28/2007 Class 6 8 Income Other case: Sometimes, increased income presents the consumer with alternatives that previously were not available Leads to significant substitution away from a cheap good (the only thing affordable at low income) towards expensive good (now affordable at the higher income If increasing income leads to a reduction in quantity of good A demanded, we say that A is an "inferior good" Examples: Ramen noodles Cassava root Taco Bell 1/28/2007 Class 6 9 Tastes Tastes may be variable for all sorts of reasons Consumers may be susceptible to advertising Consumer wants adapt to a changing environment Celebrity endorsements demonstrate the value of associating a product with a desirable image Marginal valuations for ice cream are likely to vary with the temperature Marginal valuations for Ephedra likely to fall when it is revealed that users have been dying Consumer wants adapt to changes in information 1/28/2007 Class 6 10 What shifts the Demand Curve Rightward? $ P1 Increase in the price of a substitute good Reduction in the price of a complementary good Increase in income (if this is a normal good) Reduction in income (if this is an inferior good) Change in tastes, making this good more desirable Demand Q1 1/28/2007 Q2 Class 6 Quantity 11 What shifts the Demand Curve Leftward? $ P Reduction in the price of a substitute good Increase in the price of a complementary good Reduction in income (if this is a normal good) Increase in income (if this is an inferior good) Change in tastes, making this good less desirable Demand Q2 1/28/2007 Q1 Class 6 Quantity 12 Measuring Benefits to Consumers Measure the value of goods consumed in dollars Compare this to the dollar amount paid Value of each marginal unit is given by the height of the demand curve This is simply the price Marginal unit of the good confers benefit equal to the difference between these two measures Consumer surplus 1/28/2007 Class 6 13 Consumer Surplus $ Consumer Surplus P1 Demand Q1 1/28/2007 Class 6 Quantity 14 Changes in Consumer Surplus $ P2 P1 Lost Consumer Surplus Demand Q2 1/28/2007 Q1 Class 6 Quantity 15 But where do prices come from? Two elements in model of the market: Supply Curve Demand Curve Describes suppliers' decisions about how much to supply at the given price Describes consumers' decisions about how much to buy at the given price But what price will prevail in the market? Predict a price that should be sustained "Equilibrium" price: a price that has no inherent tendency to change Class 6 16 1/28/2007 Market Prices Price Supply P0 Excess Supply Demand Qd0 1/28/2007 Qs0 Class 6 Quantity 17 Excess Supply Quantity supplied exceeds quantity demanded at given market price Also call this a "surplus" in the market Suppliers who wish to sell units at the given price are unable to find buyers These suppliers have incentive to reduce prices As the price is inherently unstable, this is not a good prediction of where the price will be 1/28/2007 Class 6 18 Market Prices Price Supply P1 Excess Demand Demand Qs1 Qd1 Class 6 Quantity 19 1/28/2007 Excess Demand Quantity demanded exceeds quantity supplied at given market price Also call this a shortage in the market Consumers who wish to buy units at the given price are unable to find sellers These buyers tend to bid prices higher As the price is inherently unstable, this is not a good prediction of where the price will be 1/28/2007 Class 6 20 Market Prices Price Supply P* Demand Qd* = Qs* 1/28/2007 Class 6 Quantity 21 The Equilibrium Price The price at which quantity demanded equals quantity supplied No shortage No surplus No inherent reason for the price to change Only price with this characteristic Equilibrium also becomes the only sensible prediction for the market price 1/28/2007 Class 6 22 The Supply & Demand Model This model gives us a method for predicting Prevailing prices in the market Quantity of the good traded Perhaps even more importantly, we are able to predict as a result of shocks to the market 1/28/2007 Class 6 23 Changes in market price Changes in quantity traded What market "shocks" will change prices? Anything that shifts the supply curve or demand curve Supply: Demand: Change in price of alternative product Change in factor prices Change in technology Change in availability of inputs Change in price of alternative consumption goods Change in incomes Change in "tastes" Class 6 24 1/28/2007 Industrial growth in China/India raises oil demand on world market Price Supply P1 P0 Demand1 Demand0 Q0 Q1 Qd Quantity Excess demand The market for cars in the US: Supply effects from oil price Supply increase Price 1 P1 P0 Supply0 Oil price increase (increasing transport costs) Demand0 Qs Q1 Q0 Quantity Excess Demand The market for cars in the US: Demand side effects of oil price increase Price Supply P0 P1 Oil price increase (oil and cars are complements) Demand1 Demand0 Qd Q1 Q0 Quantity Excess Supply The market for cars in the US: effects of oil price increases Price Supply1 Supply0 P0 Demand1 Demand0 Q1 1/28/2007 Q0 Class 6 Quantity 28 The market for cars in the US: effects of oil price increases Price Supply1 XXS Supply0 P0 P1 Demand1 Demand0 Q1 1/28/2007 Q0 Class 6 Quantity 29 The market for cars in the US: effects of oil price increases Price Supply1 Supply0 XSD P1 P0 Demand0 Demand1 Q1 1/28/2007 Q0 Class 6 Quantity 30 The car market and gas prices Demand side effects: Supply side effects: High gas prices should depress car prices Reduce sales quantity High gas prices will increase car prices Reduce sales quantity Sales will certainly fall Ambiguous effect on prices: Net effects: See: "Auto sales show 2007 was a clunker of a year" and "Auto See: Sales in Japan Fall to 35Year Low" Class 6 If XSS at initial prices (i.e. relatively large fall in demand) then prices will fall If XXS at initial prices (i.e. relatively large fall in supply) then prices will rise 1/28/2007 31 The market for small/efficient cars in the US Price Supply P1 P0 Increase in price of gas (a substitute) Demand1 Demand0 Q0 Q1 Qd Quantity Excess Demand Recent Auto Industry Experiences Reduced sales Reduction in sales most significant in relatively inefficient vehicles Relatively efficient vehicle sales have been high E.g SUV sales See: "US Goes Hybrid" See: Experiences different in different parts of the world: E.g. Electric hybrids See: "Chrysler Aims to Double Overseas Sales", "China's New Auto Sales Likely to Top 10 M. in 2008" and "Driving India" 1/28/2007 Class 6 33 ...
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