101+Class+07+W2008 - Principles of Economics I Economics...

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Unformatted text preview: Principles of Economics I Economics 101 Section 400 Class 7 Announcements Reading: Chapter 4 Assignment 4 Quiz 2 in discussion section Thursday/Friday Based on material from Assignment 4 Available online Reminder: Exam February 11 8:00pm 10:00pm Practice exam available Monday of next week Class 7 1/30/2008 2 Auction Aftermath In case you're interested, you can check this out: Heifer International Honor Card 1/30/2008 Class 7 3 Industrial growth in China/India raises oil demand on world market Price Supply P1 P0 Demand1 Demand0 Q0 1/30/2008 Class 7 Q1 Qd Quantity 4 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 1/30/2008 Q1 Q0 Class 7 Quantity 5 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 1/30/2008 Q1 Q0 Class 7 Quantity 6 Excess Supply The market for small/efficient cars in the US Price Supply P1 P0 Increase in price of gas (a substitute) Demand1 Demand0 Q0 1/30/2008 Class 7 Q1 Qd Quantity 7 Excess Demand The market for cars in the US: effects of oil price increases Price Supply1 Supply0 P0 Demand1 Demand0 Q1 1/30/2008 Q0 Class 7 Quantity 8 The market for cars in the US: effects of oil price increases Price Supply1 XXS Supply0 P0 P1 Demand1 Demand0 Q1 1/30/2008 Q0 Class 7 Quantity 9 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 7 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 1/30/2008 10 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: Class 7 11 E.g. Electric hybrids 1/30/2008 The market for cars in high growth economies (e.g China, India): effects of oil price increases Price Supply1 P1 P0 Supply0 High gas prices increase production costs Rising Incomes XSD Demand0 Demand1 QS 1/30/2008 Q0 Class 7 QD Quantity 12 High Growth Economy Experience Supply Effect: Higher gas prices Demand Effect: Higher incomes Increased price and reduced sales Increased price and increased sales Increased price Ambiguous effect on sales Increased price Increase in volumes Predicted Net Effect: Observed Effect See: "Chrysler Aims to Double Overseas Sales", "China's New Auto Sales Likely to Top 10 M. in 2008" and "Driving India" Demand effect from increased incomes is large Production costs probably also falling (associated with growth) 1/30/2008 Class 7 13 Predicting Market Changes Using Supply and Demand Demand shifts to the right Increase in market price Increase in sales Motivated by 1/30/2008 Increasing incomes (normal goods) Reducing incomes (inferior goods) Increased price of substitute good Reduced price of complementary good Favorable market information (e.g. advertising, news, etc) Increase in number of consumers Class 7 14 Predicting Market Changes Using Supply and Demand Last two examples involved simultaneous shifts in S and D Oil price increases in the US: Oil price increase in India and income growth Reduced sales, ambiguous effect on price Increased price, ambiguous effect on sales Will always be the case that: Changes is either Q or P can be predicted Changes in the other variable will be ambiguous If S & D both increase or both decrease, can predict change in Q If S & D change in opposite direction, predict change in P on the basis of the excess demand/supply created at initial price 1/30/2008 Class 7 15 Market Outcomes Supply and Demand model lets us predict changes in Q and P from changes in market conditions Raises fundamental normative questions Answer normative questions: what will happen? If we can predict what will happen, can we determine whether the outcome is desirable? 1/30/2008 Class 7 16 Market Outcomes and Efficiency To answer normative questions, we need to apply some criterion We use the notion of Pareto Efficiency Suppose the market allocates resources as described by the Supply and Demand model Is it possible to reallocate resources in such a way that we make some people better off without harming others? Produce more or less? Distribute available goods differently? 1/30/2008 Class 7 17 Social Surplus Measure of the net benefits from allocating resources in any given way The difference between: 1. The value of other goods consumers were prepared to give up in order to obtain the goods produced; and 2. The value of other goods the economy had to give up in order to produce those goods 1/30/2008 Class 7 18 Consumers' valuation of goods produced $/unit Gross consumer valuation of Q* units Demand Marginal Valuation Q* 1/30/2008 Class 7 Units of output 19 Opportunity cost of goods produced $/unit Supply Marginal Opportunity Cost Gross opportunity cost of Q* units Q* 1/30/2008 Class 7 Units of output 20 Social Surplus $/unit Gross consumer valuation of Q* units Marginal Opportunity Cost Additional social Consumer surplus from the valuation of the marginal unit Marginal Valuation Opportunity cost of the marginal unit Gross opportunity cost of Q* units Q* 1/30/2008 Class 7 Social Surplus Units of output 21 Social Surplus and Pareto Efficiency In the previous example, we had Q* units produced Showed that producing a marginal unit could increase social surplus Explicitly, the marginal unit provides benefits to somebody that exceed the opportunity cost of producing the good Suggests that this allocation is not efficient Efficiency demands that social surplus be maximized 1/30/2008 Class 7 22 Maximizing Social Surplus Possible to increase social surplus if the value of the marginal unit exceeds the cost of that unit Conclude that we should increase output of this good until MV = MC i.e. MV > MC 1/30/2008 Class 7 23 Social Surplus $/unit Gross consumer valuation of Q units MC Social surplus MV Consumer valuation of the marginal unit Lost social surplus Q Q* 1/30/2008 Class 7 Opportunity cost of the marginal unit Gross opportunity cost of Q units Units of output 24 Efficient Output Level Efficient allocation of resources demands Social Surplus is maximized MV = MC If producers and consumer face the same price, and Consumers purchase Q such that P = MV Producers produce Q such that P = MC Then market clears and output level is efficient 1/30/2008 Class 7 25 The Efficiency of the Market $/unit Consumer surplus MC Supply Social surplus P* Producer surplus MV Demand Q* 1/30/2008 Class 7 Units of output 26 ...
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This note was uploaded on 04/01/2008 for the course ECON 101 taught by Professor Gerson during the Winter '08 term at University of Michigan.

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