101+Class+07+W2009 - Principles of Economics I Economics...

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Unformatted text preview: Principles of Economics I Economics 101 Section 400 Class 7 Readings Today Chapter 3, p 7994 Chapter 4, p 98115 Next Class Chapter 4 Problem Set available on line No quiz this week Warning: Exam coming up next week More details available on Wednesday Class7 2/2/2009 2 Supply Curve Price Supply P0 P1 Qs1 2/2/2009 Qs0 Class7 Quantity 3 Demand Curve Price P1 P0 Demand Qd1 2/2/2009 Qd0 Class7 Quantity 4 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 has no inherent tendency to change "Equilibrium" Class7 5 2/2/2009 Market Prices Price Supply P0 Excess Supply Demand Qd0 2/2/2009 Qs0 Class7 Quantity 6 Excess Supply Quantity supplied exceeds quantity demanded at given market price Sometimes 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 2/2/2009 Class7 7 Market Prices Price Supply P1 Excess Demand Demand Qs1 Qd1 Class7 Quantity 8 2/2/2009 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 2/2/2009 Class7 9 Market Prices Price Supply P* Demand Qd* = Qs* 2/2/2009 Class7 Quantity 10 The Equilibrium Price The price at which quantity demanded = quantity supplied No shortage (excess demand) No surplus (excess supply) No inherent reason for the price to change There is only one price with this characteristic D curve slopes down and S curve slopes up Equilibrium is the only sensible prediction of price in the market 2/2/2009 Class7 11 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 2/2/2009 Class7 12 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" Class7 13 2/2/2009 Industrial growth in China/India raises world demand for oil Price Supply P1 P0 Demand1 Demand0 Q0 Q1 2/2/2009 Class7 Qd Quantity 14 Excess demand Increase in oil production capacity Price Supply0 Excess supply Supply1 P1 P2 Demand1 Q1 2/2/2009 Class7 Q2 Quantity 15 Impact of worldwide recession on oil prices Price Supply1 P2 P3 Excess supply Demand1 Demand2 Q3 Q2 2/2/2009 Class7 Quantity 16 The market for cars in the US: demand-side effects of recession Price Supply P0 P1 Reduction in real incomes (cars are normal goods) Demand1 Demand0 Qd 2/2/2009 Q1 Q0 Class7 Quantity 17 Excess Supply The market for cars in the US: supply-side effects of recession Price Supply1 Supply0 P1 P0 Excess Demand Demand0 Quantity 18 Qs 2/2/2009 Q1 Q0 Class7 The market for cars in the US: net effects of recession I Price Supply1 Supply0 P0 Demand1 Demand0 Q1 2/2/2009 Q0 Class7 Quantity 19 The market for cars in the US: net effects of oil recession II Price Supply1 XXS Supply0 P0 P1 Demand1 Demand0 Q1 2/2/2009 Q0 Class7 Quantity 20 The market for cars in the US: net effects of recession III Price Supply1 Supply0 XSD P1 P0 Demand0 Demand1 Q1 2/2/2009 Q0 Class7 Quantity 21 The car market and recession prices Demand side effects: Supply side effects: Low real incomes should depress car prices Also reduce sales quantity Scarcity of available capital will increase car prices Also reduce sales quantity Net effects: Sales volume will certainly fall Ambiguous effect on prices: 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 Class7 22 2/2/2009 Market Outcomes Supply and Demand model lets us predict changes in Q and P from changes in market conditions Answer positive questions: what will happen? Also raises fundamental normative questions If we can predict what will happen, can we determine whether the outcome is desirable? We will look at a specific incornation of this question: "Are outcomes efficient?" 2/2/2009 Class7 23 Market Outcomes and 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? If so, should we produce more or less of the good? Should we distribute those goods that are produced differently? Class7 24 2/2/2009 Social Surplus Method for measuring the net benefits of allocating resources in any given way Social surplus is 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 2/2/2009 Class7 25 Consumers' valuation of goods produced $/unit Gross consumer valuation of Q* units Demand Marginal Valuation Q* 2/2/2009 Class7 Units of output 26 Opportunity cost of goods produced $/unit Supply Marginal Opportunity Cost Gross opportunity cost of Q* units Q* 2/2/2009 Class7 Units of output 27 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* 2/2/2009 Class7 Social Surplus Units of output 28 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 2/2/2009 Class7 29 Maximizing Social Surplus Possible to increase social surplus if the value of the marginal unit exceeds the cost of that unit i.e. MV > MC Conclude that we should increase output of this good until MV = MC Class7 30 2/2/2009 Social Surplus $/unit Gross consumer valuation of Q units MC Social surplus MV Consumer valuation of the marginal unit Lost social surplus Q Q* 2/2/2009 Class7 Opportunity cost of the marginal unit Gross opportunity cost of Q units Units of output 31 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 2/2/2009 Class7 32 The Efficiency of the Market $/unit Consumer surplus MC Supply Social surplus P* Producer surplus MV Demand Q* 2/2/2009 Class7 Units of output 33 ...
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This note was uploaded on 05/16/2010 for the course ECON Section 40 taught by Professor Hogan during the Winter '09 term at University of Michigan.

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