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19Lecture-1 - LECTURE 19 Today is Thursday The price of...

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LECTURE 19 Today is Thursday, October 28, 2010. The price of gold is $1,343 per troy ounce. DETERMINANTS OF SUPPLY In the first part of the course, within the context of the discussion of the operation of the Tempe pizza market, we learned the rudiments of supply and demand, and the determinants of supply and the determinants of demand. We did not have the tools at that time to fully explain the operation of the market and the individual firms supplying product to the market. Now we have the tools necessary to get the complete picture. In Lecture 18, we learned that a change in a determinant of demand, such as an increase in income, a higher price of a substitute, such as silver, or two countries like China and India wanting to hedge against the dollar, would cause an increase in the market demand for gold. We traced the impact, both in the market, and for the individual typical firm in the industry, resulting from the increase in market demand. The income of the consumers of gold increased, and gold is a normal good, the price of a substitute increased, and there was a significant change in "taste" on the part of two major countries. The market demand curve for gold shifts to the right, driving the price of gold up immediately in the commodity pits. Each of the firms in the industry was initially in long-run equilibrium, producing 7 ounces per week and earning a normal profit. The increase in demand and price led to an "excess profit" rectangle for each existing firm. As soon as possible, by increasing the number of doses of K&N utilized, each firm increased its output to 8 ounces per week to reap even more profit. At this point, each firm was now in a short-run equilibrium position, producing 8 ounces per week and earning excess profits. The excess profits then attracted new producers. 1 As new producers entered the industry, and hence entered the market as new suppliers, the market supply curve shifted to the right, driving the market equilibrium price ever lower and lower as the new production and increased supply came on-line. When the equilibrium market price finally fell to its original equilibrium price of $600 per ounce, all of the original 1,000 firms were back at their original equilibrium point, producing 7 ounces per week and earning normal profits. 2 However, there was now a larger number of 1 Remember, one of the characteristics of competition is no secrets , or full information . Everyone knows how much profit everyone else is making. Publicly traded companies must publish their financial statements each quarter. 2 Note that this assumes that none of the determinants of supply, such as our cost functions, have changed. This is our old friend, ceteris paribus . Of course, a whole bunch of things could change, and often do, in
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firms in the industry, supplying the market (1,286 if you recall) each producing 7 ounces per week and earning a normal profit. As long as no other determinants of supply or demand change, the new long-run equilibrium can obtain indefinitely.
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