28
Advanced Topics

Advanced Topics. Elasticity and Equilibrium Price Changes

  • View
    227

  • Download
    2

Embed Size (px)

Citation preview

Page 1: Advanced Topics. Elasticity and Equilibrium Price Changes

Advanced Topics

Page 2: Advanced Topics. Elasticity and Equilibrium Price Changes

Elasticity and Equilibrium Price Changes

Page 3: Advanced Topics. Elasticity and Equilibrium Price Changes

Changes in Equilibrium

• When events cause a supply or demand curve to shift, the equilibrium price will shift. But how much?

• Knowledge of elasticities can provide the answer to this question.

Page 4: Advanced Topics. Elasticity and Equilibrium Price Changes

Quantitative Changes Equilibrium Effects

Page 5: Advanced Topics. Elasticity and Equilibrium Price Changes
Page 6: Advanced Topics. Elasticity and Equilibrium Price Changes

Negative Supply Shock

• Negative supply shock like embargo on Iranian oil would raise prices and reduce quantity of oil available.– But how much? Clearly depends on the

supply

Page 7: Advanced Topics. Elasticity and Equilibrium Price Changes

Equilibrium Change in Price

• A 1% shift out in the demand curve leads to a change in equilibrium price.

• A 1% shift out in the supply curve leads to a change in equilibrium price.

1%

S De e

1%

S De e

Page 8: Advanced Topics. Elasticity and Equilibrium Price Changes

Example 1

• Elasticity of demand for oil is eD = -.061 and elasticity of supply is eS = .04. World oil demand goes up by 1%. How much does the price change?

• Answer:

1 1 11 % % % 9.90%

.04 .061 .101S De e

Page 9: Advanced Topics. Elasticity and Equilibrium Price Changes

Example 2

• What would happen to oil prices for Geo-Political reasons there were a shut-down of Iranian oil production and there was an inward shift in the oil supply curve of 4.9%?

Page 10: Advanced Topics. Elasticity and Equilibrium Price Changes

A shift in the supply schedule(Spreadsheet)

Supply Supply' Demand30 29893.38 28428.61 31867.1135 30078.28 28604.44 31568.8640 30239.36 28757.63 31312.7745 30382.16 28893.44 31088.650 30510.48 29015.46 30889.4355 30627.02 29126.29 30710.3760 30733.8 29227.84 30547.865 30832.36 29321.57 30399.0170 30923.89 29408.62 30261.975 31009.35 29489.89 30134.880 31089.51 29566.12 30016.485 31164.99 29637.9 29905.690 31236.32 29705.74 29801.51

95 31303.95 29770.06 29703.39100 31368.24 29831.2 29610.59105 31429.56 29889.51 29522.57

A 4.9% shift in the supply schedule

At the new supply curve there is excess demand for oil.

• Excess demand will induce additional supply and cut back in demand.

What is the new equilibrium?

Page 11: Advanced Topics. Elasticity and Equilibrium Price Changes

Example 3

• The cross price elasticity of bacon with respect to eggs is -.2.

• The elasticity of demand for bacon is -.5. The elasticity of supply for bacon is .5.

• The price of eggs goes up by 1%. What happens to the price of bacon?

Page 12: Advanced Topics. Elasticity and Equilibrium Price Changes

Example

• What would the oil price change be in the long run, if world income went up permanently by 10% and no shift in supply curve?

Page 13: Advanced Topics. Elasticity and Equilibrium Price Changes

Excise Tax

Page 14: Advanced Topics. Elasticity and Equilibrium Price Changes

Own Price Elasticity Matters as well.

• A less important effect is that the steepness of the demand curve will also impact the size of a demand shift.

• The steepness of the supply curve will impact the size of a supply shift.

Page 15: Advanced Topics. Elasticity and Equilibrium Price Changes

.

P

QQ*

P*

D1

Steeper (less elastic) demand curve means that a demand shift will have a bigger impact on both price and quantity.

D2

Q1**

P1**

Q2**

P2**

D1’

D2’

1

0

2

Page 16: Advanced Topics. Elasticity and Equilibrium Price Changes

.

P

QQ*

S1

P*

D

Steeper (less elastic) supply curve means that a supply shift will have a stronger impact on quantity and bigger impact on price.

S2

Q1**

P1**

Q2**

P2**

S2’S1’

1

0

2

Page 17: Advanced Topics. Elasticity and Equilibrium Price Changes

Gains from Trade

Advanced Topic

Page 18: Advanced Topics. Elasticity and Equilibrium Price Changes

Market System

• A free market allows people to sell goods that they value relatively little to buyers who value them more.

• A price can be obtained between buyers and sellers valuations at which they can both benefit.

• You own shares of stock that you think are worth $5 and someone else thinks are worth $9 per share. If you sell them at $7 both the buyer and the seller are happy.

Page 19: Advanced Topics. Elasticity and Equilibrium Price Changes

Demand Curves are Valuation Curves

• To measure the benefits of the market, economists invert the meaning of the demand curve.

• Standard definition of the demand curve: how many units of Q will buyers want at price P.

• Inverted definition: What is the maximum price that buyers are willing to pay to buy the Qth unit of the good.

• Implication: What is the value that the consumer places on the Qth good.

Page 20: Advanced Topics. Elasticity and Equilibrium Price Changes

.

P

Q

Maximum that the buyer on the fence will pay to for Q1th

good is P1

Q1

P1D

D

Demand curve

Page 21: Advanced Topics. Elasticity and Equilibrium Price Changes

Supply Curves are Valuation Curves

• To measure the benefits of the market, economists invert the meaning of the supply curve.

• Standard definition of the supply curve: how many units of Q will sellers want at price P.

• Inverted definition: What is the minimum price that sellers are willing to accept for the Qth unit of the good.

• Implication: What is the value that the seller places on the Qth good.

Page 22: Advanced Topics. Elasticity and Equilibrium Price Changes

.

P

Q

Maximum that the buyer on the fence will pay to for Q1th

good is P1

Q1

P1S

S

Supply curve

Page 23: Advanced Topics. Elasticity and Equilibrium Price Changes

Equilibrium Price

• Price will be between the value that the seller places on the Qth good and what the buyer places on the same good.

• Both buyer and seller benefit.• We can calculate exactly how much each

benefits by comparing the value they place on the good vs. either the price they pay for it or sell it for.

• The gains from trade on the final good Q* is zero.

Page 24: Advanced Topics. Elasticity and Equilibrium Price Changes

.

P

QQ1

P1S

S

Gains from Trade of selling Q1 is [P1D

– P1S].

Buyers Benefit is [P1D – P*]. Sellers benefit is [P*- P1

S].

P*

P1D

D

Page 25: Advanced Topics. Elasticity and Equilibrium Price Changes

Surplus

• The sum total of gains from trade is the sum of the benefits from each good.

• This sum of gains of trade, called surplus, can be divided into two parts…consumer surplus and producer surplus.

Page 26: Advanced Topics. Elasticity and Equilibrium Price Changes

.

P

QQ1

S

Sum of the benefits from all goods.

Page 27: Advanced Topics. Elasticity and Equilibrium Price Changes

.

P

QQ1

S

Represented as a triangle

Page 28: Advanced Topics. Elasticity and Equilibrium Price Changes

.

P

QQ1

S

Triangle can be split into two triangles, total consumer benefit and total producer benefit.

P*

Consumer

Surplus

Producer

Surplus