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AGEC 340 – International Economic Development Course slides for week 11 (March 23-25) Demand, supply and market prices*. Where do prices come from?. * If you are following the textbook, this is chapte r 15. Markets & Trade Where do prices come from?. - PowerPoint PPT Presentation
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AGEC 340 – International Economic DevelopmentCourse slides for week 11 (March 23-25)
Demand, supply and market prices*
Where do prices come from?
* If you are following the textbook, this is chapter 15.
Markets & TradeWhere do prices come from?
• So far we’ve looked at development from an individual’s point of view, taking prices as given… but where do prices come from?
• What (or who) is ‘the market’? • Econ explains prices in terms of supply & demand
– we saw consumer demand in week 3:Demand is consumers’ willingness and ability to pay
– we’ve seen producers’ supply in weeks 6-9:Supply is producers’ willingness and ability to sell
Where does a supply curve come from?
Qty. of corn(bu/acre)
Qty. of labor (hours/acre)
Qty. of corn(bu/acre)
Qty. of beans(bushels/acre)
To get more corn,use more labor and grow less beans
Supply response comes from producers adjusting their production levels along IRCs & PPFs:
Suppliers’ position along these curves is determined by relative prices
Qty. of corn(bu/acre)
Qty. of labor (hours/acre)
slope of isoprofit line=Plabor/Pcorn
Qty. of corn(bu/acre)
Qty. of beans(bushels/acre)
slope of the iso-revenue line =-Pbeans/Pcorn
When corn prices rise, producers use more inputs.
Qty. of corn(bu/acre)
Qty. of labor (hours/acre)
a higher Pcorn means a flatter isoprofit line
morelabor
more corn
When corn prices rise, producers make less of others goods.
Qty. of corn(bu/acre)
Qty. of beans(bushels/acre)
a higher Pcorn meansa flatter iso-revenue line
morecorn
lessbeans
So, for each individual producer, at every price a specific quantity will be produced...
Price($/lb)
Quantity Produced (lbs/yr)
10
0.75
...and as prices rise a higher quantity will be produced...
Price($/lb)
Quantity Produced (lbs/yr)
10
1.00
15
0.75
…the slope of this curve depends on the slopes of the IRCs and PPFs...
Price($/lb)
Quantity Produced (lbs/yr)
1.25
10
1.00
15
0.75
17
and so the “supply curve” always slopes upward:
Price($/lb)
Quantity Produced (lbs/yr)
1.25
10
1.00
15
0.75
17
When price changes, producersmove along their supply curve
Adding up all producers together, we have a market supply curve:
Price($/lb)
Quantity Produced (thousands of tons/yr)
1.25
10
1.00
15
0.75
17
each producer’s production is added horizontally
Note the new scale!
Similarly, we can draw a demand curvefor each individual consumer...
Price($/lb)
Quantity Consumed(lbs/yr)
1.25
10
1.00
15 17
0.75
When price changes, consumers move along their demand curve
…and then add up all consumers togetherwe get the market demand curve:
Price($/lb)
Quantity Consumed(thousands of tons/yr)
1.25
10
1.00
15 17
0.75
each consumer’s demand is added horizontally
Again we change scale to show total market demand
And we can put the two together in a “supply-demand diagram”
Price($/lb)
Quantity (thousands of tons/yr)
1.25
10
1.00
15
0.75
17
All consumers’ market demand curve
All producers’ market supply curve
…so what price do we expect to observe?
Price($/lb)
Quantity (thousands of tons/yr)
1.25
10
1.00
15
0.75
17
market demand
market supply
We expect that producers & consumers will always be “on” the supply & demand curves...
Price($/lb)
Quantity (thousands of tons/yr)
1.25
10
1.00
15
0.75
17
D
S
at $1.25/lb there would be “excess supply”
at $0.75/lb there would be “excess demand”
when producers and consumersare optimizing, we’ll see $1.00/lb,
called the “equilibrium” price
Is the “equilibrium” price always observed?
Price($/lb)
Quantity (thousands of tons/yr)
1.25
10
1.00
15
0.75
17
D
S
What if trade with another region is possible?Price($/lb)
Quantity (thousands of tons/yr)
1.25
10
1.00
15
0.75
17
D
S
If the other region will buy from us at $1.25/lb
Price($/lb)
1.25
10
1.00
0.75
17
Exports = 7
sellerswon’t acceptless than 1.25
D
S
If the other region will buy from us at $1.25/lb
Price($/lb)
1.25
10
1.00
0.75
17
Price($/lb)
1.25
10
1.00
0.75
17
If the other region will sell to us at $0.75/lb
Imports = 7Exports = 7
buyerswon’t paymore than .75
sellerswon’t acceptless than 1.25
D
S
D
S
So it’s often trade that determines the prices of goods!
Price($/lb)
1.25
10
1.00
0.75
17
Price($/lb)
1.25
10
1.00
0.75
17
Imports = 7Exports = 7
D
S
D
S
For exported goods For imported goods
This is our textbook picture, Figure 15-1
…but in the book there’s more to the story!
Government policy matters too: Figure 15-1 with a food import subsidy
Government policies can also act on exports:Figure 15.2 shows an export tax
In conclusion…
• Prices come from the interaction of producers’ supply and consumers’ demand
…but with international trade, prices comes from world supply and demand…unless government restricts trade, and thereby helps set local prices.
• Next week: does open international trade help or hurt economic development?
