chap2-ev

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http://slidepdf.com/reader/full/chap2-ev 1/126

Chapter 2

The Basics of

Supply andDemand

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Chapter 2: The Basics of Supply and Slide 2

Topics to Be Discussed

Supply and Demand

The Market Mechanism

Changes in Market Equilibrium

Elasticities of Supply and Demand

Short-Run ersus !ong-Run Elasticities

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Topics to Be Discussed

"nderstanding and #redicting the Effectsof Changing Market Conditions

Effects of $o%ernment &nter%ention--#riceControls

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Introduction

'pplications of Supply and Demand 'nalysis

"nderstanding and predicting ho( (orldeconomic conditions affect market price andproduction

'naly)ing the impact of go%ernment price

controls* minimum (ages* price supports*and production incenti%es

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Introduction

'pplications of Supply and Demand 'nalysis

'naly)ing ho( ta+es* subsidies* and importrestrictions affect consumers and producers

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Supply and Demand

The Supply Cur%e

The supply cur%e sho(s ho( much of a goodproducers are (illing to sell at a gi%en price*holding constant other factors that mightaffect quantity supplied

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Supply and Demand

The Supply Cur%e

This price-quantity relationship can be sho(nby the equation,

) P QQ S s =

7/25/2019 chap2-ev

http://slidepdf.com/reader/full/chap2-ev 8/126Chapter 2: The Basics of Supply and Slide !

Horizontal axis measuresquantity (Q) supplied innumber of units pertime period

ertical axis measuresprice (!) recei"ed

per unit in dollars

Supply and Demand

The Supply#ur"e $raphically


Quantity

!rice

(% per unit)

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http://slidepdf.com/reader/full/chap2-ev 9/126Chapter 2: The Basics of Supply and Slide "

Supply and Demand

S

The supply cur"e slopesup&ard demonstratin' that

at hi'her prices firms

&ill increase output



Quantity

!rice

(% per unit)

P 1

Q 1

P 2

Q 2

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http://slidepdf.com/reader/full/chap2-ev 10/126Chapter 2: The Basics of Supply and Slide

Supply and Demand

on-price Determining ariables ofSupply

Costs of #roduction!abor

Capital

Ra( Materials

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Supply and Demand

The cost of ra(materials falls

't P 1* produce Q2

't P 2 * produce Q1

Supply cur%e shifts rightto S’

More produced at anyprice on S’ than on S

P S

#han'e in Supply#han'e in Supply

Q

P 1

P 2

Q 1Q 0

S’

Q 2

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Supply and Demand

Supply - ' Re%ie(

Supply is determined by non-price supply-determining %ariables as such as the cost oflabor* capital* and ra( materials.

Changes in supply are sho(n by shifting theentire supply cur%e.

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Supply and Demand

Supply - ' Re%ie(

Changes in quantity supplied are sho(n bymo%ements along the supply cur%e and arecaused by a change in the price of theproduct.

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Supply and Demand

The Demand Cur%e

The demand cur%e sho(s ho( much of agood consumers are (illing to buy as theprice per unit changes holding non-pricefactors constant.

This price-quantity relationship can be sho(n

by the equation,

(P)QQ D D =

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Supply and Demand

Quantity

Horizontal axis measuresquantity (Q) demanded innumber of units pertime period

ertical axis measuresprice (!) paid

per unit in dollars

!rice(% per unit)

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Supply and Demand

D

The demand cur"e slopesdo&n&ard demonstratin'that consumers are &illin'

to buy more at a lo&er price

as the product becomesrelati"ely cheaper and theconsumers real income

increases

Quantity

!rice(% per unit)

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Supply and Demand

on-price Determining ariables ofDemand

&ncome

Consumer Tastes

#rice of Related $oods

SubstitutesComplements

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DP

Q Q 1

P 2

Q 0

P 1

D’

Q 2

#han'e in Demand#han'e in Demand

Supply and Demand

&ncome &ncreases

't P 1* produce Q2

't P 2 * produce Q1

Demand Cur%e shifts right

More purchased at any

price on D’ than on D

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Shifts in Supply and Demand

Demand - ' Re%ie(

Demand is determined by non-price demand-determining %ariables* such as* income* priceof related goods* and tastes.

Changes in demand are sho(n by shiftingthe entire demand cur%e.

Changes in quantity demanded are sho(n bymo%ements along the demand cur%e.

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The *ar+et *echanism

Quantity

D

S

The cur"es intersect atequilibrium, or mar+et-

clearin', price .t P 0 the

quantity supplied is equalto the quantity demanded

at Q 0 .

P 0

Q 0

!rice(% per unit)

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Characteristics of the equilibrium ormarket clearing price,

/D 0 /S

o shortage

o e+cess supply

o pressure on the price to change

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Quantity

D

S

P 0

Q 0

If price is abo"e equilibrium/

0) !rice is abo"e the mar+et clearin' price1) Qs 2 Qd

3) !rice falls to the market-clearing price

P 1

Surplus

!rice(% per unit)

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The market price is abo%e equilibrium

There is e+cess supply#roducers lo(er prices

/uantity demanded increases and quantity

supplied decreasesThe market continues to ad1ust until the

equilibrium price is reached.

. Surplus. Surplus

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Chapter 2: The Basics of Supply and Slide


D

S

Q 1

.ssume the price is !0 , then/

0) Qs / Q0 2 Qd / Q1

1) 4xcess supply is Q0/Q1

3) !roducers lo&er price5) Quantity supplied decreases

and quantity demandedincreases

6) 4quilibrium at P 2 Q 3

P 1

Surplus

Q 2 Quantity

!rice(% per unit)

P 2

Q 3

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The market price is abo%e equilibrium,

There is e+cess supply#roducers lo(er prices

/uantity demanded increases and quantity

supplied decreasesThe market continues to ad1ust until the

equilibrium price is reached

Surplus - 7e"ie&/Surplus - 7e"ie&/

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D

S

Q 1 Q 2

P 2

Shorta'e

Quantity

!rice(% per unit)

.ssume the price is !1 , then/

0) Qd / Q1 2 Qs / Q0

1) Shorta'e is Q0/Q1

3) !roducers raise price

5) Quantity supplied increasesand quantity demandeddecreases

6) 4quilibrium at !3, Q3

Q 3

P 3

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The market price is belo( equilibrium,

There is a shortage#roducers raise prices

/uantity demanded decreases and quantity

supplied increasesThe market continues to ad1ust until the ne(

equilibrium price is reached.

Shorta'eShorta'e

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Market Mechanism Summary

3 Supply and demand interact todetermine the market-clearing price.

23 4hen not in equilibrium* the market(ill ad1ust to alle%iate a shortage orsurplus and return the market to equilibrium.

53 Markets must be competiti%e for themechanism to be efficient.

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#han'es In *ar+et 4quilibrium

Equilibrium prices are determined by therelati%e le%el of supply and demand.

Supply and demand are determined byparticular %alues of supply and demanddetermining %ariables.

Changes in any one or combination of these%ariables can cause a change in theequilibrium price and6or quantity.

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S’

Q 2

Ra( material pricesfall

S shifts to S’

Surplus 7 P 1 of Q1*

Q2

Equilibrium 7 P 3* Q3

P

Q

S D

P 3

Q 3Q 1

P 1


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D’ S D

Q 3

P 3

Q 2

&ncome &ncreases

Demand shifts to D1

Shortage 7 P 1 of Q1* Q2

Equilibrium 7 P 3* Q3

P

Q Q 1

P 1


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D’ S’ &ncome &ncreases 8ra( material prices fall

The increase in D isgreater than theincrease in S

Equilibrium price and

quantity increase to P 2 *Q2

P

Q

S

P 2

Q 2

D

P 1

Q 1


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Shifts in Supply and Demand

4hen supply and demand changesimultaneously* the impact on theequilibrium price and quantity is

determined by,

3 The relati%e si)e and direction of thechange

23 The shape of the supply and demandmodels

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The !rice of 4''s and the !riceof a #olle'e 4ducation 7e"isited

The real price of eggs fell 9:; from :<=to ::>.

Supply increased due to the increasedmechani)ation of poultry farming and thereduced cost of production.

Demand decreased due to the increasingconsumer concern o%er the health andcholesterol consequences of eating eggs.

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*ar+et for 4''s

Q (million dozens)

!(089:

dollars per dozen)

D089:

S 089:

%:;0

6,6::

D088<

S 088<

!rices fell untila ne& equilibrium

&as reached at %:1;and a quantity

of 6,3:: million dozen

%:1;

6,3::

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The !rice of a #olle'e 4ducation

The real price of a college education rose?> percent from :<= to ::9.

Supply decreased due to higher costs ofequipping and maintaining modernclassrooms* laboratories and libraries* andhigher faculty salaries.

Demand increased due a largerpercentage of a larger number of highschool graduates attending college.

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*ar+et for a #olle'e 4ducation

Q (millions of students enrolled))

!(annual costin 089:

dollars)

D089:

S 089:

S 0886

D0886

%5,15<

058

!rices rose untila ne& equilibrium

&as reached at %5,693and a quantity

of 013 million students

%1,63:

<;

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4age &nequality in the "nited States

Real after-ta+ income from :<< to :::,

Rose @=A; for the top 2=; of the incomedistribution

Bell =A; for the bottom 2=;

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#onsumption = !rice of #opper0<<:-088<

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The >on'-7un Beha"ior of ?atural 7esource !rices bser%ations

Consumption of copper has increased abouta hundred fold from >>= through ::>

indicating a large increase in demand.

The real price for copper has remainedrelati%ely constant.

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S 088<

D088<D08::

S 08:: S 086:

D086:

>on'-7un !ath of !rice and #onsumption


Quantity

!rice

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Conclusion

Decreases in the costs of production ha%eincreased the supply by more than enough to

offset the increase in demand.


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bser%ation

To accurately predict the future price of aproduct or ser%ice* it is necessary to consider

the potential change in supply and demand.

:<= predictions for oil and other mineralspro%ed incorrect because they only

considered the demand side of the market.


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4lasticities of Supply and Demand

$enerally* elasticity is a measure of thesensiti%ity of one %ariable to another.

&t tells us the percentage change in one%ariable in response to a one percentchange in another %ariable.

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Measures the sensiti%ity of quantitydemanded to price changes.

&t measures the percentage change in thequantity demanded for a good or ser%ice thatresults from a one percent change in the

price.

!rice 4lasticity of Demand!rice 4lasticity of Demand

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The price elasticity of demand is,

#3/36D;D;E# ∆∆=

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The percentage change in a %ariable is

the absolute change in the %ariabledi%ided by the original le%el of the%ariable.


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So the price elasticity of demand is also,

#

/

/

#

#6#

/6/ E#

∆

∆=

∆

∆=


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&nterpreting #rice Elasticity of Demandalues

3 ecause of the in%erse relationshipbet(een P and QF E P is negati%e.

23 &f E P > * the percent change in quantity is

greater than the percent change in price.4e say the demand is price elastic .

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&nterpreting #rice Elasticity of Demandalues

53 &f E P < * the percent change inquantity is less than the percentchange in price. 4e say the demand

is price inelastic .

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The primary determinant of priceelasticity of demand is the availaility !"

sustitutes#

Many substitutes demand is price elastic

Be( substitutes demand is price inelastic


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!rice 4lasticities of Demand

Q

!rice

Q = 8 - 2P

E p = -1

E p = 0

∞= - E P The lo&er portion ofa do&n&ard slopin'

demand cur"e is less elasticthan the upper portion

5

<

1

5

>inear Demand #ur"eQ = a - bP

Q = 8 - 2P

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DP *

∞= - E P

Quantity

!rice Infinitely Elastic Demand

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Q*

$ E P =

Quantity

!rice Completely Inelastic Demand

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&ncome elasticity of demand measuresthe percentage change in quantitydemanded resulting from a one percentchange in income.

@ther Demand 4lasticities@ther Demand 4lasticities

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The income elasticity of demand is,

I

Q

Q

I

I/I

Q/Q E I

∆

∆=

∆

∆=


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Cross elasticity of demand measures thepercentage change in the quantity

demanded of one good that results froma one percent change in the price ofanother good.

Bor e+ample consider the substitutegoods* butter and margarine.


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The cross elasticity of demand is,

m

b

b

m

mm

bb P Q

P Q

Q P

/P P /QQ E mb

∆

∆

=∆

∆

=

The cross elasticity for substitutes is positi%e*(hile that for complements is negati%e.

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#rice elasticity of supply measures thepercentage change in quantity supplied

resulting from a percent change in price. The elasticity is usually positi%e because

price and quantity supplied are directly

related.

4lasticities of Supply4lasticities of Supply

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4e can refer to elasticity of supply (ithrespect to interest rates* (age rates* and the

cost of ra( materials.

4lasticities of Supply4lasticities of Supply

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:> Supply Cur%e for 4heat

QS $ *>== A 2@=P

:> Demand Cur%e for 4heat

QD $ 3%&&' - 2??P

The *ar+et for AheatThe *ar+et for Aheat

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Equilibrium, / S 0 / D

P P 26655$%324$!$$%# −=+

75$%#5$6 = P

bushel P &46'3=bushelsmillion63$%2)46'3)24$!$$%# =+=Q


#hapter 1/ The Basics of Supply and Demand Slide ;1

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&nelastic $35')66'263$%2

46'3−=−=

∆

∆=

P

Q

Q

P

E D D

P

&nelastic $32')4$'263$%2

46'3==

∆

∆

= P

Q

Q

P E S

S

P


#hapter 1/ The Basics of Supply and Demand Slide ;3

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'ssume the price of (heat is G@.==6bushel

4!6%2)$$'4)26655$%3 −−= DQ

43'$)2664!6%2

$$'4−=−=

D

P

Q


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08<0 0<:: 15:P 366: - 1;;P 0<::15:P C 366:-1;;P

6:;P = 096:P 1981 = %35;bushel

088< 0,855 1:9P 3,155 - 1<3P 1,91:9P = 3,155-1<3P

P 1998 C %1;6bushel

Supply (Qs) Demand (QD) 4quilibrium !rice (Qs C QD)

#han'es in the *ar+et/ 08<0-088<


Sh t 7

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Short-7un ersus>on'-7un 4lasticities

#rice elasticity of demand %aries (ith theamount of time consumers ha%e to

respond to a price.

DemandDemand

Sh t 7

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Most goods and ser%ices,

Short-run elasticity is less than long-runelasticity. e.g. gasoline* Drs.3

ther $oods durables3,

Short-run elasticity is greater than long-runelasticity e.g. automobiles3

Short-7un ersus>on'-7un 4lasticitiesDemandDemand

$ li Sh t 7 d

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$asoline/ Short-7un and>on'-7un Demand #ur"es

DS!

D"!

!eople tend todri"e smaller and

more fuel efficientcars in the lon'-run

$asoline

Quantity

!rice

. t bil Sh t 7 d

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DS!

D"!

!eople may putoff immediate

consumption, bute"entually older cars

must be replaced

.utomobiles

.utomobiles/ Short-7un and>on'-7un Demand #ur"es

Quantity

!rice

Sh t 7

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&ncome elasticity also %aries (ith theamount of time consumers ha%e to

respond to an income change.


Income 4lasticitiesIncome 4lasticities

Sh t 7

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&ncome elasticity is greater in the long-run

than in the short run.Higher incomes may be con%erted into

bigger cars so the income elasticity of

demand for gasoline increases (ith time.



Sh t 7

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ther $oods durables3,

&ncome elasticity is less in the long-run than

in the short-run.riginally* consumers (ill (ant to hold

more cars.

!ater* purchases (ill only to be to replaceold cars.



Sh t 7

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$asoline and automobiles arecomplementary goods.


The Demand for $asoline and .utomobiles


Sh t 7

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$asoline

The long-run price and income elasticitiesare larger than the short-run elasticities.

'utomobiles

The long-run price and income elasticitiesare smaller than the short-run elasticities.




Short 7un ersus

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!rice -:00 -:11 -:31 -:58 -:<1 -009

Income ::9 :03 :1: :31 :65 :9<

Eears Follo&in' !rice or Income #han'e

4lasticity 0 1 3 5 6 ;

The Demand for $asolineThe Demand for $asoline


Short 7un ersus

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!rice -01: -:83 -:96 -:66 -:51 -:5:

Income 3:: 133 0<< 03< 0:1 0::

Eears Follo&in' !rice or Income #han'e

4lasticity 0 1 3 5 6 ;

The Demand for .utomobilesThe Demand for .utomobiles


Short 7un ersus

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Data E+plains,

3 4hy the price of oil did not continue torise abo%e G5=6barrel e%en though itrose %ery rapidly in the early :<=s.

23 4hy automobile sales are so sensiti%eto the business cycle.




Short 7un ersus

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!ong-run price elasticity of supply is greater

than short-run price elasticity of supply.

ther $oods durables* recyclables3,

!ong-run price elasticity of supply is lessthan short-run price elasticity of supply


SupplySupply

Short 7un ersus

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S S!

!rimary #opper/ Short-7un and >on'-7un Supply #ur"es

!rimary #opper/ Short-7un and >on'-7un Supply #ur"es

Quantity

!rice


S "!

Due to limitedcapacity, firmsare limited by

output constraintsin the short-run

In the lon'-run, theycan expand

Short 7un ersus

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S S!

Secondary #opper/ Short-7un and >on'-7un Supply #ur"es

Secondary #opper/ Short-7un and >on'-7un Supply #ur"es

Quantity

!rice


S "!

!rice increasespro"ide an incenti"e

to con"ert scrapcopper into ne& supply

In the lon'-run, this

stoc+ of scrap copper be'ins to fall

Short 7un ersus

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!rimary supply :1: 0;:

Secondary supply :53 :30

Total supply :16 06:

!rice 4lasticity of/ Short-run >on'-run

Supply of #opper Supply of #opper


Short 7un ersus

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Elasticity e+plains (hy coffee prices are%ery %olatile.

Due to the differences in supply elasticity inthe long-run and short run.


Aeather in Brazil andthe price of #offeein ?e& Eor+

Aeather in Brazil andthe price of #offee

in ?e& Eor+

!rice of Brazilian #offee

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!rice of Brazilian #offee

Short 7un ersus

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D

S

P 0

Q 0 Quantity

!rice

P 1

Short-7un0) Supply is completely inelastic1) Demand is relati"ely inelastic

3) ery lar'e chan'e in price

. freeze or drou'htdecreases the supply

of coffee

S’

Q 1

Short-7un ersus>on'-7un 4lasticities#offee#offee

Short-7un ersus

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S’

D

S

P 0

Q 0

P 2

Q 2

Intermediate-7un0) Supply and demand are

more elastic1) !rice falls bac+ to P 2 .

3) Quantity falls to Q1


Quantity

!rice

#offee#offee

Short-7un ersus

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D

S P 0

Q 0

>on'-7un0) Supply is extremely elastic1) !rice falls bac+ to P 0 .

3) Quantity increase to Q:

Short-7un ersus>on'-7un 4lasticities#offee#offee

Quantity

!rice

Gnderstandin' and !redictin' the 4ffectsf #h i * + t # diti

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Birst* (e must learn ho( to IfitJ lineardemand and supply cur%es to marketdata.

Then (e can determine numerically ho(a change in a %ariable (ill cause supplyor demand to shift and thereby affect themarket price and quantity.

of #han'in' *ar+et #onditions


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'%ailable Data

Equilibrium #rice* P K

Equilibrium /uantity* Q(

#rice elasticity of supply* E S % and

demand* E D#



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Demand# Q = a - bP

a$bSupply/ Q = c % &P

-c$&

P*

Q*

E D = -bP*$Q*

E S = &P*$Q*


Quantity

!rice


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!etLs begin (ith the equations for supplyand demand,

Demand) QD $ a * P

Supply) QS $ c + dP

4e must choose numbers for a% % c%and d#



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Step ,

Recall,

P)Q/ (P/Q)( E ∆∆=



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Bor linear demand cur%es* the change inquantity di%ided by the change in price isconstant equal to the slope of the cur%e3.


Gnderstandin' and !redictin' the 4ffectsof #han'in' *ar+et #onditions

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Substituting the slopes for each into theformula for elasticity* (e get,

/Q*)*b(P - E D =

/Q*)*d(P E S =



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Since (e (ill ha%e %alues for E D% E S % P(%and Q(% (e can sol%e for 8 d * and a 8c .


(( bP aQ D −=

((

dP cQS +=


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Deri%ing the long-run supply and demandfor copper,

The rele%ant data are,

/K 0 <.9 mmt6yr.

#K 0 <9 cents6pound

E S $ .?

E D $ *=.>



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E s $ d,P(-Q(.

.? 0 d<96<.930 =.d

d 0 .?6=. 0 ?

E d $ *,P(-Q(.

*=.> 0 -b.<96<.930 -=.b

b 0 =.>6=. 0 >



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Supply $ QS ( $ c + dP(

<.9 0 c + ?=.<93

<.9 0 c + 2

c 0 <.9 - 2

c 0 [email protected]

/ 0 [email protected] A ?P

Demand 0 QD( $ a *P(

<.9 0 a *>3.<93

<.9 0 a - ?

a 0 <.9 A ?

a $5.9

/ 0 5.9 - >P



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Setting supply equal to demand gi%es,

Supply 0 [email protected] A ? p 0 5.9 - > p $ Demand

? p A > p 0 5.9 A @.9

p 0 >62@ 0 .<9



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Supply/ Q S = - 56 0;P

-c$& Demand# Q D = 036 - <P

a$b

.'(

'.(


*mtyr

!rice


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4e ha%e (ritten supply and demand sothat they only depend upon price.

Demand could also depend upon income.

Demand (ould then be (ritten as,


fI bP aQ +−=


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4e kno( the follo(ing informationregarding the copper industry,

& 0 .=

P( $ =.<9

Q( $ <.9

0 >&ncome elasticity, E $ .5



7/25/2019 chap2-ev



" can be found by substituting kno(n%alues into the income elasticity formula,

I Q f ∆∆= &

)&)& I QQ I E ∆∆=

and



7/25/2019 chap2-ev



Sol%ing for " gi%es,

.5 0 .=6<.93"

" $ .53<.936.= 0 :.<9



7/25/2019 chap2-ev



Sol%ing for a gi%es,

<.9 0 a - >=.<93 A :.<9.=3

a $ 5.<9


fI bP aQ +−=((

Declinin' Demand and the

7/25/2019 chap2-ev



'Beha"ior of #opper !rices

The rele%ant factors leading to adecrease in the demand for copper are,

3 ' decrease in the gro(th rate of po(ergeneration

23 The de%elopment of substitutes, fiber

optics and aluminum

7eal "ersus ?ominal

7/25/2019 chap2-ev



!rices of #opper 08;6 - 0888

7eal "ersus ?ominal

7/25/2019 chap2-ev



4e (ill try to estimate the impact of a 2=percent decrease in the demand forcopper.

Recall the equation for the demandcur%e,

Q $ 5.9 - >P


7eal "ersus ?ominal

7/25/2019 chap2-ev



Multiply this equation by =.>= to get thene( equation. This gi%es,

Q $ =.>=35.9 - >P.

Q $ =.> - ?.@P

Recall the equation for supply,/ 0 [email protected] A ?P


7eal "ersus ?ominal

7/25/2019 chap2-ev



The ne( equilibrium price is,

[email protected] A ?P 0 =.> - ?.@P

*?P + ?.@P $ =.> A @.9

P $ 9.5622.@

P $ ?>.5 cents6pound


7eal "ersus ?ominal

7/25/2019 chap2-ev



The t(enty percent decrease in demandresulted in a reduction in the equilibriumprice to ?>.5 cents from <9 cents* or =

percent.


!rice of #rude @il

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Gphea"al in the Aorld @il *ar+et

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p

4e can predict numerically the impact ofa decrease in the supply of #EC oil.

&n ::9,P K 0 G>6barrel

4orld demand and total supply 0 25 bb6yr.

#EC supply 0 = bb6yr.

on-#EC supply 0 5 bb6yr

!rice 4lasticity 4stimates

7/25/2019 chap2-ev



y

4orld Demand, -=.=9 -=.@=

Competiti%e Supply =.= =.@=non-#EC3

Short-7un >on'-7un


7/25/2019 chap2-ev



p

Short-Run &mpact of a stoppage of Saudi#roduction equal to 5 bb6yr.

Short-run Demand

D $ 2@.=> - =.=?P

Short-run Competiti%e Supply

SC $ .<@ A =.=<P


7/25/2019 chap2-ev



p

Short-Run &mpact of a stoppage of Saudi#roduction equal to 5 bb6yr.

Short-run Total Supply--before supply

reduction includes #EC* =bb6yr3S/ $ 2.<@ A =.=<P

Short-run Total Supply--after supply reduction

S/ $ >.<@ A =.=<P


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e( #rice 'fter Reduction

Demand 0 Supply

2@.=> - =.=?P $ >.<@ A =.=<P

P $ @.=>

Impact of Saudi !roduction #ut

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D

Quantity(billions barrelsyr)

!rice(% perbarrel)

6

0<

S )

: 6 06 1: 16 3: 360:

0:

06

1:

16

3:

36

5:

56

13

S

Short-7un4ffect

S’ )


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!ong-Run &mpact of a stoppage Saudi#roduction equal to 5 bb6yr..

!ong-run Demand

D $ 52.> - =.9P

!ong-run Total Supply

S 0 <.<> A =.2:P


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e( #rice is found setting long-runsupply equal to long-run demand,

52.> - =.9P $ @.<> A =.2:P

P $ 2.<9

Impact of Saudi !roduction #ut

7/25/2019 chap2-ev



D

Quantity(billions barrelsyr)

!rice(% perbarrel)

6

S )

: 6 06 1: 16 3: 360:

0:

06

1:

16

3:

36

5:

56

13

0<

S

Due to the elasticity

of the lon'-runsupply and demand

cur"es, the lon'-runeffect of a cut

in production ismuch less

S’ ) Long-run Effect

4ffects of $o"ernment Inter"ention

7/25/2019 chap2-ev



--!rice #ontrols

&f the go%ernment decides that theequilibrium price is too high* they mayestablish a ma+imum allo(able ceiling

price#

4ffects of !rice #ontrols

7/25/2019 chap2-ev



D

Quantity

!rice

P 0

Q 0

S

P ma+

4xcess demand

If price is re'ulated tobe no hi'her than P ma+ ,

quantity supplied fallsto Q 1 and quantity

demanded increases toQ 2 . shorta'e results

!rice #ontrols and

7/25/2019 chap2-ev



?atural $as Shorta'es

&n :9@* the federal go%ernment beganregulating the (ellhead price of naturalgas.

&n :?2* the ceiling prices that (ereimposed became binding and shortagesresulted.

!rice #ontrols and

7/25/2019 chap2-ev



#rice controls created an e+cess demandof < trillion cubic feet.

#rice regulation (as a ma1or componentof ".S. energy policy in the :?=s and:<=s* and it continued to influence thenatural gas markets in the :>=s.

?atural $as Shorta'es

!rice #ontrols and

7/25/2019 chap2-ev



G26TcB7

.9oilfor demandof elasticityCross

=.oilfor supplyof elasticityCross

Demand Supply

P P Q Demand

P P QSupply

P

P

O

O

D E

S E

=

+−=

++=

=

−=

=

=

75'35:

25'2#4:

5'$

2'$

?atural $as Shorta'esThe Data/ ?atural $asThe Data/ ?atural $as

!rice #ontrols and

7/25/2019 chap2-ev


?atural $as Shorta'esThe Data/ ?atural $asThe Data/ ?atural $as

TcB6yr <Shortage

TcB29andTcB

G.==6TcB 't

G.==priceregulated:<9

=

==

=

QQS #!

chap2-ev

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