LECTURE 431 January 2013

1Thursday, January 31, 13

ANNOUNCEMENTS

• HW 1 due tomorrow at 11:45 PM

• Read Fuel Consumption in Europe (on Moodle) and the US for Tuesday

• Auction today after class at 4:45 PM

• Office is 3-125 (not 3-128)

2Thursday, January 31, 13

REVIEW: DEMAND

• What are five factors that can affect the demand schedule (curve)?

• When will we see a shift along the demand curve versus a shift of the demand curve?

• Suppose we are interested in the market for iPhones

• The only viable substitute’s (Galaxy SIII) price increases

• What will happen to price and quantity in a new equilibrium?

3Thursday, January 31, 13

PRICES OF OTHER GOODS

• Let’s consider oil and corn

• Oil and corn are related in many way, particularly because corn can be used to make ethanol--a substitute for gas

• How will demand for corn change as the price of oil increases?

Corn Price Q(D), Oil $40 Q(D), Oil $80

0 8 120.50 7 111.00 6 101.50 5 92.00 4 82.50 3 73.00 2 63.50 1 54.00 0 4

4Thursday, January 31, 13

PRICES OF OTHER GOODS

• Notice that change in prices of other goods SHIFTS DEMAND

Quantity of Corn

P in $

US Corn Market

0

1

2

3

4

5

0 1 2 3 4 5 6 7 8 9 10

D, Oil $40

11 12

Corn Price Q(D), Oil $40 Q(D), Oil $80

0 8 120.50 7 111.00 6 101.50 5 92.00 4 82.50 3 73.00 2 63.50 1 54.00 0 4

D, Oil $40

5Thursday, January 31, 13

PRICES OF OTHER GOODS

• Assume supply is unchanged, how has the equilibrium changed?

• We can see price and quantity have increased

• Why?

• Higher demand increases scarcity, which forces up prices

• Higher prices increase supply so supply and demand “meet” somewhere in the middle

Quantity of Corn

P in $

US Corn Market Demand

0

1

2

3

4

5

0 1 2 3 4 5 6 7 8 9 10

D, Oil $40

11 12

D, Oil $80

Supply

6Thursday, January 31, 13

REAL DATA

• Here is data on the relationship between corn and oil prices from August 2004 to August 2012

• We can see how they move together more clearly on a graph

Time Oil Price/Barrel Corn Price/Bushel

8/2004 $46.02 $2.348/2005 $66.21 $1.948/2006 $72.95 $2.098/2007 $73.36 $3.278/2008 $113.46 $5.268/2009 $66.72 $3.338/2010 $75.17 $3.658/2011 $87.88 $6.888/2012 $94.35 $7.54

7Thursday, January 31, 13

REAL DATA

• As price of oil increases so does price of corn; what’s the connection?

• Price of oil drives up corn demand

• Higher corn demand increases equilibrium prices for corn too

• What else is driving high corn prices now?

!

Recent Prices of Oil and Corn (August 2004-2012)

012345678

0 25 50 75 100 125Oil ($ per barrel)

Cor

n ($

per

bus

hel) 2012!

2011!2008!

2009,2010!2004!

8Thursday, January 31, 13

PRICES OF OTHER GOODS

• Other goods related to the good we are looking at are either substitutes or complements

• Substitutes: I would exchange my good for this other good

• We saw corn demand increased as the substitute’s (oil) price increased

• Typically as P(Substitute) increases, Demand(Our Good) increases, why?

• The opposite is true when P(Substitute) decreases

• Complements: I would like to use this good with my own good (hot dogs and ketchup? iPhones and Macs?)

• Here as P(complement) increases, D(our good) decreases, why?

• Higher prices of hot dogs make ketchup less attractive so my demand for it will fall

9Thursday, January 31, 13

INCOME

• What do we expect is the impact of higher income on demand?

• It depends on whether a good is inferior or normal

• Inferior good: as income increases demand for this good decreases

• Normal good: as income increases demand for this good increases

• Examples?

10Thursday, January 31, 13

INCOME INCREASESInferior Good Normal Good

Quantity

Price

PC Demand

D, Higher Wealth

D, Wealth

Quantity

Price

Mac

D, Wealth

D, Higher Wealth

11Thursday, January 31, 13

NUMBER OF BUYERS

• Demand in a market is the sum of demand from all buyers

• As the number of buyers increases, it obviously follows that demand increases

• Can you think of a counterexample?

• As the number of buyers decreases, the opposite (should be) is true

12Thursday, January 31, 13

CONSUMER TASTES

• What we want to buy is largely motivated by some type of consumer taste

• What happened to the Blackberry?

• Better phones (HTC, Samsung, iPhone) changed consumer tastes and expectations in smart phones so demand decreased

Quantity

Price

Blackberry Demand

D, New Tastes

D, Old Tastes

13Thursday, January 31, 13

DETERMINANTS OF SUPPLY

• As with demand, there is a law of supply: as price increases (decreases), quantity supplied increases (decreases)

• Other than price what factors are important for supply?

1. Prices of inputs (labor, materials)

2. Number of Sellers

3. Technology

14Thursday, January 31, 13

SHIFTING SUPPLY

• Suppose there is a large influx of immigrants willing to work for a low wage on farms

• What is the effect on the supply curve?

• Lower wages imply lower costs

• At a given price, firms can now produce more than they were before

• Supply should shift to the rightQuantity of Corn

P in $

US Corn Market Supply

Supply Supply 2

15Thursday, January 31, 13

SHIFTING SUPPLY

• In general:

• Lower costs imply supply increases, so the supply curve shifts right

• An increase in the number of sellers increases supply (shifts right)

• An improvement in technology allows greater production for the same or lower cost so supply increases (shifts right)

• What might shift supply left?

16Thursday, January 31, 13

MULTIPLE SHIFTS

• Suppose again that the price of oil increases

• As a substitute for corn, we showed as oil price increases demand shifts to the right

• What other effect does it have?

• Oil is an input into corn production!

• Higher input prices contract supply (shifts to the left)

17Thursday, January 31, 13

SHIFT IN DEMAND ONLY

• Oil prices increase drives up demand for its substitute (corn)

Quantity of Corn

P in $

US Corn Market

D 1

D 2

Supply

QE1 QE2

PE1

PE2

Equilibrium quantity increases

Equilibrium price increases

18Thursday, January 31, 13

SHIFT IN SUPPLY ONLY

• Oil prices increase drives up cost for corn

Quantity of Corn

P in $

US Corn Market

D 1

D 2

S 1

QE1QE2

PE1

PE2

Equilibrium quantity

decreases

Equilibrium price increases S 2

19Thursday, January 31, 13

BOTH SHIFT

• When we shift both, the result is ambiguous

Quantity of Corn

P in $

US Corn Market

D 1

D 2

S 1

QE1 QE2

PE1

PE2 Equilibrium quantity increases

Equilibrium price increases S 2

20Thursday, January 31, 13

BOTH SHIFT

• If the shift were slightly different, we could see quantity decrease

Quantity of Corn

P in $

US Corn Market

D 1

D 2

S 1

QE1QE2

PE1

PE2 Equilibrium quantity

decreases

Equilibrium price increases S 2

21Thursday, January 31, 13

SHIFT IN DEMAND AND SUPPLY

• We can collect these changes more clearly in a table

• In recitation you will have more chances to play with different types of shifts

Corn Price Shifts Change in corn price

Change in corn quantity

Increase in substitute

priceQ(D) Increase Increase

Increase in input price Q(S) Increase Decrease

Combined Q(D), Q(S) Increase Ambiguous

22Thursday, January 31, 13

SUMMARY

• The competitive market is able to reach a market clearing condition without the intervention of a third party manager

• The equilibrium price is the price that ensures demand is equivalent to supply

• Demand and supply are determined by factors other than price that can cause SHIFTS in demand and supply when manipulated

• Demand and supply shifts will cause a new equilibrium price and supply to arise in the market

23Thursday, January 31, 13