Chapter 2. Supply and Demand

Supply Factors determining supply Price of the good Costs of production (Technology advance) Government rules and regulations

Supply curve

Effects of other variables on supply

Hot Topic: Supply Curve in the News *Also available at the State and county level National supply curves* for Energy crops (POLYSYS output), ORNL

Supply function Q=S(p,ph) Q=178+40p-60ph At price of hogs fixed at $1.50 per kg Q=88+40p P=1/40Q-88/40 -> P=0.025Q-2.2 Two points on x and y axis (p=0,Q=88), (Q=0,p=-88/40) Δp=$1 cause the quantity supplied to increase ΔQ=40 million kg per year

Equilibrium Equilibrium (in general) The condition of a system in which competing influences are balanced Genetic equilibrium (in biology) Theoretical state in which a population is not evolving Chemical equilibrium (in chemistry) The state in which the concentrations of the reactants and products have no net change over time Social equilibrium (in sociology) A system in which there is a dynamic working balance among its interdependent parts

Equilibrium in Economics A situation in which no one wants to change his or her behavior Market equilibrium All traders are able to buy and sell as much as they want and no deviation is needed

Market equilibrium

Using math to determine the equilibrium Demand function Qd=286-20p Supply function Qs=88+40p We want to find p at which Qd=Qs=Q, the equilibrium quantity 286-20p=88+40p 198=60p P=$3.30, Q=220

Shocking the equilibrium

Policies that cause demand to differ from supply (Price Ceiling)

Economic Analysis about Price Ceiling “The Welfare Costs of Rationing by Waiting” by Deacon, Robert T and Sonstelie, Jon (1989, Economic Iquiry) Abstract: With price controls and rationing by waiting, rational consumers increase the quantity bought per purchase. This individually rational response is socially wasteful and the cost of making it is a deadweight loss. This cost plus the value of time spent in queues may exceed the total rent transferred from suppliers to consumers by price controls, i.e., the value of resources spent competing for the rent may exceed the rent itself. This point is illustrated by an empirical application to gasoline price controls. Rent seeking exhausts an estimated 116 percent of the rent transferred. Interpretation: Every dollar consumers save for the price ceiling during the oil shock in 1972, they lost $1.16 in waiting time and other factors.

How shapes of demand curves matter

Sensitivity of quantity demanded to price Importance of sensitivity of quantity demanded to price Price elasticity of demand Percentage change in the quantity demanded in response to a given percentage change in the price

Price elasticity of demand 1% increase in price of pork leads to 0.3% decrease in the quantity demanded A price increase causes a less than proportionate fall in the quantity of pork demanded

Quiz #2 Draw supply curve for the supply function for the processed pork, Q=88+40p (or P=1/40Q-88/40), Find two points on x and y axis (when p=0, Q=?; when Q=0, p=?) and connect the two points What happens to the supply curve for the processed pork if hog price increases? Using a linear downward-sloping demand curve and a linear upward-sloping supply curve for gasoline: 3. Illustrate the effect of reduction of supply of crude oil in the gasoline market (Graph new supply curve, find new equilibrium point, and explain). If the government issues price ceiling at the original price before the reduction of supply of crude oil, illustrate the effect on the graph and explain.

Quiz #2 Draw supply curve for the supply function for the processed pork, Q=88+40p (or P=1/40Q-88/40), Find two points on x and y axis (when p=0, Q=?; when Q=0, p=?) and connect the two points Answer) 2. What happens to the supply curve for the processed pork if hog price increases?

Using a linear downward-sloping demand curve and a linear upward-sloping supply curve for gasoline: Illustrate the effect of reduction of supply of crude oil in the gasoline market (Graph new supply curve, find new equilibrium point, and explain). Answer: The supply curve for the gasoline shifts from S1 to S2. Without governmental intervention, new equilibrium from e1 to e2 will be achieved and equilibrium quantity will be down and the equilibrium price will be up to p2.

If the government issues price ceiling at the original price before the reduction of supply of crude oil, illustrate the effect on the graph and explain. Answer: Government prohibited gasoline price greater than pbar. So, at the pbar, supply will be at Qs and demand will be at Qd. As a result, there would be Qd-Qs, excess demand. With excess demand, the price goes up normally because consumers are willing to pay more to get gasoline. However, at the price is arbitrarily controlled at pbar. Gas station can’t sell the gasoline more than pbar, causing the excess demand continues. We call this shortage of gasoline, a persistent excess demand. At this circumstance, suppliers would make decision who gets gasoline, eg., friends, old customers, and others do not.