Lecture 2.5 Leftovers: Elasticity, Market Equilibrium & Interesting Questions 1

Demand Elasticity & Total Revenue Change TR Max Ed < 1 Ed > 1 Ed = 1 2

Demand Curves Properties –Marginal Value: (incremental) value of the next unit demanded –Marginal Revenue: (incremental) revenue of next unit sold –Average Revenue: average revenue received for selling a given quantity 3

A Short Quiz Seattle Times Oct 3, 2007 Olympic National Park officials are suggesting raising the price of an entrance pass for motorists — good for seven days — from $15 to $25 starting in 2009, with the fee for individuals such as cyclists climbing from $5 to $12. Season passes would increase from $30 to $50 But public response, particularly from tourist-dependent local businesses has been generally negative said a spokeswoman for Olympic National Park. 1.Illustrate the effect of the increase of the price for park passes on the demand for trips to the park 2.Illustrate how the park fee increase would affect the demand for other tourist-related businesses, e.g., hotels, restaurants. 4

Another Variation At each price, determine whether there would be a shortage (Qd > Qs) or a surplus (Qs > Qd) If there was a shortage, how would price adjust to clear the market? If there is a surplus, how would price adjust to clear the market? # of Pizzas Demand ed Price Per Pizza # of Pizzas Supplie d Shortage or Surplus 1000$ $ $ $ $ $

Answers # of Pizzas DemandedPrice Per Pizza# of Pizzas SuppliedShortage (-) or Surplus (+) 1000$ $ $ $ $ $

The Cobweb Theorem D S 7 Price (£) Quantity Bought and Sold (millions) 9 D1 In a ‘divergent cobweb’ - also termed an unstable cobweb - the price tends to move away from equilibrium. Assume the initial equilibrium price is £7 and the quantity 9. If demand rises, the shortage pushes the price up to £11 per turkey Farmers respond by planning to increase supply, ten months later, the supply of turkeys is 15 million. At this level, there will be a surplus of turkeys and the price drops. 8 The price falls to £5 and farmers react by cutting plans for turkey production. Ten months later, supply on the market will be 8 million. 5 This creates a massive shortage of 9 million turkeys and the price is forced up – and so the process continues! A divergent cobweb leads to price instability over time. 17 7

Cobweb Theorem Hungarian-born economist Nicholas Kaldor ( )Nicholas Kaldor Simple dynamic model of cyclical demand with time lags between the response of production and a change in price (most often seen in agricultural sectors). Cobweb theory is the process of adjustment in markets Traces the path of prices and outputs in different equilibrium situations. Path resembles a cobweb with the equilibrium point at the center of the cobweb. Sometimes referred to as the hog-cycle (after the phenomenon observed in American pig prices during the 1930s). 8

Useful Websites –Understanding differences between factors that cause shifts in demand or supply tmlhttp://hspm.sph.sc.edu/COURSES/ECON/SD/SD.h tml –Basics of demand and supply economics3.asphttp:// economics3.asp –Cobweb theorem 4.ppthttp:// 4.ppt 9

Markets for Biodiesel Fuel and Food Initial conditions –Corn is a major input (ingredient) to both food and biodiesel –Gas prices have significantly increased during the past few years in the automobile gasoline market 1.What is the impact of higher gasoline prices on the demand for biodiesel? 2.What is the impact of higher gasoline prices on the demand for food products? 10

More Questions #9 City Parks more polluted than country club grounds –Are people who use parks less concerned than those who golf? –Is it an issue of property-right assignment? –CC tend to use fertilizers that seep into the water table. Who owns the water table? 11

Diamond/Water Paradox Diamonds sell for a much higher price than bottles of water. Does that mean diamonds are more valuable than water? 12

Paul’s example Two brewers Two beers: Stout or Lager –What is the opportunity cost? “Next” best alternative BrewerGal of Stout Gal of Lager Opp Cost of Stout Opp Cost of Lager Jones5102 g lager½ g stout Brown43¾ g lager4/3 g stout 13