Econ 102 SY Lecture 2 Supply and Demand June 12 and 17, 2008

Econ 102 SY Key concepts Supply and demand Market equilibrium Shifts in Demand Shifts in Supply Shifts in both Supply and Demand Income and price elasticities Policy analysis

Econ 102 SY Petroleum Prices

Econ 102 SY Crude Oil Prices Factors Affecting Oil Prices

Econ 102 SY Oil Supply and Prices

Econ 102 SY Iran’s Oil Production

Econ 102 SY Iraq’s Oil Production

Econ 102 SY Iran and Iraq Influence The combination of the Iranian revolution and the Iraq-Iran War cause crude oil prices to more than double increasing from $14 in 1978 to $35 per barrel in Twenty-six years later Iran's production is only two-thirds of the level reached under the government of Reza Pahlavi, the former Shah of Iran. Iraq's production remains about 1.5 million barrels below its peak before the Iraq-Iran War.

Econ 102 SY OPEC and Oil Prices

Econ 102 SY Current price increases

Econ 102 SY Non-OPEC Production and Prices

Econ 102 SY Low inventories

Econ 102 SY Venezuela production

Econ 102 SY Factors affecting Asian demand Low inventories Venezuela oil supply problems

Econ 102 SY Summary Prices move because of shifts in demands and supply Price Quantity Supply Demand

Econ 102 SY Describing Demand

Econ 102 SY Describing Supply: Text Messaging Market

Econ 102 SY How the Market May Look Like

Econ 102 SY Excess Demand Excess demand is demand less supply Positive, demand exceeds supply Negative, supply exceeds demand (excess supply) Between prices 10 and 8, excess demand changes sign

Econ 102 SY Excess Demand: Effect on Buyers and Sellers Positive excess demand buyers bid prices up to secure their purchases producers sell more because of higher profits Negative excess demand (or excess supply) Producers bid prices down to unload their supplies As prices go down, buyers buy more

Econ 102 SY When there’s Excess Demand Buyers bid up prices Sellers Increase amounts produced

Econ 102 SY When there’s Excess Supply Suppliers bid down prices And buyers Increase amounts purchased

Econ 102 SY Market Equilibrium Excess Demand is Zero No incentive to change prices Equilibrium price: 9.5 and quantity:

Econ 102 SY Rise in Demand and Market Equilibrium Suppose income per capita goes up and demand increases Price goes up (9.5 to 12), quantity increases (26 to 31)

Econ 102 SY Fall in Demand and Market Equilibrium Suppose demand goes down Price goes down (9.5 to 8), quantity falls (26 to 23)

Econ 102 SY Increase in Supply and Market Equilibrium Suppose technology improves, and supply rise Price goes down (9.5 to 8), quantity rises (26 to 29)

Econ 102 SY Fall in Supply and Market Equilibrium Suppose production cost increases, and supply falls. Price goes down (9.5 to 10), quantity falls (26 to 25)

Econ 102 SY Supply and demand applications

Econ 102 SY Outline of Presentation Effect of a tax on text messaging Earmarking revenues for technology improvement Effect of imported vegetables on vegetable prices Restricting imports of vegetables Increase in world rice prices Virtual equilibrium Subsidizing rice consumption Consumer surplus, producer surplus and deadweight loss

Econ 102 SY Taxing Text Product: text messaging services Producers: mobile phone companies Buyers: mobile phone users

Econ 102 SY How the Market May Look Like

Econ 102 SY Text Messaging Market

Econ 102 SY Tax on Text Supply curve: Q=1+10*P Suppose the tax is: percent New Supply curve: Q= *P If before we bought 11 million SMS for a price of one peso Now that will cost buyers 1.67 pesos Result: Buyers react by reducing texting Producers in turn react by reducing supply Eventually market settles at 1.2 pesos per text

Econ 102 SY How the Market Looks Like

Econ 102 SY Graphically….

Econ 102 SY Who pays for the tax on text and deadweight loss of the tax

Econ 102 SY Earmarking revenues Let the 3.6 billion pesos, or part thereof, be spent for technological improvement of mobile phone industry Let the R&D result in increase productivity

Econ 102 SY Effect on the Market

Econ 102 SY Effects Price goes down from 1.2 to.857 Quantity goes up from 9 to million Revenue roughly is unaffected: 3.6 before to 3.55 billion pesos after technology improvement

Econ 102 SY Vegetable Market

Econ 102 SY Imported Vegetables Two sources of supply Local vegetables Imported vegetables Assume that the country is small relative to the world Price taker in the world market The world can provide any amount the country needs at a the world price

Econ 102 SY The Vegetable Market with Imports

Econ 102 SY Graphically…

Econ 102 SY Taxing Imported Vegetables Political objective: to appease local producers Economic: to encourage local production, employment Suppose the tax is 12.5 percent on the price

Econ 102 SY Vegetable Market with Import tax

Econ 102 SY Graphically…

Econ 102 SY Welfare analysis…

Econ 102 SY Welfare effects of an import tax Supply Demand P Q 0 Consumer surplus Producer surplus Tax revenues Deadweight Loss

Econ 102 SY Effects of the Tax on Imported Vegetables Consumers pay a higher price Price goes up by 10 pesos per kilo Revenues to the government: 16.5 billion pesos Local producers increase supply by 170 thousand tons

Econ 102 SY Rice Market Local Supply Demand 1 Demand 2 Total Demand Import Supply Price Quantity QsQs Q d Qs’ Q d’ Exports Imports P P’ Export Demand Kinked Total Demand Kinked Total Supply

Econ 102 SY Observations With the unanticipated increase in the world price of rice, we get  Country shifts from being importer to exporter of rice  Local rice prices go up to P’ With that problems:  Poorer income class unable to meet daily rice requirement  Situation that we feed the world but cannot feed all of our people

Econ 102 SY Government’s options Ban rice exports Control the domestic price of rice Subsidize the domestic price of rice General subsidy Targeted subsidy Import rice and targeted subsidy

Econ 102 SY Ban Rice Exports Local Supply Demand 1 Demand 2Total Local Demand Price Quantity Qs’ Qd’Qd’ Exports Imports P P’ Export Demand Q d ’’ Qs’’ P’’ Kinked Total Demand (Local and Export) Deadweight Loss

Econ 102 SY Observations Assuming that the export ban policy is perfectly enforced, these are the effects  Local rice prices go down  Daily rice requirement of the poor may or may not be met  Local farmers lose  Local consumers gain  Consumers’ gain less than farmers’ loss, i.e. there is deadweight loss

Econ 102 SY Control Rice Prices Local Supply Demand 1 Demand 2 Total Demand Import Supply Price Quantity QsQd’QsQd’ QdQd Q d’ Exports Imports P P’ Export Demand Kinked Total Demand (Local and Export) Kinked Total Supply P’’

Econ 102 SY End of Lecture 2 Supply and Demand