1. ECN202: Macroeconomics S&D

2. Supply & Demand Think of how important markets are in your life? Stories about them fill the news, as you can see in some headlines. Markets determine the price you pay for food, phones, and air travel, which affects what you eat, what phone you buy, and if you travel by plane. They also affect the wages you earn or the interest you pay on a loan or the value of the US $. In this unit we will look at the model economists use to explain movements in price so you will be able to explain past moves and forecast future moves. We start with some examples of how prices can be really wrong. Like the housing bubble we just experienced, and the one China may be in right now. Then we get some practice with those curves.

3. What are the major stories of prices? One group of stories about prices are about disequilibrium prices and shortages and surpluses that are associated with those prices. There is a shortage of tickets to the finals of the NFL playoff game at the current price? The second, and more frequent, group of stories is about price changes driven by shocks to the market. This is the type we spend the most time on in this course.

4. What are the primary drivers of price changes? 1.Demand shocks 2.Supply shocks 3.Changes in market power (competition) 4.Government intervention

5. Cookbook approach 1.Identify the market 2.Identify the participants 3.Identify the determinants of behavior 4. Identify the type of problem 1.disequilibrium - wrong price 2.comparative static - price change 5. Identify the appropriate curves How should you approach these questions about prices and markets? Follow these steps one-by-one.

6. Some Practice: What is the market? 1.“The ageing of baby-boomers casts doubt over asset prices” 2.“Race to satisfy caviar craving” 3.“A love affair with SUVs begins to cool” Identify the market in these headlines Write it down and then read on

7. What is the market? 1.“The ageing of baby-boomers casts doubt over asset prices” (Market for assets such as stocks or homes) 2.“Race to satisfy caviar craving” (Market for caviar) 3.“A love affair with SUVs begins to cool” (Market for SUVs) Identify the market in the headlines

8. Determinants of demanders’ behavior 1.Ability to pay (income ) 2.Number (demographics ) 3.Preferences (fads, fashions, habits) 4.Expectations (bubbles ) 5.Price of other things (complements & substitutes) 6.Price of product Make a list of factors that affect demand for some product and then see if you missed anything.

9. Ability to pay – an increase in income or wealth would increase demand Number – an increase in the number of driving age population would increase demand Preferences – increased advertising expenses will increase demand Price of other things – increase in price of gas will reduce demand Price of product – increase in price of SUVs will reduce quantity demanded Headline: “A love affair with SUVs begins to cool” Market: SUVs What affects demand for SUVs?

10. Determinants of suppliers’ behavior 1.Number of suppliers 2.Costs of production 1.Price of inputs / resources 2.Productivity / efficiency of resources 3.Price of product

11. Number of suppliers - an increase in the number of fish farms increases supply Costs of production –Price of inputs – an increase in feed costs raises cost, which decreases supply –Productivity – new harvesting technique reduces harvesting costs = increases supply Price of product – increases in price = increase quantity supplied Headline: “Race to satisfy caviar craving” Market: domestic grown caviar What affects supply domestic grown caviar?

12. Now let’s look closely at those S&D curves We will use a simple numerical example, so get out that pad of paper

13. Demand Curve Relationship between Price and Quantity (amount) demanded. Nature of relationship: As price rises demand falls. Picture of relationship: Plot these points on the following graph before moving on. PriceQuantity $220 $415

14. Demand Curve “Picture” of Buyers / demanders Now plot those points from the table

15. Demand Curve $2 20 Q1s $4 15 Price Quantity @ price of $4 demand is 15 @ price of $2 demand is 20 Here is what it should look like

16. What can change demand? Short answer: Change in any of the factors that affect demand Longer answer: There are two “Types” of factors 1.price change –if the price changes then this causes a change in quantity demanded 2.Change in ANYTHING else –if any factor other than price changes then this causes a change in demand

17. Decrease in quantity demanded ______ D $2 20 Increase in quantity demanded When P falls to $2 demand rises to 20 Movement ALONG demand curve Q1s $4 15

18. INCREASE in demand ______ D $2 20 Q1s $4 15 Increase in demand When income of buyers increase @ each price demand is now higher

19. INCREASE in demand ______ D $2 20 Q1s $4 15 Increase in demand When income of buyers increase @ each price demand is now higher

20. Supply Curve Relationship between Price and Quantity (amount) supplied. Nature of relationship: As price rises supply rises. Picture of relationship: Plot these points on the following graph before moving on. PriceQuantity $218 $422

21. Demand Curve “Picture” of Sellerss Now plot those points from the table

22. Supply Curve $2 22 $4 18 Price Quantity @ price of $4 supply is 22 @ price of $2 supply is 18 Here is what it should look like

23. What can change supply? Short answer: Change in any of the factors that affect demand Longer answer: There are two “Types” of factors 1.price change –if the price changes then this causes a change in quantity supplied 2.Change in ANYTHING else –if any factor other than price changes then this causes a change in supply

24. Supply Curve $2 22 $4 18 Price Quantity Increase in quantity supplied When P rises to $4 supply rises to 22 Movement ALONG supply curve

25. Supply Curve $2 22 $4 18 Price Quantity Increase in supply When productivity increases @ each price supply is now higher

26. Supply Curve $2 22 $4 18 Price Quantity Increase in supply When productivity increases @ each price supply is now higher

27. Summary A curve shifts – something other than the price shocks the market Increase in demand – demand curve shifts OUT Increase in supply– supply curve shifts OUT No curve shifts when the price changes – this is just a movement along a curve.

28. Hint The most common mistake is to shift two curves. Most shocks only directly affect either buyers or sellers so we have only one shift. Example1: How do we show higher incomes on demand for Toyota cars? – it is the buyers’ income that changes so it will be demand that changes – so supply does not shift. Demanders of cars feel wealthier and will buy more cars and this increases demand – the D curve shifts out. NO shift in S.

29. Hint The most common mistake is to shift two curves. Most shocks only directly affect either buyers or sellers so we have only one shift. Example2: How do we show higher jet fuel prices on market for airplane travel? – you never wake up and think about jet fuel prices and neither do other travelers – so demand does not shift. Suppliers of seats, however, do care about jet fuel prices and this raises costs so it reduces supply – the S curve shifts in. NO shift in D. Example1: How do we show higher incomes on demand for Toyota cars?

30. Supply & Demand Curves Disequilibrium prices Equilibrium price Picture of market PriceSupplyDemand $21820 $319 $42215

31. Demand Curve “Picture” of Buyers & Sellers Now plot those points from the table

32. Supply & Demand Curves $2 22 $4 18 Price @ price of $4 supply is 22 & demand is 15 = surplus Here is what it should look like @ price of $2 supply is 18 & demand is 20 = shortage

33. What will happen? If price is $2 then the shortage will prompt sellers to raise the price and as the price rises the shortage falls as quantity supplied increases and quantity demanded decreases. If price is $4 then the surplus will prompt sellers to lower the price and as the price falls the surplus falls as quantity supplied decreases and quantity demanded increases. So prices keep moving until at some price S = D. We call it the equilibrium price and that happens where the S&D curves intersect.

34. Equilibrium $2.5 19 Price @ price of $2.5 supply = demand = 19 = equilibrium

35. Now let’s look at some examples to see how well you have mastered this. On the next two slides think about how we show the impact of the shock on the market – and use the cookbook approach. Do it before you move on.

36. How will China’s economic rise affect the price of oil in the US?

37. How will China’s economic rise affect the price of labor in the US?

38. How will China’s economic rise affect the price of oil in the US? 1.Identify the market – oil market 2.Identify the participants – demanders (us), suppliers (oil companies) 3.Identify the determinants of behavior- China is a demander of oil 4. Identify the type of problem comparative static - price change from shock 5. Identify the appropriate curves - China’s growth increases demand for oil = demand curve shifts outward

39. How will China’s economic rise affect the price of oil in the US?

40. How will China’s economic rise affect the price of labor in the US? 1.Identify the market – US labor market 2.Identify the participants – demanders (US firms), suppliers (US workers) 3.Identify the determinants of behavior- China is a substitute for US workers as firms move to China 4. Identify the type of problem comparative static - price change from shock 5. Identify the appropriate curves - China’s growth decreases demand for US workers by US firms = demand curve shifts inward

41. How will China’s economic rise affect the price of labor in the US?

42. Use a S&D graph to demonstrate the Impact on oil market of _____. a.US increases in mileage standards on automobiles b.Nigeria revolt upsets oil supply c.New technology finds new oil in old wells d.Rise in smart phones behind drop in computer salesQuestions

43. a.US increases in mileage standards on automobiles

44. b. Nigeria revolt upsets oil supply

45. c. New technology finds new oil in old wells

46. d. Rise in smart phones behind drop in computer sales

47. Use a S&D graph to demonstrate the Impact on oil market of _____. a.US increases in mileage standards on automobiles – if costs rise this will decrease Supply b.Nigeria revolt upsets oil supply –Nigeria is supplier = decrease in supply c.New technology finds new oil in old wells –New tech increases supply d.Rise in smart phones behind drop in computer sales –People buying a smartphone instead of computer = decrease in demandQuestions

48. Generalization: Single Shift PriceQuantity Demand -  Demand -  Supply -  Supply -  Fill in the table again – see if it is easier now

49. What will happen to the price of marijuana if it is legalized? Do this before you move onQuestions

50. Marijuana legalized Reduces social cost of getting caught - increases demand =  D  P,  Q Reduces cost of transportation – increase supply=  S  P,  Q Combined effect -  Q, not forecast change in Q

51. What will happen to the price of marijuana if it is legalized? Big increase in DQuestions

52. What will happen to the price of marijuana if it is legalized? Big increase in SQuestions

53. Double shift When we have two curves shifting it s only possible to predict either price or quantity change, but not both. I suggest always trying to figure out what happens to price and you are done. Example: Increase S&D increase in D pushes prices higher Increase in supply pushes prices lower Can’t predict price Both increase in D & S push quantity higher

54. Generalizations: Double Shift PriceQuantity Demand increase Supply increase Demand increase Supply decrease Demand decrease Supply increase Demand decrease Supply decrease Fill in the table again – see if it is easier now