1. Econ 102 SY 2008 2009 Lecture 2 Supply and Demand June 12 and 17, 2008

2. Econ 102 SY 2008 2009 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

3. Econ 102 SY 2008 2009 Petroleum Prices

4. Econ 102 SY 2008 2009 Crude Oil Prices 1947-2007 Factors Affecting Oil Prices

5. Econ 102 SY 2008 2009 Oil Supply and Prices

6. Econ 102 SY 2008 2009 Iran’s Oil Production

7. Econ 102 SY 2008 2009 Iraq’s Oil Production

8. Econ 102 SY 2008 2009 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 1981. 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.

9. Econ 102 SY 2008 2009 OPEC and Oil Prices

10. Econ 102 SY 2008 2009 Current price increases

11. Econ 102 SY 2008 2009 Non-OPEC Production and Prices

12. Econ 102 SY 2008 2009 Low inventories

13. Econ 102 SY 2008 2009 Venezuela production

14. Econ 102 SY 2008 2009 Factors affecting Asian demand Low inventories Venezuela oil supply problems

15. Econ 102 SY 2008 2009 Summary Prices move because of shifts in demands and supply Price Quantity Supply Demand

16. Econ 102 SY 2008 2009 Describing Demand

17. Econ 102 SY 2008 2009 Describing Supply: Text Messaging Market

18. Econ 102 SY 2008 2009 How the Market May Look Like

19. Econ 102 SY 2008 2009 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

20. Econ 102 SY 2008 2009 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

21. Econ 102 SY 2008 2009 When there’s Excess Demand Buyers bid up prices Sellers Increase amounts produced

22. Econ 102 SY 2008 2009 When there’s Excess Supply Suppliers bid down prices And buyers Increase amounts purchased

23. Econ 102 SY 2008 2009 Market Equilibrium Excess Demand is Zero No incentive to change prices Equilibrium price: 9.5 and quantity: 26 26 9.5

24. Econ 102 SY 2008 2009 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)

25. Econ 102 SY 2008 2009 Fall in Demand and Market Equilibrium Suppose demand goes down Price goes down (9.5 to 8), quantity falls (26 to 23)

26. Econ 102 SY 2008 2009 Increase in Supply and Market Equilibrium Suppose technology improves, and supply rise Price goes down (9.5 to 8), quantity rises (26 to 29)

27. Econ 102 SY 2008 2009 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)

28. Econ 102 SY 2008 2009 Supply and demand applications

29. Econ 102 SY 2008 2009 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

30. Econ 102 SY 2008 2009 Taxing Text Product: text messaging services Producers: mobile phone companies Buyers: mobile phone users

31. Econ 102 SY 2008 2009 How the Market May Look Like

32. Econ 102 SY 2008 2009 Text Messaging Market

33. Econ 102 SY 2008 2009 Tax on Text Supply curve: Q=1+10*P Suppose the tax is: 66.67 percent New Supply curve: Q=1+6.6667*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

34. Econ 102 SY 2008 2009 How the Market Looks Like

35. Econ 102 SY 2008 2009 Graphically….

36. Econ 102 SY 2008 2009 Who pays for the tax on text and deadweight loss of the tax

37. Econ 102 SY 2008 2009 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

38. Econ 102 SY 2008 2009 Effect on the Market

39. Econ 102 SY 2008 2009 Effects Price goes down from 1.2 to.857 Quantity goes up from 9 to 12.43 million Revenue roughly is unaffected: 3.6 before to 3.55 billion pesos after technology improvement

40. Econ 102 SY 2008 2009 Vegetable Market

41. Econ 102 SY 2008 2009 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

42. Econ 102 SY 2008 2009 The Vegetable Market with Imports

43. Econ 102 SY 2008 2009 Graphically…

44. Econ 102 SY 2008 2009 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

45. Econ 102 SY 2008 2009 Vegetable Market with Import tax

46. Econ 102 SY 2008 2009 Graphically…

47. Econ 102 SY 2008 2009 Welfare analysis…

48. Econ 102 SY 2008 2009 Welfare effects of an import tax Supply Demand P Q 0 Consumer surplus Producer surplus Tax revenues Deadweight Loss

49. Econ 102 SY 2008 2009 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

50. Econ 102 SY 2008 2009 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

51. Econ 102 SY 2008 2009 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

52. Econ 102 SY 2008 2009 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

53. Econ 102 SY 2008 2009 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

54. Econ 102 SY 2008 2009 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

55. Econ 102 SY 2008 2009 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’’

56. Econ 102 SY 2008 2009 End of Lecture 2 Supply and Demand