Transcript Markets and Prices - Yau Chung Hei

Equilibrium:
How Supply and Demand Determine Prices
Ka-fu Wong
University of Hong Kong
1
Markets and Prices
o Why does Jeremy LIN earn more than Ka-fu WONG (an
award winning teacher)?
2
Markets and Prices
o Why do diamonds cost more than water?
3
Markets and Prices
o Why do Picasso’s paintings sell for more than Leroy
Nieman’s?
4
Markets and Prices
o Why do the crabs of Qi BaiShi (齊白石) sell for more
than the real ones?
5
Markets and Prices
o Is it cost of production
that determines prices
(as Adam Smith
thought)?
6
Markets and Prices
o Or is it willingness to pay
that determines prices (as
Stanley Jevons thought)?
7
Markets and Prices
o Alfred Marshall (Principles
of Economics, 1890) was
the first to explain clearly
how both costs and
willingness to pay interact
to determine market
prices.
8
Markets and Prices
o The market for any
good or service
consists of all
(actual or potential)
buyers or sellers of
that good or service.
Shau Kei Wan Market
Sai Kung Pier Market
o Supply (sellers) and
demand (buyers)
jointly determine
the market price.
9
The market for lobsters
o The market for lobsters in Portland, Maine, on July 20,
2004.
10
The demand for lobsters
o The demand curve is the set of all price-quantity pairs
for which buyers are satisfied. ("Satisfied" means being
able to buy the amount they want to at any given price.)
Price ($/lobster) D
10
8
6
4
2
D
0
1
2
3
4
5
Quantity
(1000s of lobsters/day)
11
The supply of lobsters
o The supply curve is the set of price-quantity pairs for
which sellers are satisfied. ("Satisfied" means being able
to sell the amount they want to at any given price.)
Price ($/lobster)
10
S
8
6
4
2
S
0
1
Quantity
(1000s of lobsters/day)
2
3
4
5
6
12
Market Equilibrium Quantity and Price
o Equilibrium occurs at the price-quantity pair for which
both buyers and sellers are satisfied.
Price ($/lobster)
10
D
S
8
6
4
2
D
S
0
1
At the market equilibrium
price of $6 per lobster,
buyers and sellers are each
able to buy or sell as many
lobsters as they wish to.
2
3
4
5
Quantity
(1000s of lobsters/day)
13
Market Equilibrium
o Equilibrium:
o the condition of a system in which all competing influences
are balanced, such that the system has no tendency to
deviate from the current condition.
o When Qs = Qd at a certain price, the market is in equilibrium,
o the amount consumers would purchase at this price is
matched exactly by the amount producers wish to sell.
o When both consumers and producers are satisfied, the
current condition (characterized by P and Q) will has no
tendency to change.
14
Excess supply
o A situation in which price exceeds its equilibrium value is
called one of excess supply, or surplus.
Price ($/lobster)
10
excess
supply
D
S
8
6
At $8, there is an excess
supply of 2000 lobsters
in this market.
4
2
D
S
0
1
2
3
4
5
Quantity
(1000s of lobsters/day)
15
From disequilibrium to equilibrium
Price ($/lobster)
10
D
S
S
D
8
6
At prices above equilibrium,
sellers are not selling as
much as they want to.
The impulse of a
dissatisfied seller is to
reduce his price.
4
2
0
1
2
3
4
5
Quantity
(1000s of lobsters/day)
16
Excess Demand
o A situation in which price lies below its equilibrium value
is referred to as one of excess demand.
Price ($/lobster)
10
D
S
8
excess
dem and
6
4
2
D
S
0
1
At a price of $4 in this
lobster market, there is
an excess demand of
2000 lobsters.
2
3
4
5
Quantity
(1000s of lobsters/day )
17
From disequilibrium to equilibrium
Price ($/lobster)
10
D
S
S
D
8
6
4
2
0
1
2
3
4
5
At prices below the
equilibrium value, buyers
cannot obtain the
quantities they wish to
purchase. Some buyers
adjust by offering slightly
higher prices.
Quantity
(1000s of lobsters/day)
18
Zero excess supply and demand
o Equilibrium occurs at the price-quantity pair for which
both buyers and sellers are satisfied.
Price ($/lobster)
10
D
S
8
6
4
2
D
S
0
1
At the market
equilibrium price of $6,
both excess demand
and excess supply are
exactly zero.
2
3
4
5
Quantity
(1000s of lobsters/day)
19
The Trading Locus
o When price differs from the equilibrium price, trading in
the marketplace will be constrained -- by the behavior of
buyers if the price lies above equilibrium, by the
behavior of sellers if below.
Price ($/lobster)
10
D
S
S
D
Trading locus
8
6
4
2
0
1
2
3
4
5
Quantity
(1000s of lobsters/day)
20
Comparative Statics
Shifting Demand and Supply Curves
Price of
energy
drinks
An increase in
demand
S
Causes the
equilibrium to
change to a
P1
higher P and Q
P0
D0
Q0
Q1
D1
Quantity of energy
drinks
21
Comparative Statics
Shifting Demand and Supply Curves
Price of
energy
drinks
A decrease in
demand
S
Causes the
equilibrium to
change to a
P0
lower P and Q
P1
D01
Q1
Q0
Quantity of energy
drinks
22
Comparative Statics
Shifting Demand and Supply Curves
Price of
energy
drinks
An increase in
supply
SS10
P0
Causes the
equilibrium to
change to a
lower P and
higher Q
P1
D0
Q0
Q1
Quantity of energy
drinks
23
Comparative Statics
Shifting Demand and Supply Curves
Price of
energy
drinks
A decrease in
supply
SS
10
P1
Causes the
equilibrium to
change to a
higher P and
lower Q
P0
D0
Q1
Q0
Quantity of energy
drinks
24
Gains from Trade Are Maximized at
Equilibrium Price and Quantity
Unexploited Gains from Trade Exist when Quantity is Below the Equilibrium Quantity
Price of Oil
per Barrel
Satisfied Wants
$57
Supply Curve
Unsatisfied Wants
At Q=24, there are buyers who
value buying the good more than
sellers value selling the good
(there are unexploited gains from
trade up until 65 units)
Equilibrium
$30
Price
$15
Unexploited
Gains from
Trade
24
Demand Curve
65
Equilibrium
Quantity
Quantity of Oil
(MBD)
25
Gains from Trade Are Maximized at
Equilibrium Price and Quantity
Wasteful Trades Exist when Quantity is Above the Equilibrium Quantity
Price of Oil
per Barrel
Supply Curve
$50
Equilibrium
Price
$30
Value of
Wasted
Resources
$15
Demand Curve
65
Equilibrium
Quantity
95
Quantity of Oil
(MBD)
26
Gains from Trade Are Maximized at
Equilibrium Price and Quantity
Price of Oil
per Barrel
Supply Curve
At the Equilibrium Quantity There
Are No Unexploited Gains from
Trade nor Any Wasteful Trades!
Equilibrium
Price
$30
Demand Curve
65
Equilibrium
Quantity
Quantity of Oil
(MBD)
27
Gains from Trade Are Maximized at
Equilibrium Price and Quantity
A Free Market Maximizes Producer plus Consumer Surplus (the gains from trade)
Price of Oil
per Barrel
Supply Curve
Buyers
Equilibrium
Price
$30
Non-Sellers
Consumer
Surplus
Producer
Surplus
Sellers
Non-Buyers
Demand Curve
65
Equilibrium Quantity
Quantity of Oil
(MBD)
28
Equilibrium and Total Surplus
o Equilibrium in a free market yields two important results:
o Goods must be produced at the lowest possible cost.
o Goods must satisfy the highest valued demands.
o These results indicate that total surplus (both of the
consumer and producer) is maximized in free markets.
o The market equilibrium price and quantity are socially
optimal.
o
The market equilibrium price and quantity are socially optimal
o when all relevant production costs are incurred by sellers, and
o when all relevant product benefits accrue to buyers.
Fine print
29
The Price of Oil, 1960-2005
30
Prediction
o An oil shock will cause the price oil to increase, quantity
to decrease.
31
Hong Kong examples
o Impact of X on the price and quantity various kinds of
meat, and on the price of wine and quantity of wine
o Fishing holiday
o Avian Flu
o Mad-cow disease
o The impact of development of genetic modified food
o The expansion of HKU on the housing prices in the
Western District.
32
Conclusion
o We observed an increase in price and a decrease in
quantity.
o Likely a supply shock had occurred.
33
Policy
o The housing price is too high. What can government do
to lower the price?
o Increase the supply.
o Price will be lower and quantity will be higher.
34
Example: Impact of food aid
An important determinant of the amount of grains harvested next year
by Ethiopian farmers is the amount of seeds planted this year. Given
that Western nations have guaranteed to donate five hundred tons of
grain next year, this year the Ethiopian farmers will:
A. plant more seeds as the food aid established a minimum price for
grain.
B. plant more seeds as the farmers’ confidence is restored.
C. plant the same amount of seeds as they would have without the
food aid.
D. plant less seeds as consumers’ demand for grain is completely
price elastic.
E. plant less seeds as the price of grain will be lower with the food
aid.
35
Example: Impact of food aid
o Donate five hundred tons of grain next year means that
the demand for domestic production of grain will be
lowered by the same amount at all prices?
Price
500 tons
S
Anticipating a lower market
equilibrium price next year, farmer
would want to supply less quantity
next year.
P
P’
D’
Q’
Q
D
They do so by planting less
seeds this year.
Quantity (tons of grain)
36
Example: Impact of food aid
An important determinant of the amount of grains harvested next year
by Ethiopian farmers is the amount of seeds planted this year. Given
that Western nations have guaranteed to donate five hundred tons of
grain next year, this year the Ethiopian farmers will:
A. plant more seeds as the food aid established a minimum price for
grain.
B. plant more seeds as the farmers’ confidence is restored.
C. plant the same amount of seeds as they would have without the
food aid.
D. plant less seeds as consumers demand for grain is completely price
elastic.
E. plant less seeds as the price of grain will be lower with the food
aid.
37
Example: Two or more shifting factors
o What will happen to the equilibrium price and quantity in
the fresh seafood market if both of the following events
occur:
o a scientific report is issued saying that fish contains
mercury, which is toxic to humans; and
o the price of diesel fuel falls significantly?
38
Example: Two or more shifting factors
o The equilibrium price will go down, but the equilibrium
quantity may go either up (right panel) or down (left
panel)
P
P
S
S S'
S'
S
S
S'
D'
D
S'
Q
D'
D
Q
39
Example: Rental Regulation
Suppose the supply and demand curves for two-bedroom
Collegetown rental apartments are as shown.
Monthly Rent
($/apartment)
Supply
1500
1000
500
Demand
1
2
3
Quantity
(thousands of apartments per month)
40
Example: Rental Regulation
o The city council is concerned that many students cannot
afford the equilibrium rent of $1000 per month and is
considering a regulation forbidding landlords from
charging more than $500.
o What will be the likely consequences of adopting this
regulation?
41
Example: Rental Regulation
o Rent Controls Produce Excess Demand in the Housing
Market.
At this quantity, the marginal buyer is willing
to pay 1000 more to obtain an apartment.
Monthly Rent
($/apartment)
Supply
1500
At this price, excess demand = 2000
apartments.
1000
Controlled Rent 500
Demand
1
2
3
Quantity
(thousands of apartments per month)
42
Example: Rental Regulation
o Responses to excess demand in a regulated housing
market:
finder’s fees
key deposits
required furniture rental
excessive damage deposits
curtailed maintenance
apartment conversion
43
Alternative to helping the poor (students?)
o There are much more effective ways to help poor people
than to regulating prices of apartments and other goods
at artificially low levels.
For example, income transfers:
Wage subsidies
Public service jobs
44
Examples of price control in Hong Kong?
o Rent control
o Cheung, S.N.S. (1979), “Rent Control and Housing Reconstruction: The
Postwar Experience of Prewar Premises in Hong Kong”, Journal of Law
& Economics, 22 (1), pp. 27-53.
o
o
o
o
Designated LPG pump stations
Brokerage fee of trading stock
Public housing
Taxi fare
45
Taxi regulations
o Taxi is in excess supply at the regulated taxi fare.
o Every day, a lot of taxi line up at the airport for
customers. Some of them have to wait several hours
for business.
o Some offer discount to customers.
o Number of taxi license is also regulated.
TITLE
Conflicting interests in taxi-fare regulation / Yue-Chim Richard Wong, Ka-Fu Wong.
IMPRINT
Hong Kong : Asia Case Research Centre, The University of Hong Kong, c2005.
http://library.hku.hk/record=b3580220
46
Taxi Regulations
Taxi Fare
S
Economy in a recession:
Excess supply
Economy in a boom:
Excess demand
Regulated fare
D2
(economy in a boom)
D1 (economy in a recession)
Taxi services
47