PPA723-lecture2

McPeak

Lecture 2

PPA 723

A market is in equili= brium at the point where the demand and supply curves cross.

The equilibrium price= is the market price at which consumers can buy as much as they want and sellers can sell as much as they want.

The equilibrium quant= ity is the quantity demanded / quantity sold at the equilibrium price.<= /span>

The equilibrium price quantity pair (p^*, q^* ) is= the price and quantity at which neither buyers nor sellers have an incentive to change their behavior. <= /o:p>

Finding it on a graph= :

The price quantity pa= ir where the supply curve crosses the demand curve.

Finding it by algebra= :

Q^d=3D286-2= 0*p

Q^s=3D88+40= *p

At what price does Q<= sup>d=3DQ^s ?

Q^d=3DQs where 286-20*p=3D88+40*p, 198=3D60*p, p=3D$3.30=

What is the implied q= uantity? 286-20*3.30=3D 88+40*3.30=3D220

[Derive inverse, show= p=3D(286/20) – (1/20)*Q(d), p =3D (-88/40) + (1/4= 0)*Q(s) is an equivalent statement of the relationship, and is easier to graph – y=3Df(x) issue here.]

What happens if we de= viate from this equilibrium?

Price above equilibri= um: $4.

We will have excess s= upply – the amount by which the quantity supplied is greater than the quant= ity demanded.

The quantity demanded= is 206. (286-20*4)

The quantity supplied= is 248. (88+40*4)

Producers have oversu= pplied 42 units (excess supply).

These can either be w= asted, or stored. =

As there are costs to= storage, why not lower the price on the excess supply?

Say for simplicity th= at each firm produces one unit. The f= irst 220 firms to figure out they can lower the price to $3.30 (the equilibrium price) and not have to store the pork do so.

That leaves 28 firms = that moved too slowly. =

They have pork at a p= rice that nobody wants to buy ($4).

They close down their operations, and give away the excess pork as a severance package. The market has moved to its equili= brium.

Or, alternatively, ea= ch firm decides to produce slightly less.

Price below equilibri= um: $2.

We will have excess d= emand – the amount by which quantity demanded exceeds quantity supplied at a given price.

The quantity demanded= is 246. (286-20*2)

The quantity supplied= is 168. (88+40*2)

Consumers want to buy= 78 units more at the price of $2, but are not able to get it at the prevailing market price.

Potential producers n= otice this, and rush to open factories.

Again, assuming each = firm produces one unit, 52 firms open and start selling, driving the price up to $3.30 and the quantity up to 220.

Why is the price goin= g to go up from $2 to $3.30 when there is more being produced?
What is to be made of the statement “supply =3D demand”?

By definition, they a= re equal in equilibrium.

However, this is only= in equilibrium.

In our first example,= we had the observed price $4, and the corresponding consumer demand of 206. If we see a $4 price, and observe = that 206 units were sold, does this tell us supply =3D demand? No, recall this was a case of exce= ss supply. Supply > Demand at= going market price.

Likewise, when we had= $2 and 168 units supplied. This was = a case of excess demand. Demand > Supply at going market price.

In economic terms, su= pply =3D demand only at the equilibrium point.

How do we know we are= at equilibrium and not in a situation of excess supply or demand?

No firms entering or = leaving the market (expanding or contracting production).

No shortage of the go= od / no unsold surplus of the good.

Price of the good is = stable.

Arriving at the equil= ibrium is an example of moving along a supply curve and along a demand curve to ar= rive at a stable point.

How do policies influ= ence the intersection of supply and demand?

Return to the idea of= supply and demand curves shifting as introduced in an earlier lecture.<= /span>

Now, we want to think= about what happens to the market equilibrium when “all else constant” that is in the background experiences a change.

Recall that there are= things like prices of complements, prices of inputs, rules and regulations that can lead to shifts in supply or demand curves.

Let’s move some= supply and demand graphs around:

1) What happens if new environmental regulation is introduced relaxing the restrictions on the disposal of pig waste, thus lowering the cost of production for hog producers?

Supply ->

= 2)&n= bsp; Wh= at happens if new regulations on pork processing hygiene that are more stringe= nt are introduced, thus increasing the costs of producing processed pork.=

Supply <-

= 3)&n= bsp; What happens if the government funds an advertis= ing campaign “Pork, it whitens teeth and freshens breath” and consu= mers believe it?

Demand ->

= 4)&n= bsp; What happens if the price of chicken decreases dramatically in response to a new veterinary innovation at Cornell funded by USDA money.

Demand <-
How do policies influence the intersection of supply and demand?=

1)&n= bsp; Price Floor= . There is a minimum price, legally enforced, below which a commodity can not be purchased.

E= xcess supply – agricultural surplus, unemployment.

What if the price flo= or is set at $2?

The price floor is non-binding. It is there, but= has no effect on the market equilibrium.

2)&n= bsp; Price Ceiling. There is a maximum p= rice, legally enforced, above which a commodity can not be sold.

N= on-binding.

What if the price cei= ling is set at $2?

There is excess deman= d. Waiting in lin= e, black market exchange.