July07

Outline for Monday, July 7

� Remember

�Quiz on Friday

� Homework due Monday

� Review from Thursday� Review from Thursday

� Where do we get a demand curve?

� Application: oil speculators

� What causes shifts in curves?

Using the graph: summary

You should understand

� What do the demand and supply curves mean?

� What makes demand and supply shift or change?

� How do shifts change the equilibrium, where the � How do shifts change the equilibrium, where the curves intersect?

� What happens when we’re not at the equilibrium price? shortages and surpluses

� Remember that quantity responds to price:

� buyers choose how much to buy, not at what price to buy

� Sellers choose how much to sell, not at what price to sell

Assumption #1: Quantity responds to

price

� There are a lot of buyers and sellers

� This only applies to certain markets

� This means that no one can choose the price

� So buyers and sellers are both called price-takers� So buyers and sellers are both called price-takers

and this is called the price-taking assumption

� This also suggests that buyers and sellers all pay

and see the same price, so there are no

� Transaction costs

� Search costs

Assumption #2: Scarcity

� The economy must have scarce resources because…

If they are not scarce � an infinite amount of the

good could be made � so no one would pay for it

Assn. #3: Rationality

� Buyers and sellers will change their behavior so that

equilibrium is reached

S

surplus

E

D

pE

qE

p2

q2Sq2D

surplus

Approaching equilibrium

� How does a shortage get fixed?



� New sellers, with higher costs, enter

� Current sellers produce more

� Low-value buyers re-sell to high-value buyers� Low-value buyers re-sell to high-value buyers



� New sellers, with higher costs, enter

� Current sellers produce more

� Low-value buyers re-sell to high-value buyers� Low-value buyers re-sell to high-value buyers

� How does a surplus get fixed?

Supply & Demand Model

We assume We get

Assumption #1: Price-taking P � Q

Assumption #2: Scarcity P > 0

Assumption #3: Rationality EquilibriumAssumption #3: Rationality Equilibrium


� Remember

�Quiz on Friday






Where do we get a demand curve?

� Suppose that, for lunch today, I’m willing to pay $5

for a burger, $4 for another burger, $2 for a third

and nothing for any more

� What next?� What next?


� Suppose that, for lunch today, I’m willing to pay $5

for a burger, $4 for another burger, $2 for a third

and nothing for any more

� This gives my demand schedule:� This gives my demand schedule:

� Let’s graph it…Note that it’s downwards sloping

$0 $1 $2 $3 $4 $5

Quantity Demanded 3 3 3 2 2 1


� Suppose there are two hamburger eaters with the

following schedules:$0 $1 $2 $3 $4 $5

Quantity demanded by A 3 3 3 2 2 1

Quantity demanded by B 11 6 3 2 1 1

� What is the total demand schedule?



� Suppose there are two hamburger eaters with the

following schedules:$0 $1 $2 $3 $4 $5

Quantity demanded by A 3 3 3 2 2 1


� Clearly the total demand is…

� Again, we have a downward sloping demand curve


Total quantity demanded 14 9 6 4 3 2


� Suppose that no one wants more than one Nintendo

Wii. Twenty consumers have the following

willingness-to-pay (in dollars): 500, 400, 100, 200,

300, 0, 600, 100, 200, 300, 400, 500, 200, 0, 0,

0, 100, 200, 300, 4000, 100, 200, 300, 400

� What is the demand schedule?





300, 0, 600, 100, 200, 300, 400, 500, 200, 0, 0,

0, 100, 200, 300, 4000, 100, 200, 300, 400

� What is the demand schedule?$0 $100 $200 $300 $400 $500

Quantity demanded 20 16 13 9 6 3





300, 0, 600, 100, 200, 300, 400, 500, 200, 0, 0,

0, 100, 200, 300, 4000, 100, 200, 300, 400

� What is the demand schedule?

� What price should Nintendo charge?

$0 $100 $200 $300 $400 $500

Quantity demanded 20 16 13 9 6 3

Where do we get the curves?

� For demand: add up, or aggregate, the price-

responses of individual consumers




� For supply: do the same for firms� For supply: do the same for firms




� For supply: do the same for firms� For supply: do the same for firms

� We add along the horizontal x-axis because we’re

concerned with the total amount supplied or

demanded


� Remember

�Quiz on Friday






Oil speculators

� We’ll examine the positive claim “Oil speculation is

driving up prices” using Paul Krugman’s model

Oil speculators

� We’ll examine the positive claim “Oil speculation is

driving up prices” using Paul Krugman’s model

� I’ll present the model and the data used to test it

� As we go through it, think of what is missing that might � As we go through it, think of what is missing that might

change our conclusion

Oil speculators

Going long –

� Buy oil now, planning to sell it later

�Gain if price goes up sufficiently

P

Selling short –

� Have no oil, promise to deliver it later

�Gain if price drops

P

Oil speculators

Going long –

� Buy oil now, planning to sell it later

�Gain if price goes up sufficiently

P

Selling short –

� Have no oil, promise to deliver it later

�Gain if price drops

� We’re worried about the long-buyers

P

Oil speculators

� Suppose that, without speculators, demand and

supply would be in equilibrium at (PE, QE)

Oil speculators



� Why do speculators drive up prices?

Oil speculators



� Why do speculators drive up prices?

� How do speculators drive up prices?� How do speculators drive up prices?

Oil speculators

We observe We cannot observe

Current price P

Current quantity sold Q

Current consumption C

Speculators’ future price PF

Storage costs S

The demand curve

The supply curve

The equilibrium without speculators

Oil speculators

We observe We cannot observe

Current price P

Current quantity sold Q

Current consumption C

Speculators’ future price PF

Storage costs S

The demand curve

The supply curve

The equilibrium without speculators

� How can we test the claim that “Oil speculation is

driving up prices”?

Oil speculators



�Oil storage should be high

Q – C >> 0Q – C >> 0

� Speculators’ future price should be high above current

prices

PF – P >> S

Oil speculators



�Oil storage should be high

Q – C >> 0Q – C >> 0

There’s only 55-days worth in storage

� Speculators’ future price should be high above current

prices

PF – P >> S

The price gap is not above storage costs

Oil speculators

� What is this model missing that might give us a

different answer?

� Are the numbers convincing?

Oil speculators

Oil speculators

� What is this model missing that might give us a

different answer?

� Are the numbers convincing?

� It’s still under investigation at the U.S. Commodities

and Futures Trading Commission


� Remember

�Quiz on Friday






What shifts demand?

� Recall that a change or shift in demand is a change

in any factor besides the good’s own price. Like

what?

What shifts demand?

� A change or shift in demand may be caused by

� The price of a related good

�Gas price increases � demand for cars falls

What shifts demand?



� Income

� Professors get a raise � demand for books increasesProfessors get a raise � demand for books increases

� Congress gives itself a raise � members can pay for their

own flights � demand for lobbyist-paid flights falls

What shifts demand?



� Income

� Tastes� Tastes

� Shakira sings at the Super Bowl � demand goes up

What shifts demand?



� Income


� The number of buyers

� The border is closed � demand for anything sold along the

border falls

What shifts demand?



� Income



� Beliefs about the good’s properties

� Thabo Mbeki says potatoes slow AIDS � demand goes up

What shifts demand?



� Income




� Beliefs about future prices

�We expect a recession � demand for gold goes up

What shifts demand?



� Income





�Maybe other stuff, too

What shifts demand?



� Income






� Lets consider outside prices and income in more detail

Other goods’ prices

� Goods that go well together are complements

� Popcorn and movies, Windows and PCs, cereal and

milk



�When a complement is more expensive, demand falls

�When a complement is cheaper, demand rises





� Goods that can be substituted for each other are � Goods that can be substituted for each other are

substitutes

� Ice cream and frozen yogurt, lectures and books

≈ ?






substitutes

�When a substitute is more expensive, demand increases

�When a substitute is cheaper, demand falls






substitutes

�When a substitute is more expensive, demand increases

�When a substitute is cheaper, demand falls

� Whether a good is a complement or substitute

depends on consumers’ tastes

Income

� Most goods we’ll consider are normal goods: as

income increases, so does demand

� Those goods with the opposite relationship are

called inferior goodscalled inferior goods

Income

� Most goods we’ll consider are normal goods: as

income increases, so does demand

� Those goods with the opposite relationship are

called inferior goodscalled inferior goods

� A single good can be both types at different

income levels

Income

� Demand for normal goods increases with income

� Other goods are called inferior

� A single good can be both

Income

� Demand for normal goods increases with income

� Other goods are called inferior

� A single good can be both

� Recall that the Law of Demand says demand falls

with price

� Goods whose demands rise with price are Giffen

goods

What shifts supply?

� A change or shift in supply may be caused by

What shifts supply?


� Input prices

�Grain is more expensive � supply of burgers falls, both for

the bun and the burger

What shifts supply?


� Input prices

� Technology

� The internet allows for cheaper music sales � supply The internet allows for cheaper music sales � supply

increases

What shifts supply?


� Input prices

� Technology

� The number of sellers� The number of sellers

� New York City allows anyone to work a taxi � supply

increases

What shifts supply?


� Input prices

� Technology



� The oil boom is ending � OPEC wants to sell while the price

is still high � current supply increases

What shifts supply?


� Input prices

� Technology




What shifts supply?


� Input prices

� Technology




�We’ll consider input prices in more detail when we

model the producer’s problem


� Remember

�Quiz on Friday






Business

July07