HONORS ECONOMICSPATTERNS & NARRATIVES

DEMANDSUPPLY

PRICE

SUPPLY & DEMAND

SUPPLY & DEMAND BASICSIn a market system INTERSECTION of supply & demand curves = PRICES

Marginal COST (supply) = marginal VALUE (demand)

Price = y-axis / quantity = X-AXIS

ACCORD – 5 MODELSA uctioneer (Leon Walras)

= series of simultaneous equations solved by the “invisible hand” auctioneer.

C obweb (Nicholas Kaldor)= inward & outward spirals based on the mismatch of long-run & short-run supply / elasticities of supply & demand

CO rridor (Axel Leijonhufvud)= behaves like the “Rocking Horse” within range of the corridor, however, inflationary & deflationary traps exist outside its range. Equilibrium & Disequilibrium Special States

R ocking Horse (Ragnar Frisch – Jan Tinbergen)= shock-absorber & thermostat. Price system propagates exogenous shocks, but tends toward long-run equilibrium.

D isco (Peter Diamond)= Search Equilibrium; Matching & Pairing. Multiple equilibria with unstable optimal & stable-suboptimal equilbria. Often, what you want, you can’t have; what you have, you don’t want. Markets must be made.

DEMANDDemand curves slope DOWNWARDS –

buy more when prices are lowerShape of the aggregate DEMAND curve = WEALTH,

population, & the availability of SUBSTITUTES

SUPPLYSHAPE of the supply curve = FACTORS of production

(land, labor, & capital) + TECHNOLOGY + substitutesSupply curves slope UPWARDS –

produce more when prices are higherBr

ando

n’s A

pplau

se Su

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Curv

e

Francine’s Applause Supply Curve

Samantha’s Applause Supply Curve

Alyssa’s Applause Supply Curve?

$ 1 Mystery Item

$ 5 Mystery Item

INCREASING/DIMINISHING RETURNSSUPPLY & DEMAND ILLUSTRATE “NO FREE LUNCH”

EVERYTHING HAS OPPORTUNITY COSTS AS COSTS (PRICE) OF CONSUMPTION / PRODUCTION

INCREASE THEY CONSUME / PRODUCE LESS. INCREASING RETURNS:

– DIVISION OF LABOR: UNIT COSTS DECREASE AS PRODUCTION INCREASES– RESOURCE CONSTRAINTS: PRICE INCREASES AS RESOURCE STOCKS DIMINISH– EDUCATION: PREVIOUS KNOWLEDGE QUICKER ACQUISITION OF NEW

KNOWLEDGE– NETWORK EFFECTS: THE VALUE OF THE NEWORK = NUMBERS OF MEMBERS.

DECREASING RETURNS:– DECREASING MARGINAL UTILITY: THE 10TH SLICE OF PIZZA DOES NOT TASTE AS

GOOD AS THE 1ST – CROWDING/CONGESTION: TRAFFIC; CLUBS; FASHION – COST DISEASE: OVERBUREACRATIZATION / PROFESSIONALIZATION

DEMAND

SUPPLY

PRICE

A

BC

D

PRICE

Mr. Brunelli Demands Higher Grades, but the Supply Function for Students is a “kinked” step function

SUPPLY & DEMAND

;AUCTIONEER MODEL

8

6

2

15 F(d)Frieda = 8a + 1b + 2c = 1

“Outer” Beauty = A = -1“Inner” Beauty = B = 5 $$$$$ = C = 2

F(d)Lucy = 4a + 1b + 0.5c = 2

F(d)Marcie = 1a + 2b + -1.5c = 6 F(d)Patti = -2a + 1b + 1c = 8

F(d)Violet = 4a + 0.6b + 3c = 5

AUCTIONEER MODEL

Walrasian Auctioneer = individual consumer demand functions & individual producer supply functions

matrix of SIMULTANEOUS equations aggregate functions

Then, F(D) [Aggregate Demand) = F(S) (Aggregate Supply)

“ONE PRICE”Assumptions: Determinate, one unique solution, system in

equilibrium, no transaction costs.

A B C

PRICES & PHYSICS]

ROCKING HORSE MODEL

BIGSHOCK

ROCKING HORSE MODELFluctuations in price = EXOGENOUS shocks propagated

through the rocking horse.Exogenous Shocks =

• Supply shortages from War, Famine, & Weather • New Technology • Government Policy• Changes in Credit / Money• Structural Changes in the Economy (Agriculture Industry)

Market system tends toward long-run EQUILIBRIUM. Rocking Horse = SHOCK ABSORBER, internal economic mechanism (PRICE SYSTEM) never wrong.

Economy = CYBERNETIC = Self-Adjusting & Self-Regulating Thermostat

Friction = “PRICE DISCOVERY”

“DISCO” MODELl

BOYS

GIRLS

STABLE – SUBOPTIMAL EQUILIBRIUM

STABLE – SUBOPTIMAL EQUILIBRIUM UNSTABLE – OPTIMAL EQUILIBRIUM

“DISCO” MODELl

INSURERS

INSUREES

“DISCO” MODEL

Buyers, No SellersStable,

SuboptimalEquilibrium

Sellers, No BuyersStable,

SuboptimalEquilibrium

Sellers = BuyersUnstable, Optimal

Equilibrium

Small Shock

Small Shock

“DISCO” MODELSupply & Demand = SEARCH EQUILIBRIUM; Pairing

& Matching– Workers & Employers– Insurers & Insurees– Schools & Students– Entrepreneurs & Capital

Markets & Non-Markets: Markets cannot be assumed, they must be CREATED.

MULTIPLE equilibria: Stable, SUBOPTIMAL equilibria + Unstable, optimal equilibrium.

Disequilibrium = natural state of affairs.

Economic Agents ≠ PERFECT INFORMATION. Information / Transactions = Costly

CORRIDOR MODELCORRIDOR

ACCELERATING INFLATION

ACCELERATING DEFLATION

INFLATION 2% -- 10%

UNEMPLOYMENT 10% -- 5%

INFLATIONARY SHOCK

• DEFAULT

• CURRENCY SPREAD

• WAGE SPIRAL

• COMMODITY PUSH

DEFLATIONARYSHOCK

• DEBT

• REDUCTION IN SPENDING

• REDUCTION IN CREDIT / INVESTMENT

• LEISURE / TECHNOLOGY SHOCK

DEFLATIONARY TRAPa.k.a. “LIQUIDITY” TRAP

INFLATIONARY TRAPa.k.a. “GALLOPING” INFLATION

CORRIDOR MODELMost fluctuations occur in narrow BANDS or “corridors” The Federal Reserve = control interest rate = SPEED-BUMP

or guardrail.Within these ranges, economy = “rocking horse” model,

but . . . High and low levels of INFLATION / UNEMPLOYMENT = runaway feedback effects.

EXPECTATIONS are important. SELF-FULFILLING PROPHECIESThe economy behaves normally, IF we believe it behaves normally. Expected Inflation InflationExpected Deflation Deflation

Shocks = not SELF-CORRECTING

ELASTICITYELASTICITY = sensitivity of quantity to priceVertical = perfectly INELASTIC (e = 0)

Demand = addictive behavior– ADDICTIONS – Your life / health

Supply = TECHNOLOGICAL / Resource Constraint– In this house we obey the laws of thermodynamics!– Water in a desert

Horizontal = perfectly elastic (e = ∞)demand = fixed price

– Perfectly SUBSTITUTABLE GOODS = paper clips– BUDGET CONSTRAINT

supply = fixed costs– Commodities – identical production processes– LIQUIDITY TRAPS– “COST – DISEASE” of service workers / professionals

INELASTIC DEMAND

SUPPLY

PRICE

INELASTIC DEMAND

“New” Diagnoses

DEMAND

SUPPLY

PRICE

GIFFEN GOODS / CONSPICUOUS CONSUMPTION

POSITIONAL & NON-POSITIONAL

Demand = positively elastic GIFFEN GOODSHigher price higher quantity demanded

Use vs. Exchange value: (fetish commodities) demand ≠ value, price value demand

CONSPICUOUS consumption: consume for others’ benefit: flowers/chocolates, perfume, WEDDING REGISTRIES.

Food / consumption staples: largest budget item displaces others as price increases.

Status/POSITIONAL goods: is the best worth it?– Is private school worth the tuition?– Is expensive healthcare better healthcare?– McMansions anyone?

Positional goods = socially sanctioned MASOCHISMSocially INEFFICIENT use of resources

COBWEBS

If slopesupply > slopedemand INWARD spiral to PRICE STABILITYIf slopesupply < slopedemand OUTWARD spiral to PRICE

INSTABILITY

Caused by time LAG between supply & demand decisions• Agriculture – planting (costs) & HARVESTING (benefits) • LABOR MARKETS – education (costs) & compensation (benefits)• Stock markets (esp. Technology) – investment (costs) & return (benefits)

COBWEBS & PRICE FLUCTUATIONS

TIME

PRICE

CONSUMER & PRODUCER SURPLUSCONSUMER SURPLUS = AREA BETWEEN DEMAND CURVE

& EQUILIBRIUM PRICE PRODUCER SURPLUS (PROFITS) = AREA BETWEEN THE

SUPPLY CURVE & EQUILIBRIUM PRICE

***IN A CAPITALIST – COMPETITIVE – MARKET ECONOMY, THERE SHOULD BE NO LONG-TERM PROFITS***

INEQUALITY & DISTRIBUTIONSINEQUALITY = DISPROPORTIONATE OR “UNFAIR” CONCENTRATION

OF VALUED ITEMS – INCOME, JOBS, GRADES – IN ONE GROUP INCOME INEQUALITY = MEASURED BY GINI COEFFICIENTGINI = GAP BETWEEN “PERFECT EQUALITY” & THE ACTUAL

LORENZ CURVE CUMULATIVE SHARE OF INCOME

EQUALITY = LEPTOKURTIC, HOMOSKEDASTIC DISTRIBUTION MODE MEAN MEDIAN

INEQUALITY = PLATYKURTIC, HETEROSKEDASTIC DISTRIBUTION MEAN MEDIAN (SKEW) & MULTIPLE MODES

KURTOSIS = SINGULAR OR MULTIPLE MODESSKEWNESS = MEAN VALUE RELATIVE TO MEDIAN VALUE

MEAN > MEDIAN SKEW RIGHTMEAN < MEDIAN SKEW LEFT

GINIGINI