Economics 2 Professor Christina Romer Spring 2019 Professor David - - PDF document

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Economics 2 Professor Christina Romer Spring 2019 Professor David - - PDF document

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Economics 2 Professor Christina Romer Spring 2019 Professor David Romer LECTURE 4 EXTENSIONS OF SUPPLY AND DEMAND ANALYSIS January 31, 2019 I. O VERVIEW II. R EVIEW OF THE S UPPLY AND D EMAND F RAMEWORK A. Supply and demand diagram (example:

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SLIDE 1

Economics 2 Professor Christina Romer Spring 2019 Professor David Romer LECTURE 4 EXTENSIONS OF SUPPLY AND DEMAND ANALYSIS January 31, 2019 I. OVERVIEW

  • II. REVIEW OF THE SUPPLY AND DEMAND FRAMEWORK
  • A. Supply and demand diagram (example: light trucks)
  • B. What shifts the demand curve?
  • C. What shifts the supply curve?
  • III. ELASTICITY
  • A. Price elasticity of demand
  • B. Relationship between elasticity and the slope of the demand curve
  • C. Impact of elasticity on the market outcome
  • D. Demand elasticity and expenditure (example: illegal opioid drugs)
  • 1. Comparison of supply-side and demand-side policies
  • 2. What the simple analysis may be missing
  • E. Price elasticity of supply
  • IV. EFFECTS OF A TAX
  • A. Terminology and set-up (example: gas tax)
  • B. Effects on price and quantity
  • C. Who pays the tax?
  • D. Interaction with demand elasticity
  • E. Government tax revenue
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SLIDE 2

LECTURE 4

Extensions of Supply and Demand Analysis

January 31, 2019

Economics 2 Christina Romer Spring 2019 David Romer

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SLIDE 3

Announcements

  • Problem Set 1 is due next Tuesday (February 5).
  • Problem Set Work Session this afternoon (Jan. 31)
  • 5:00–7:00 in 648 Evans Hall
  • Ground Rules:
  • Answers must be in your own words,

handwritten, and with acknowledgements to the people you worked with.

  • Graded on a scale of 1 to 10.
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SLIDE 4

Announcements

  • Collecting the Problem Sets:
  • They are due at the beginning of lecture.
  • We will have boxes with your GSIs’ names on

them in the middle of the lecture hall (both sides).

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SLIDE 5

Announcements

  • Journal article reading for Tuesday (by Kahneman,

Knetsch, and Thaler):

  • You can access for free through any University

computer, or from off campus using the library proxy (see http://www.lib.berkeley.edu/using- the-libraries/connect-off-campus).

  • Don’t stress over every word or parts you

don’t understand.

  • Read for approach and findings.
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SLIDE 6
  • I. OVERVIEW
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SLIDE 7

Plan for the Lecture

  • What shifts demand and supply curves?
  • Discuss elasticity.
  • Examine the effect of another government

intervention in the market (a tax).

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SLIDE 8
  • II. REVIEW OF SUPPLY AND DEMAND
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SLIDE 9

Market for Light Trucks

D1 Q P S1 P1 Q1 Equilibrium

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SLIDE 10

What Causes the Demand Curve to Shift?

  • In general, anything that changes the desirability
  • f the good at a given price.
  • Change in the price of a complement.
  • Change in tastes; news.
  • Change in the price of a substitute.
  • Change in demographics.
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SLIDE 11

Retail Price of Gasoline

Source: Bureau of Labor Statistics.

100 150 200 250 300 350 400 2011-01 2011-07 2012-01 2012-07 2013-01 2013-07 2014-01 2014-07 2015-01 2015-07 2016-01 2016-07 2017-01 2017-07 2018-01 2018-07

Index 1982–84 = 100

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SLIDE 12

Market for Light Trucks Fall in the Price of Gasoline

D1 Q P S1 P1 Q1 D2 P2 Q2

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SLIDE 13

What Causes the Supply Curve to Shift?

  • In general, anything that changes the additional

cost associated with supplying one more unit at a given quantity of the good.

  • Change in the price of an input.
  • Change in technology.
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SLIDE 14

Producer Price Index for Rolled Steel

Source: Bureau of Labor Statistics.

150 170 190 210 230 250 270 290 2011-01 2011-07 2012-01 2012-07 2013-01 2013-07 2014-01 2014-07 2015-01 2015-07 2016-01 2016-07 2017-01 2017-07 2018-01 2018-07

Index, June 1982=100

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SLIDE 15

Market for Light Trucks Rise in the Price of Steel

D1 Q P S1 P1 Q1 S2 P2 Q2

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SLIDE 16
  • III. ELASTICITY
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SLIDE 17

Price Elasticity of Demand (εD)

Percentage change in quantity demanded

εD =

Percentage change in price (In absolute value) Elastic

εD > 1

Inelastic

εD < 1

Perfectly inelastic

εD = 0

Perfectly elastic

εD = ∞

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SLIDE 18

Relationship between Demand Elasticity and the Slope of the Demand Curve ΔQD / QD εD = ΔP / P ΔQD P = • ΔP QD 1 P =

  • Slope QD
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SLIDE 19

Slope of the Demand Curve

Q P ΔP Slope = ΔQD ΔP ΔQD D

1 P

εD = •

Slope QD

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SLIDE 20

Demand Curves

Q P Q P Inelastic Elastic D1 D1

1 P

εD = •

Slope QD

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SLIDE 21

Demand Elasticity Matters for Market Outcomes (Effect of a Shift Out in the Supply Curve)

Inelastic Q P D1

P1 Q1Q2

S1 S2

P2

Q P Elastic D1

P1 Q1 Q2

S1 S2

P2

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SLIDE 22

Source: National Institute on Drug Abuse; Center for Disease Control.

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SLIDE 23

Market for Illegal Opioid Drugs

D1 Q P S1 P1 Q1

Market for Illegal Opioid Drugs

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SLIDE 24

Market for Illegal Opioid Drugs (Supply Restriction)

D1 Q P S1 P1 Q1 S2 Q2 P2

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SLIDE 25

Total Expenditure Total Expenditure = Price • Quantity

  • Total expenditure and total revenue are the same

thing.

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SLIDE 26

Demand Elasticity and Expenditure

  • Inelastic (εD < 1): Total expenditure rises when the

supply curve shifts back.

  • Elastic (εD > 1): Total expenditure falls when the

supply curve shifts back.

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SLIDE 27

Market for Illegal Opioid Drugs (Increased Drug Treatment)

D1 Q P S1 P1 Q1 Q2 P2 D2

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SLIDE 28

What are some of the complexities that we are ignoring with this analysis?

  • It neglects the time element (demand may be

more elastic in the long run than in the short run.)

  • It neglects new users (new users may be more

sensitive to the price).

  • It neglects the cost or effectiveness of various

policies.

  • Others?
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SLIDE 29

Price Elasticity of Supply (εS)

Percentage change in quantity supplied

εS =

Percentage change in price Elastic

εS > 1

Inelastic

εS < 1

Perfectly inelastic

εS = 0

Perfectly elastic

εS = ∞

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SLIDE 30

Supply Curves

Q P Q P Inelastic Elastic S1 S1

As with the εD, the relationship between εS and the slope of the supply curve is a useful, but crude approximation.

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SLIDE 31
  • IV. EFFECTS OF A TAX
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SLIDE 32

Effect of a New 50¢ per Gallon Tax on Gasoline (Physically Collected from Sellers)

D1 Q P S1 P1 Q1 S2 Tax (50¢) Q2 P2 P2−tax

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SLIDE 33

Typical Effects of a Tax

  • Quantity bought and sold declines.
  • Production and consumption are still allocated by

price.

  • Price rises by less than the amount of the tax.
  • Both sides pay some of the tax.
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SLIDE 34

Demand Elasticity and the Effects of a Tax

Inelastic Elastic Q P Q P D1 D1

P1 Q1

S1

P1 Q1

S1 S2

P2 P2

S2

Tax Tax

Q2 P2−tax P2−tax Q2

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SLIDE 35

Two Ways of Visualizing Tax Revenues

(1) (2) Q P Q P D1

P2 Q2

S1

P2 Q2

S1 S2 S2

Tax Tax

P2−tax

D1

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SLIDE 36

Demand Elasticity and the Effects of a Tax

  • A tax will change the equilibrium quantity more,

the more elastic demand is.

  • Buyers will pay more of the tax, the less elastic

demand is.

  • Government revenue from the tax will be larger,

the less elastic demand is.