Professor Christina Romer. LECTURE 4 EXTENSIONS OF SUPPLY AND DEMAND ANALYSIS January 31, 2019

Transcription

1 Economics 2 Spring 2019 rofessor Christina Romer rofessor David Romer LECTURE 4 EXTENSIONS OF SULY AND DEMAND ANALYSIS January 31, 2019 I. OVERVIEW II. REVIEW OF THE SULY 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. rice 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. rice 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

2 Economics 2 Spring 2019 Christina Romer David Romer LECTURE 4 Extensions of Supply and Demand Analysis January 31, 2019

3 Announcements roblem Set 1 is due next Tuesday (February 5). roblem 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.

4 Announcements Collecting the roblem 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).

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 Don t stress over every word or parts you don t understand. Read for approach and findings.

6 I. OVERVIEW

7 lan for the Lecture What shifts demand and supply curves? Discuss elasticity. Examine the effect of another government intervention in the market (a tax).

8 II. REVIEW OF SULY AND DEMAND

9 Market for Light Trucks S 1 1 Equilibrium D 1 Q Q 1

10 What Causes the Demand Curve to Shift? In general, anything that changes the desirability of 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.

11 Retail rice of Gasoline Index = Source: Bureau of Labor Statistics.

12 Market for Light Trucks Fall in the rice of Gasoline S D 2 D 1 Q Q 1 Q 2

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.

14 roducer rice Index for Rolled Steel Index, June 1982= Source: Bureau of Labor Statistics.

15 Market for Light Trucks Rise in the rice of Steel S 2 S D 1 Q Q 2 Q 1

16 III. ELASTICITY

17 rice Elasticity of Demand (ε D ) ε D = ercentage change in quantity demanded ercentage change in price (In absolute value) Elastic ε D > 1 Inelastic ε D < 1 erfectly inelastic ε D = 0 erfectly elastic ε D =

18 Relationship between Demand Elasticity and the Slope of the Demand Curve ε D = ΔQ D / Q D Δ / ΔQ D = Δ Q D 1 = Slope Q D

19 Slope of the Demand Curve Δ Slope = Δ ΔQD ΔQ D 1 ε D = Slope Q D D Q

20 Demand Curves Inelastic Elastic D 1 D 1 Q 1 ε D = Slope Q D Q

21 Demand Elasticity Matters for Market Outcomes (Effect of a Shift Out in the Supply Curve) Inelastic Elastic S 1 S 2 S 1 S D 1 D 1 Q 1 Q 2 Q Q 1 Q 2 Q

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

23 Market for Illegal Opioid Drugs S 1 1 Q 1 D 1 Q

24 Market for Illegal Opioid Drugs (Supply Restriction) S 2 S Q 2 Q 1 D 1 Q

25 Total Expenditure Total Expenditure = rice Quantity Total expenditure and total revenue are the same thing.

26 Demand Elasticity and Expenditure Inelastic (ε D < 1): Total expenditure rises when the supply curve shifts back. Elastic (ε D > 1): Total expenditure falls when the supply curve shifts back.

27 Market for Illegal Opioid Drugs (Increased Drug Treatment) S Q 2 Q 1 D 2 D 1 Q

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?

29 rice Elasticity of Supply (ε S ) ε S = ercentage change in quantity supplied ercentage change in price Elastic ε S > 1 Inelastic ε S < 1 erfectly inelastic ε S = 0 erfectly elastic ε S =

30 Supply Curves Inelastic S 1 Elastic S 1 Q As with the ε D, the relationship between ε S and the slope of the supply curve is a useful, but crude approximation. Q

31 IV. EFFECTS OF A TAX

32 Effect of a New 50 per Gallon Tax on Gasoline (hysically Collected from Sellers) S 2 S tax Tax (50 ) D 1 Q Q 2 Q 1

33 Typical Effects of a Tax Quantity bought and sold declines. roduction and consumption are still allocated by price. rice rises by less than the amount of the tax. Both sides pay some of the tax.

34 Demand Elasticity and the Effects of a Tax Inelastic Elastic S 2 S 2 Tax S 1 Tax S tax 2 2 Q 2 Q 1 D 1 D 1 Q 1 2 tax Q 2 Q 1 Q

35 Two Ways of Visualizing Tax Revenues (1) (2) Tax S 2 S 2 S 1 Tax S tax 2 D 1 D 1 Q 2 Q Q 2 Q

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.