Lecture 2.5

Leftovers:

Elasticity, Market Equilibrium &

Interesting Questions

Demand Elasticity &Total Revenue Change

price per unit quantity demandedelasticity tot rev$10 1 10$9 2 -0.10 18$8 3 -0.22 24$7 4 -0.38 28$6 5 -0.57 30$5 6 -0.83 30$4 7 -1.20 28$3 8 -1.75 24$2 9 -2.67 18$1 10 -4.50 10

Individual Demand Curve

$0

$10

$20

$30

$40

1 2 3 4 5 6 7 8 9 1P

rice

per

un

it

TR Max

Ed < 1

Ed > 1

Ed = 1

Demand Curves

• Properties– Marginal Value: (incremental) value of the

next unit demanded– Marginal Revenue: (incremental) revenue of

next unit sold– Average Revenue: average revenue received

for selling a given quantity

A Short QuizSeattle Times Oct 3, 2007

Olympic National Park officials are suggesting raising the price of an entrance pass for motorists — good for seven days — from $15 to $25 starting in 2009, with the fee for individuals such as cyclists climbing from $5 to $12. Season passes would increase from $30 to $50

But public response, particularly from tourist-dependent local businesses has been generally negative said a spokeswoman for Olympic National Park.

1. Illustrate the effect of the increase of the price for park passes on the demand for trips to the park

2. Illustrate how the park fee increase would affect the demand for other tourist-related businesses, e.g., hotels, restaurants.

Another Variation

• At each price, determine whether there would be a shortage (Qd > Qs) or a surplus (Qs > Qd)

• If there was a shortage, how would price adjust to clear the market?

• If there is a surplus, how would price adjust to clear the market?

# of Pizzas Demanded

Price Per Pizza

# of Pizzas Supplied

Shortage or Surplus

1000 $10 400  

900 $12 450  

800 $14 500  

700 $16 550  

600 $18 600  

500 $20 650  

Answers

# of Pizzas Demanded Price Per Pizza # of Pizzas Supplied Shortage (-) or Surplus (+)

1000 $10 400 -600

900 $12 450 -450

800 $14 500 -300

700 $16 550 -150

600 $18 600 0

500 $20 650 150

The Cobweb Theorem

D

S

7

Price (£)

Quantity Bought and Sold (millions)

9

D1

In a ‘divergent cobweb’ -also termed an unstable cobweb - the price tends to move away from equilibrium.

Assume the initial equilibrium price is £7 and the quantity 9. If demand rises, the shortage pushes the price up to £11 per turkey.

11

15

Farmers respond by planning to increase supply, ten months later, the supply of turkeys is 15 million. At this level, there will be a surplus of turkeys and the price drops.

8

The price falls to £5 and farmers react by cutting plans for turkey production. Ten months later, supply on the market will be 8 million.

5

This creates a massive shortage of 9 million turkeys and the price is forced up – and so the process continues!

A divergent cobweb leads to price instability over time.

17

Cobweb Theorem

• http://www.bized.co.uk/current/mind/2004_5/251004.ppt• Hungarian-born economist Nicholas Kaldor (1908-1986)• Simple dynamic model of cyclical demand with time lags

between the response of production and a change in price (most often seen in agricultural sectors).

• Cobweb theory is the process of adjustment in markets • Traces the path of prices and outputs in different

equilibrium situations. Path resembles a cobweb with the equilibrium point at the center of the cobweb.

• Sometimes referred to as the hog-cycle (after the phenomenon observed in American pig prices during the 1930s).

Useful Websites

– Understanding differences between factors that cause shifts in demand or supply

• http://hspm.sph.sc.edu/COURSES/ECON/SD/SD.html

– Basics of demand and supply• http://www.investopedia.com/university/economics/

economics3.asp

– Cobweb theorem• http://www.bized.co.uk/current/mind/2004_5/25100

4.ppt

Markets for Biodiesel Fuel and Food

• Initial conditions– Corn is a major input (ingredient) to both food and

biodiesel– Gas prices have significantly increased during the

past few years in the automobile gasoline market

1. What is the impact of higher gasoline prices on the demand for biodiesel?

2. What is the impact of higher gasoline prices on the demand for food products?

More Questions

• #9 City Parks more polluted than country club grounds– Are people who use parks less concerned

than those who golf?– Is it an issue of property-right assignment?– CC tend to use fertilizers that seep into the

water table. Who owns the water table?

Diamond/Water Paradox

• Diamonds sell for a much higher price than bottles of water. Does that mean diamonds are more valuable than water?

Paul’s example

• Two brewers• Two beers: Stout or Lager

– What is the opportunity cost?• “Next” best alternative

Brewer Gal of

Stout

Gal of Lager

Opp Cost of Stout

Opp Cost of Lager

Jones 5 10 2 g lager ½ g stout

Brown 4 3 ¾ g lager 4/3 g stout