Economics 2 Professor Christina Romer Spring 2018 Professor David Romer LECTURE 4 EXTENSIONS OF SUPPLY AND DEMAND ANALYSIS January 25, 2018 I. O VERVIEW II. R EVIEW OF THE S UPPLY AND D EMAND F RAMEWORK A. Two sides of the market (example: light trucks) B. Equilibrium C. What shifts the demand curve? D. What shifts the supply curve? III. E LASTICITY 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. E FFECTS OF A T AX 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
Economics 2 Christina Romer Spring 2018 David Romer L ECTURE 4 Extensions of Supply and Demand Analysis January 25, 2018
Announcements • Problem Set 1 is due next Tuesday (January 30). • Problem Set Work Session this afternoon (Jan. 25) • 4:00–6:00 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.
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).
Announcements • Journal article reading for Tuesday (by Esther Duflo): • You can access for free through any campus 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; think about relevance to consumer behavior.
I. O VERVIEW
Plan for the Lecture • Review the supply and demand framework. • Discuss elasticity. • Examine the effect of another government intervention in the market (a tax).
II. R EVIEW OF S UPPLY AND D EMAND
Equilibrium in the Market for Light Trucks P Q
What Causes the Demand Curve to Shift?
Retail Price of Gasoline 400 350 Index, 1982-84 = 100 300 250 200 150 100 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 Source: Bureau of Labor Statistics.
Effect of a Fall in the Price of Gasoline on the Demand for Light Trucks P S 1 P 1 D 1 Q Q 1
Growth of Light Trucks Source: Trucks.com
What Causes the Supply Curve to Shift?
Producer Price Index for Iron and Steel 270 250 Index, 1982=100 230 210 190 170 150 2012-01 2012-07 2013-01 2013-07 2014-01 2014-07 2015-01 2015-07 2016-01 2016-07 2017-01 2017-07 Source: Bureau of Labor Statistics.
Effect of a Fall in the Price of Steel on the Supply of Light Trucks P S 1 P 1 D 1 Q Q 1
III. E LASTICITY
Price Elasticity of Demand ( ε D ) Percentage change in quantity demanded ε D = Percentage change in price (In absolute value) ε D > 1 Elastic ε D < 1 Inelastic ε D = 0 Perfectly inelastic ε D = ∞ Perfectly elastic
Relationship between Demand Elasticity and the Slope of the Demand Curve Δ Q D / Q D ε D = Δ P / P Δ Q D P = • Δ P Q D 1 P = • Slope Q D
Slope of the Demand Curve P D Q 1 P ε D = • Slope Q D
Demand Curves Inelastic Elastic P P Q Q 1 P ε D = • Slope Q D
Demand Elasticity Matters for Market Outcomes Inelastic Elastic P P S 1 S 1 P 1 P 1 D 1 D 1 Q 1 Q 1 Q Q
Demand Elasticity Matters for Market Outcomes
Source: National Institute on Drug Abuse; Center for Disease Control.
Market for Illegal Opioid Drugs Market for Illegal Opioid Drugs P Q
Market for Illegal Opioid Drugs (Supply Restriction) P S 1 P 1 D 1 Q Q 1
Total Expenditure Total Expenditure = Price • Quantity • Total expenditure and total revenue are the same thing.
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.
Market for Illegal Opioid Drugs (Increased Drug Treatment) P S 1 P 1 D 1 Q Q 1
What are some of the complexities that we are ignoring with this analysis?
Price Elasticity of Supply ( ε S ) Percentage change in quantity supplied ε S = Percentage change in price ε S > 1 Elastic ε S < 1 Inelastic ε S = 0 Perfectly inelastic ε S = ∞ Perfectly elastic
Supply Curves Inelastic Elastic P P Q Q
IV. E FFECTS OF A T AX
Effect of a New 50¢ per Gallon Tax on Gasoline (Levied on Sellers) P S 1 P 1 D 1 Q Q 1
Typical Effects of a Tax
Demand Elasticity and the Effects of a Tax Inelastic Elastic P P S 2 S 2 S 1 S 1 Tax Tax P 1 P 1 D 1 D 1 Q 1 Q 1 Q Q
Two Ways of Visualizing Tax Revenues (1) (2) P P S 2 S 2 S 1 Tax Tax S 1 P 2 P 2 P 2 − tax D 1 D 1 Q 2 Q 2 Q Q
Demand Elasticity and the Effects of a Tax
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