lecture 2: using supply and demand to analyze...

Admin RFH E CS and PS Price Regs Reg. Q

Lecture 2:Using Supply and Demand to Analyze Markets

September 6, 2016


Overview

Course Administration

Ripped from the Headlines

Elasticity, Reprise

Consumer and Producer Surplus

Price Regulations

Quantity Regulations


Course Administration

1. Collect PS 1

2. PS 2 is posted

3. Check Ripped from Headlines assignments

4. You are responsible for what we cover in class

5. Any problems with the course website?

6. Check your GW email – it is how I will communicate with you

7. If there are any Blackboard functions you’d like me to activate(chat room, discussion board), please let me know

8. Other administrative questions or issues?


Ripped From the Headlines

As a reminder, next week

AfternoonFinder Presenter

Marc Hernandez Faith GriggThomas Coyne Nathan Rupp

EveningFinder Presenter

Kaitlin Smith Matt MillerAdam Brooks Thomas Waldrop


Elasticity

• Intuitively, what does elasticity tell us?

• Percentage change in one outcome given a percentage changein another

• E ≡ percent change in quantity demanded divided by percentchange in price = %∆Q

%∆P


Perfectly Elastic and Inelastic Supply and Demand

Draw the usual supply and demand axes.

• If demand (or supply) is perfectly inelastic, what does thecurve look like?

• If demand (or supply) is perfectly elastic, what does the curvelook like?


Perfectly Elastic or Perfectly Inelastic Demand or Supply


Using Supply and Demand to Analyze Markets

1. Consumer and Producer Surplus

2. Price Regulations

3. Quantity Regulations

4. (skip in favor of later in depth coverage) Taxes

5. (skip) Subsidies


Consumer Surplus

Consumer surplus ≡ “difference between the amount consumerswould be willing to pay for a good and the amount they actuallyhave to pay”


Getting to Consumer SurplusIs this a person with a little or a lot?

P

D

P*

Q


And this person?

P

D

P*

Q

a lot of surplus


Where is Someone Without Surplus?

P

D

P*

Q

a lot of surplus

a little surplus


And Total Consumer Surplus?

P

D

P*

Q

a lot of surplus

a little surplus

not any surplus at all


The Whole Shebang of Consumer Surplus

P

D

P*

Q

a lot of surplus

a little surplus

not any surplus at all


Identifying Consumer Surplus

• For what goods do you have a positive consumer surplus?

• For what goods do you have a consumer surplus of zero?

• Give an example when your consumer surplus increased


Producer Surplus

• Producer surplus ≡“difference between price atwhich producers are willingto sell their good or serviceand the price they actuallyreceive”

• Above the supply curve, andbelow price, this is surplus

• You are a producer of labor.Have you ever receivedsurplus?


Why Should You Care About Surplus?

• Want to understand overall welfare implications of a policychange

• Welfare is not just P ∗ Q• It is also consumers benefits above the purchase price• And supplier benefits below the purchase price

• And maybe there is a little surplus unclaimed• Founder of Priceline.com said “In putting together an R&D

laboratory [called Walker Digital], one of the problems weworked on was, how do you see the demand curve below theprice of a product? All sellers of products in the moderneconomy sell by posting a retail price, or they negotiate a priceon a market basis. Most prices are set by the seller. When theseller sets the price, there’s a problem: They can’t see howmuch demand there is below the dollar price they’ve set. Wesaid, ‘You know what? Could there be solutions in the new,modern age that would allow sellers to see the demand belowthe price line?’ Hence the name of the company.”


Distribution of Gains and Losses from Changes in MarketConditions

• How do shocks to supply or demand – which might be afunction of policy choices – affect consumers and producers?

• We will analyze impact of decrease in supply

• You should be able to reason out an impact of an increase insupply, or changes in demand


Math Reminder: Area of a Triangle

a

b

• Area of the triangle is12 ∗ a ∗ b

• With linear supply anddemand curves, you can findall the points on a triangle.

• We will always be workingwith linear demand andsupply curves


What if it’s Not a Right Triangle?

a

b

• What do you do?

• Still 12 ∗ a ∗ b


Analyze Impact of Decrease in Supply

• Suppose it rains less in Cote d’Ivoire and chocolate productionsuffers

• We analyze the welfare consequences in the US chocolatemarket

• You can imagine using this framework for policy-induced shiftsas well


Analyzing a Decrease in SupplyInitial Consumer and Producer Surplus

P

D

S

P*

CS

PS

Q* Q


Supply Shifts Inward: What are Pnew and Qnew?

P

D

S

P*

S’

Q* Q


Supply Shifts Inward: New CS and PS?

P

D

S

P*

S’

Pnew

Qnew Q* Q


New Producer and Consumer Surplus

P

D

S

P*

S’

Pnew

Qnew Q*

CSnew

PSnew

Q


Figuring Out the Difference

P

Q

D

S

P*

S’

Pnew

Qnew Q*

A

B C

DE


Figuring Out the Difference, Details

P

Q

D

S

P*

S’

Pnew

Qnew Q*

A

B C

DE

• Before• CS =

A + B + C• PS = D + E

• After• CS = A• PS = B + D

• Difference• ∆CS = A−(A+B+C ) =−(B + C ) < 0

• ∆PS =(D+E )−(B+D) = E−B,sign ambiguous

• Note that nobody gets Cor E after



P

Q

D

S

P*

S’

Pnew

Qnew Q*

A

B C

DE

• Before• CS = A + B + C• PS =

D + E







P

Q

D

S

P*

S’

Pnew

Qnew Q*

A

B C

DE

• Before• CS = A + B + C• PS = D + E







P

Q

D

S

P*

S’

Pnew

Qnew Q*

A

B C

DE


• After• CS =

A• PS = B + D






P

Q

D

S

P*

S’

Pnew

Qnew Q*

A

B C

DE


• After• CS = A• PS =

B + D






P

Q

D

S

P*

S’

Pnew

Qnew Q*

A

B C

DE







Price RegulationsTwo Flavors

1. Price Ceiling ≡ a regulated “highest lawful price for a good orservice”

2. Price Floor ≡ a regulated “lowest lawful price for a good orservice”

Price regulations distort market outcomes. Some trades that wouldoccur in equilibrium do not occur.


Using Math to Understand Policy Implications

We assume Pceiling < Pmarket . We’d like to know

• how much worse off producers are

• how much better or worse off consumers are

• what the difference is between these ≡ transfer

• how much surplus is lost

• Deadweight loss ≡ reduction in total surplus as a result ofmarket inefficiency

Use algebra and geometry to do this. What does your intuition tellyou happens to quantity when the government setsPceiling < Pmarket?


Should be Quite Clear to VenezuelansVenezuelan Presidents Chavez and Maduro Respond to Inflation with Price Ceilings


Policy Aside: Other Price Ceiling Examples

• Cottage cheese in Israel• in 2011, government removed price ceiling and prices spiked,

leading to a revolt and a return of a ceiling

• Corn tortillas in Mexico• ceiling lifted in 1999, reimposed in 2007 amid soaring corn

prices

• Other favorite examples?


Think About the Problem in Steps

1. Find the initial Pmarket and Qmarket

2. Find the initial CS

3. Find the initial PS

4. Find the quantity after the ceiling

5. Find the final CS

6. Find the final PS


Graphing Impact of a Price CeilingStart with Market Equilibrium

P

D

S

P*

CS

PS

Q* Q


Graphing Impact of a Price CeilingWhere is the Price Ceiling?

P

D

S

P*

Q* Q


Graphing Impact of a Price CeilingAdding the Price Ceiling

P

D

S

P*

Q* Q

price ceiling


Graphing Impact of a Price CeilingGiven the Price Ceiling, What Happens to Quantities?

P

D

S

P*

Q* Q

price ceiling


Graphing Impact of a Price CeilingPrice Ceilings Cause Shortages

P

D

S

P*

Q* Q

price ceiling

QS QD

shortage


Graphing Impact of a Price CeilingFiguring Out the Difference

P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

PSnew

CSnew



P

D

S

P*

Q* Q

price ceiling

QS QD

shortage



P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

A

F

C

D E

B



P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

A

F

C

D E

B

• Before• CS =

A + B + C• PS = D + E + F

• After• CS = A + B + D• PS = F

• Difference• ∆CS = (A + B + D)−

(A + B + C ) = D − C ,sign ambiguous

• ∆PS = F−(D+E +F ) =−(D + E ) < 0

• transfer from producers toconsumers is D

• Note that nobody gets Cor E after → trades thatdon’t take place →DWL = C + E



P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

A

F

C

D E

B


D + E + F




• ∆PS = F−(D+E +F ) =−(D + E ) < 0





P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

A

F

C

D E

B

• Before• CS = A + B + C• PS = D + E + F




• ∆PS = F−(D+E +F ) =−(D + E ) < 0





P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

A

F

C

D E

B


• After• CS =

A + B + D• PS = F



• ∆PS = F−(D+E +F ) =−(D + E ) < 0





P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

A

F

C

D E

B


• After• CS = A + B + D• PS =

F



• ∆PS = F−(D+E +F ) =−(D + E ) < 0





P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

A

F

C

D E

B





• ∆PS = F−(D+E +F ) =−(D + E ) < 0





P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

A

F

C

D E

B





• ∆PS = F−(D+E +F ) =−(D + E ) < 0

• transfer from

producers toconsumers is D




P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

A

F

C

D E

B





• ∆PS = F−(D+E +F ) =−(D + E ) < 0

• transfer from producers toconsumers is

D• Note that nobody gets C

or E after → trades thatdon’t take place →DWL = C + E



P

D

S

P*

Q* Q

price ceiling

QS QD

shortage

A

F

C

D E

B





• ∆PS = F−(D+E +F ) =−(D + E ) < 0




Deadweight Loss

• Lost surplus from trades that fail to occur because of thepolicy

• Should be balanced against benefits from a policy


Give it a Try

QS = 2000P − 10000, QD = 20000− 1000P, price ceiling of $8

1. In market equilibrium, find

1.1 equilibrium price1.2 producer surplus1.3 consumer surplus

2. After the price ceiling, find

2.1 producer surplus2.2 consumer surplus2.3 transfer2.4 deadweight loss2.5 deadweight loss as a share of the transfer


Deadweight Loss and Elasticities

• Consider DWL size as a share of the transfer (D from ourpicture)

• Elasticities determine size of transfer and DWL

• Do we have a greater DWL in more or less elastic markets?


DWL Higher for More Elastic Demand and Supply


Impact of Price Floors

• Price floor ≡ regulated “lowest lawful price for good orservice”

• Generally rarer than price ceilings

• Examples?

• minimum wage• quite hard to come up with other good examples!


Impact of Price Floors

• Price floor ≡ regulated “lowest lawful price for good orservice”

• Generally rarer than price ceilings

• Examples?• minimum wage• quite hard to come up with other good examples!


Graphing Impact of a Price FloorInitial Equilibrium, No Floor: Where Does Price Floor Go?

P

D

S

P*

Q* Q


Graphing Impact of a Price FloorWhat Are QS and QD?

P

D

S

P*

Q* Q

price floor


Graphing Impact of a Price FloorWhere is New PS and CS?

P

D

S

P*

Q* Q

price floor

surplusQD QS


Graphing Impact of a Price FloorNow, Compare to Old CS and PS

P

D

S

P*

Q* Q

price floor

surplus

CSnew

PSnew

QD QS



P

D

S

P*

Q* Q

price floor

surplus

A

F

CD EB

QD QS

• Before• CS =

A + B + C• PS = D + E + F

• After• CS = A• PS = B + D + F


• ∆PS = (B + D + F )−(D + E + F ) = B − E ,sign ambiguous

• transfer from consumersto producers is B




P

D

S

P*

Q* Q

price floor

surplus

A

F

CD EB

QD QS


D + E + F








P

D

S

P*

Q* Q

price floor

surplus

A

F

CD EB

QD QS









P

D

S

P*

Q* Q

price floor

surplus

A

F

CD EB

QD QS


• After• CS =

A• PS = B + D + F







P

D

S

P*

Q* Q

price floor

surplus

A

F

CD EB

QD QS



B + D + F







P

D

S

P*

Q* Q

price floor

surplus

A

F

CD EB

QD QS









P

D

S

P*

Q* Q

price floor

surplus

A

F

CD EB

QD QS





• transfer from

consumersto producers is B




P

D

S

P*

Q* Q

price floor

surplus

A

F

CD EB

QD QS





• transfer from consumersto producers is

B• Note that nobody gets C




P

D

S

P*

Q* Q

price floor

surplus

A

F

CD EB

QD QS








Two Types of Quantity Regulations

We just looked at regulations on price. Now we considerregulations on quantity.

1. Quota ≡ a regulated (almost always limited) “quantity of agood or service provided”

2. Government provision of a good or service (skip for timereasons)


Analyzing Quotas

• Now we explore the impact of a quota on price

• Give an example of a market with quotas

• See this White House report on the perils of occupationallicensing

https://www.whitehouse.gov/sites/default/files/docs/licensing_report_final_nonembargo.pdf


Quotas in PicturesMarket Equilibrium: How Does Supply Change with a Quota?

P

D

S

P*

QQ*


Quotas in PicturesSupply with a Quota: What Happens to Price?

P

D

S

P*

Q

S’

Qnew Q*


Quotas in PicturesSupply with a Quota: What Happens to CS and PS?

P

D

S

P*

Q

S’

quota price

Qnew Q*


Quotas in PicturesSupply with a Quota: What Happens to CS and PS?

P

D

S

P*

Q

S’

quota price

Qnew

CSnew

PSnew

Q*


Quotas in PicturesFiguring Out the Differences

P

D

S

P*

Q

S’

quota price

Qnew

A

C

DE

B

Q*



P

D

S

P*

Q

S’

quota price

Qnew

A

C

DE

B

Q*

• Before• CS =

A + B + C• PS = D + E



• ∆PS =(B+D)−(D+E ) = B−E ,sign ambiguous





P

D

S

P*

Q

S’

quota price

Qnew

A

C

DE

B

Q*


D + E








P

D

S

P*

Q

S’

quota price

Qnew

A

C

DE

B

Q*









P

D

S

P*

Q

S’

quota price

Qnew

A

C

DE

B

Q*


• After• CS =

A• PS = B + D







P

D

S

P*

Q

S’

quota price

Qnew

A

C

DE

B

Q*



B + D







P

D

S

P*

Q

S’

quota price

Qnew

A

C

DE

B

Q*









P

D

S

P*

Q

S’

quota price

Qnew

A

C

DE

B

Q*





• transfer from

consumersto producers is B




P

D

S

P*

Q

S’

quota price

Qnew

A

C

DE

B

Q*





• transfer from consumersto producers is

B• Note that nobody gets C




P

D

S

P*

Q

S’

quota price

Qnew

A

C

DE

B

Q*








Recap of Today

1. Elasticity Reprise

2. Producer and Consumer Surplus• Definitions• Impact of a decrease in supply on surplus

3. Price Regulations• Price ceilings• Price floors

4. Quantity Regulations• Quotas


For Next Class

• Bring name tent

• Ripped from the Headlines

• Turn in Problem Set 2

• GLS Chapter 4

lecture 2: using supply and demand to analyze...

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