Session 3: Supply and Demand 2 PDF (Fall 2020)

Session 3: Supply and Demand 2 Principle of Economics 1 School of Economics Seoul National University Dong-Hyun Ahn Fall, 2020 1  Today’...

Session 3: Supply and Demand 2 Principle of Economics 1 School of Economics Seoul National University Dong-Hyun Ahn Fall, 2020 1  Today’s Coverage Income Elasticity of Demand Durable Goods vs Non-durable Goods Short-run and Long-run Equilibrium Oil shocks and Price Response 2  Income Elasticity Measures responsiveness of demand to change in income. ΔQ D /Q D I ΔQ D IED = = ΔI/I Q D ΔI A positive number, in general 1% ?% Luxuries ?>1% Normal ?>0% Necessities ?0% 3  Short-run vs. Long-run Elasticities Short-run Long-run Price Elasticity < of Demand Income Elasticity of Demand < Non-durable Goods Price Elasticity of Supply < Price Elasticity of Demand > Income Elasticity of Demand > Durable Goods Price Elasticity of Supply < 4  Short-run vs. Long-run Elasticities Short-run demand Po Long-run demand Long-run drop in demand Short-run drop in demand 5 Short-run vs. Long-run Elasticities 6 Example: Upheaval in the World Oil Market 7 Oil Shock 8  Rough Figures in 1997 Cf. US Consumption=5.5 bb/yr Price=$18/barrel World Demand and Supply=23bb/yr OPEC supply=10 bb/yr Non-OPEC supply=13 bb/yr Price Elasticity Short-run Long-run World Demand: -0.05 -0.40 Competitive Supply: 0.10 0.40 (non-OPEC) 9  OPEC Organization of Petroleum Exporting Countries (OPEC) members include Algeria, Indonesia, Iran, Iraq, Kuwait, Lybia, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela. 10  Short-run Demand/Supply -0.05 Assumption: Linear Demand/Supply Curves 0.10 Price Elasticity Demand Curve $18/b Price Supply Curve 23bb/yr Quantity 13bb/yr Assumption: Equilibrium Demand SR P* ( = 18) D SR = a + b ´ P EP = -.05 = SR* b Þ b = -.06389 D ( = 23) D SR* = 23 = a + ( -.06389)(18) Þ a = 24.15 Þ D SR = 24.15 - 0.06389P Demand : D SR = 24.15 -.06389P Similarly SR Competitive supply : SC = 11.7 + 0.07222P SR SR Total supply : ST = 10 + SC = 21.7 + 0.07222P 11  Long-run Demand/Supply -0.40 Assumption: Linear Demand/Supply Curves 0.40 Price Elasticity Demand Curve $18/b Price Supply Curve 23bb/yr Quantity 13bb/yr Assumption: Equilibrium Demand LR P* ( = 18) D LR = a + b ´ P EP = -.40 = LR* b Þ b = -.5111 D ( = 23) D LR* = 23 = a + ( -.51111)(18) Þ a = 32.2 Þ D LR = 32.2 - 0.5111P Demand : D LR = 32.2 -.5111P Similarly LR Competitive supply : SC = 7.8 + 0.2889P LR LR Total supply : ST = 10 + SC = 17.8 + 0.2889P 12  Question Saudi Arabia accounts for 3bb/yr (1/3 of OPEC production and 13% of total world production). What would have happened to the price of oil if it stopped producing oil for some reason? 13  Projected Prices Short-run Demand : D SR = 24.08 - 0.06P SR New Total supply : S T = 18.74 + 0.07P Þ P = $41.08/bar rel Long-run Demand : DLR = 32.18 - 0.51P LR New Total supply : S T = 14.78 + 0.29P Þ P = $21.75/bar rel 14  Short-run Change in Equilibrium SC D S’T ST Price 45 ($ per barrel) 40 35 30 25 20 18 15 10 5 Quantity (billions barrels/yr) 0 5 10 15 20 23 25 30 35 15  Long-run Change in Equilibrium SC S’T ST Price 45 D ($ per barrel) 40 35 Due to the elasticity of the long-run 30 supply and demand curves, the long-run 25 effect of a cut in production is 20 much less. 18 15 10 5 Quantity (billions barrels/yr) 0 5 10 15 20 23 25 30 35 16  Recap Income Elasticity Durables vs. Non-durables -Cyclical vs. Defensive Retrieving Demand/Supply Curves -Price Elasticity of Demand -Price Elasticity of Supply Price/Consumption Forecasting -Elasticities 17  Next Class Firm Theory I: Short-Run Cost Function – Types of Costs – Marginal/Average Costs Reading – PR: Chapter. 7.1-7.2 18