PRINCIPLES OF MACROECONOMICS (EC0 200): LECTURES FROM WEEK 2
Ranjit S. Dighe
SUNY-Oswego
Fall 1999

[Owing to time limitations, these are still in a much cruder form than I'd like.  In particular, I still need to add graphs to them.  I will refine them very soon.  They were last revised on Sat., Sept. 11, at 6 pm.]
 

WEEK 2, LECTURE 4
Mon., Sept. 6, 1999

Today: Micro review, Part II
I.  Demand (finish)
II. Supply (begin)
 

I.  DEMAND

Where we left off: Parting question: Why do demand curves slope downward? If the price of potato chips falls from $1.50 to $1.25 a bag, why is it that people will buy more?

[Graph, to be added later:  The demand curve for potato chips, with real numbers on the P and Q axes.]

Why demand curves slope downward:
(1) INCOME EFFECT: As the price of a good falls, your real income (in terms of that good) rises; you can now afford to buy more of it, and so you do.
(2) SUBSTITUTION EFFECT: As the price of a good falls, its relative price (i.e., its price relative to other goods' prices) falls, causing you to buy less of other goods (especially close substitutes) and more of that good.
-- These two effects reinforce each other.

Note well:
CHANGES IN DEMAND (shifts of the demand curve)
are different from
CHANGES IN QUANTITY DEMANDED (occur in response to price; movements along the demand curve).

The same goes for supply curves.

Exs.

Enrollment at SUNY-Oswego is up, so there is more demand for economics textbooks.
--> Demand curve shifts up; demand increases.

[Graph will be added later.]

The College Store cut the price of new textbooks, so more economics textbooks are being sold.
--> movement along the demand curve; quantity demanded increases.

[Graph will be added later.]
 

To repeat: A change in a good's price causes a movement along the demand curve for that good. What causes the demand curve to shift?

Things that cause demand to increase (demand curve shifts out, people are willing to pay more for the good, and want more of it):
(1) Higher incomes (for normal goods, as people get richer, they buy more of the good)
(2) Increased population
(3) Increased popularity of a good (from changes in people's tastes)
(4) Increases in the price of other, substitute goods
-- Ex.: If CD's become more expensive, the demand for tapes will go up.
(5) Decreases in the price of complementary goods (goods that are used together with the first good)
-- Ex.: If tape decks become cheaper, the demand for tapes will go up.
 

II. SUPPLY

SUPPLY CURVE: a graph showing how much of a product will be produced and supplied at different prices
-- "Law" of Supply: As the price of a good goes up, the quantity supplied of that good goes up, too
--> supply curves slope upward

Note: A firm's supply curve is the upward-sloping portion of its marginal cost (MC) curve. This will be explained in detail later.

[Graph, to be added later:  The supply curve of wheat, with real numbers for P and Q.]

Why supply curves slope upward: DIMINISHING RETURNS.
-- In the diagram in the previous lecture, of a short-run production function, each additional unit of output required more labor (was more costly) than the previous unit.

Crucial assumption behind the supply curve:  The industry is competitive. (In a monopolistic or otherwise non-competitive industry, there is no supply curve.) A competitive industry is one with a very large number of firms producing an identical product, and free entry and exit from the industry. Firms in such an industry are "price takers," in that they must sell their output at the market price.
-- Where the supply curve comes from: The supply curve is the upward-sloping portion of the marginal cost (MC) curve.
---- Why: A profit-maximizing firm equates marginal revenue (MR) and marginal cost (MC). In a competitive industry, where an individual firm's demand curve is flat at the market equilibrium price P*, the price of the good is equal to the marginal revenue from selling an extra unit of that good. So the supply curve just shows what the profit-maximizing outputs for the firm will be at different prices.

***

PRINCIPLES OF MACROECONOMICS
WEEK 2, LECTURE 5
Wed., Sept. 8, 1999

Today: Micro review, Part III
I.   Supply (finish)
II.  Industry demand and supply curves
III. Equilibrium (begin)
 

I. SUPPLY (finish)

Q: What causes the supply curve to shift?
A: Changes in the (marginal) costs of production. (Keep in mind that the supply curve is the upward-sloping part of the marginal cost curve.)
(1) Changes in input prices -- e.g., if labor or physical capital (or raw materials used in production, like mozzarella cheese at Pavone's) becomes more expensive, then the cost of production goes up and the supply curve shifts up (or in).
(2) Changes in technology, i.e. shifts of the production function
-- Better technology makes production cheaper --> the marginal cost curve shifts down, so the supply curve shifts down (or out), too
(3) Entry or exit of firms (more firms means a larger quantity will be supplied at each price)
(4) Other factors: prices of substitutes or complements in production; changes in the capacities or inventories of firms
 

II. INDUSTRY DEMAND AND SUPPLY CURVES

These are obtained by "horizontally summing" (adding quantities demanded at given prices) the individual demand curves of consumers or the individual supply curves of firms.

Ex. The demand for ketchup in a two-household economy

[Graphs will be added later.]
 

Ex. The supply of ketchup in a two-firm economy.

[Graphs will be added later.]
 

III. EQUILIBRIUM

The point where the industry supply and demand curves intersect is the market's EQUILIBRIUM.

[Graph will be added later.]

EQUILIBRIUM: occurs when there is no force acting to change prices, i.e. when quantity supplied equals quantity demanded.

[The diamond-water paradox: We need water for survival, and we don't need diamonds for survival; yet water costs next to nothing and diamonds are extremely expensive. Why?]
-- [Graphs and answer to be added later.]

Changes in the equilibrium price and quantity, as caused by shifts in demand and supply:

Ex. 1 The technology for making ketchup takes a great leap forward --> supply of ketchup increases

[Graph will be added later.]

Result:
P* decreases
Q* increases
Q (quantity demanded increases)

Ex. 2 Health-conscious consumers start shunning ketchup as too salty --> demand for ketchup falls

[Graph will be added later.]

Result:
P* decreases
Q* decreases
Q (quantity supplied decreases)

***

PRINCIPLES OF MACROECONOMICS
WEEK 2, LECTURE 6
Fri., Sept. 10, 1999

O.  IMPEDIMENTA

* Today: Micro review, Part IV
I.  Equilibrium (finish)
II. Disequilibrium
III. Perfect competition and the "law of one price"
IV. Elasticity

* Quiz (I will start posting old quizzes on the Internet as soon as someone sends me an e-mail asking me to do that)

* Tutor for Eco 200: Mahar 112, Tues 4-5, Wed 6-8, Thurs 4-5

* Problem Set 1 (PS1) due Monday
 

I.  EQUILIBRIUM (finish)

More examples of supply and demand shifts, and changes in equilibrium:

Ex. 3 A bad tomato harvest raises the (marginal) cost of production --> supply of ketchup decreases

[Graph will be added later.]

Result:
P* increases
Q* decreases
Q (quantity demanded decreases)

Ex. 4 An increase in the population --> demand for ketchup increases

[Graph will be added later.]

Result:
P* increases
Q* increases
Q (quantity supplied increases)

A summing up:
Cause  Effect
demand increases P* increases, Q* increases
demand decreases P* decreases, Q* decreases
supply increases  P* decreases, Q* increases
supply decreases  P* increases, Q* decreases

II. DISEQUILIBRIUM

When P is not equal to P*, then the market is in DISEQUILIBRIUM -- there will either be a shortage (too little) or a surplus (too much) of the good, because quantity supplied is not equal to quantity demanded.

If a PRICE CEILING is set below the equilibrium price P*, preventing the price from rising above a certain level, as in the New York City rental apartments market, then:

quantity demanded > quantity supplied;

==> SHORTAGE, long lines

[Graph to be added later.]
 

If a PRICE FLOOR is set above the equilibrium price P*, preventing the price from falling below a certain level, as in government milk-price support programs, then:

quantity supplied > quantity demanded;

==> SURPLUS, vast unsold quantities

[Graph to be added later.]
 

III. PERFECT COMPETITION AND THE "LAW OF ONE PRICE"

The intersection of the industry supply and demand curves determines the equilibrium price and quantity for the whole industry. The total quantity produced will be divided up among the many firms in the industry, with each one producing up to the point where marginal cost equals price. The firms will all have to charge the same price, the industry equilibrium price P*.
-- Since the good they're producing is identical, and since there are many firms for consumers to choose from, if a firm tried to sell at a price higher than P*, nobody would buy any of its output.
-- A firm could sell its output for less than P* if it wanted to, but what's the point? It can already sell all of its output at P*.

Each firm in the industry, therefore, faces a flat demand curve -- the firm's demand curve is flat at the industry (or market) equilibrium price.

[Graph to be added later.]
 

IV. ELASTICITY

Not all demand curves are the same. Some are very flat (quantity demanded is very responsive to price), others are very steep (quantity demanded is not very responsive to price). The same goes for supply curves. Since we often want to know just how responsive demand (or supply) is to price in a particular market, we need some way of measuring that responsiveness. Slope is one possible way of measuring that responsiveness, but it's overly sensitive to one's choice of units to measure the quantity demanded or supplied.

--> Economists have a better measure of the responsiveness of quantity demanded (or supplied) to price, called...

ELASTICITY (responsiveness). It is used to quantify the response of one variable (say, quantity demanded, QD , or quantity supplied, QS) to another (usually price, P).

If the demand for a good is very elastic with respect to price, its demand curve will be relatively flat. (Perfectly elastic demand means a perfectly flat demand curve.)

If the demand for a good is very inelastic with respect to price, its demand curve will be relatively steep. (Perfectly inelastic demand means a perfectly vertical demand curve.)

If the supply for a good is very elastic with respect to price, its supply curve will be relatively flat. (Perfectly elastic supply means a perfectly flat supply curve.)

If the supply for a good is very inelastic with respect to price, its supply curve will be relatively steep. (Perfectly inelastic supply means a perfectly vertical supply curve.)

[Graphs to be added later.]