05/12/2016. The basic of Demand and Supply. The basic of Supply and Demand

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1 The basic of Demand and Supply Demand and Supply The Market Mechanism Changes in Market Equilibrium Elasticities of Supply and Demand Short-Run versus Long-Run Elasticities Understanding and Predicting the Effects of Changing Market Conditions Effects of Government Intervention Price Controls Pindyck and Rubinfeld, chapter The basic of Supply and Demand Demand A market consists of those individuals who are willing and able to purchase the particular good and sellers who are willing and able to supply the good. The market brings together those who demand and supply the good to determine the price. The Law of Demand captures this relationship between price and the quantity demanded of a product. It states that there is an inverse (or negative) relationship between the price of a good and the quantity demanded. 40 1

2 The basic of Demand and Supply Demand The demand schedule shows the combinations of price and quantity demanded of apples in a table format. The graphical representation of the demand schedule is called the demand curve. 41 The basic of Demand and Supply Demand The demand curve reflects our marginal benefit and thus our willingness to pay for additional amounts of a good. It makes sense that our marginal benefit, or willingness to pay for a good, would decline as we consume additional units because we get less additional satisfaction from each successive unit consumed. For example, at lunch time you decide to buy pizza by-the-piece. You'd be willing to pay a lot for that first piece to satisfy your hunger. But what about the second piece? Perhaps a little less. If we keep considering each additional piece, we might ask what the 3rd, 4th or 5th piece is worth to you. By that point, you'd be willing to pay less, perhaps much less. The law of demand and our models illustrate this behavior. 42 2

3 The basic of Demand and Supply The demand curve, labeled D or Q D (p), shows how the quantity of a good demanded by consumers depends on its price. A more formal examination of the law of demand shows the most basic reasons for the downward sloping nature of demand. The first factor is the price effect which states that as the price of the good declines, it becomes relatively less expensive thus the quantity demanded is greater at a lower price. When the price of the good rises, the opposite occurs. The changes in price that we have discussed cause movements along the demand curve, called changes in quantity demanded. Q D (p) 43 The basic of Demand and Supply But there are factors other than price that cause complete shifts in the demand curve which are called changes in demand. The second factor is the income effect which states that as the price of a good decreases, consumers become relatively richer. Now, their incomes have not increased, but their buying power has increased due to the lower price. If they continued to buy the same amount, they would have some money left over - some of that extra money could be spent on the good that has the lower price, that is quantity demanded would increase. 44 3

4 The basic of Demand and Supply But there are factors other than price that cause complete shifts in the demand curve which are called changes in demand. The third factor is due to the existence of complementary and substitute goods. Substitutes: Two goods for which an increase (decrease) in the price of one leads to an increase (decrease) in the quantity demanded of the other. Complements: Two goods for which a decrease (increase) in the price of one leads to a increase (decrease) in the quantity demanded of the other. The fourth factor is the number of consumers. 45 The basic of Demand and Supply The demand curve: Relationship between the quantity of a good that consumers are willing to buy and the price of the good.. We can write this relationship between quantity demanded and price as an equation: Q D = Q D(P ); QD P = QD (P)<0 46 4

5 The basic of Demand and Supply Factors of Demand: Number of consumers in a market. Income. Taste and Preference. Practice: Identify how each of the following would change the demand (shift right, shift left, move along). 47 The basic of Supply and Demand Demand Supply shows the amount that producers are willing and able to supply to the market at each given price. Producers must receive a price that covers the marginal cost of production. As the price of the good rises, producers are willing to produce more of the good even though there is an increasing marginal cost. An individual may be willing to work a few hours at a low wage since the value of what they are sacrificing is relatively low. As the wage rate rises, individuals are typically willing to work more hours since the marginal benefit becomes greater than or equal to the marginal cost of what has to be sacrificed. Many stars and celebrities never attend college or drop out since the income that they would be foregoing at that time in their lives, exceeds the increase in their earnings potential of attending school. 48 5

6 The basic of Demand and Supply The supply curve, labeled S or Q s (p)in the figure, shows how the quantity of a good offered for sale changes as the price of the good changes. The supply curve is upward sloping: The higher the price, the more firms are able and willing to produce and sell. Similarly to the Demad, the Supply is affected by many factors that determine its shift. Similarly to the Demad, the Supply is affected by many factors that determine its shift. To recap, changes in the price of a good will result in movements along the supply curve called changes in quantity supplied. Q S (p) 49 The basic of Demand and Supply A change in any of the other factors we've discussed (and listed above), will shift the supply curve either right or left. The main factors: Resource price: if the price of crude oil (a resource or input into gasoline production) decreases, the quantity supplied of gasoline at each price would increase, shifting the supply curve to the right. Technique of production: If a new method or technique of production is developed, the cost of producing each good declines and producers are willing to supply more at each price - shifting the supply curve to the right. Q S (p) 50 6

7 The basic of Demand and Supply Price of other inputs: Substitutess in production are goods that can be subtitutes in the production process: if the price of gas decrease relative to the price of oil that could be employed in the same plant to produce energy, the quantity of energy will increase. Complements in production are goods that are jointly produced: a decrease in the price of works will cause an increase in the quantity supplied of energy produced trough oil. Q S (p) 51 The Equilibrium and the Market Mechanism Practice Identify how each factor will shift the supply curve: right, left, or move along. Market Change Computers Price of memory chips decreases. Airline Tickets Government imposes a new jet fuel tax. Milk Demand for milk increases. Cars A new engine design reduces the cost of producing cars. Corn The price of wheat (a substitute in production increases in price). Oranges A freeze in Sicily kills 25% of the orange crop. 52 7

8 The Equilibrium and the Market Mechanism Practice For almost two years there has been a lot of worry about (Dynamic Random Access Memory) DRAM spot prices. This post s graphic plots the lowest weekly spot price per gigabyte for the cheapest DRAM, regardless of density, on a semi-logarithmic scale. (Remember that on a semi-logarithmic scale constant growth appears as a straight line.) 53 The Equilibrium and the Market Mechanism Practice Today s electric vehicles promise several advantages over gas-powered cars. For commuters, there are no trips to the gas station all you need is an outlet at home or work and a full charge only costs a couple ofdollars. And electric motors, which need only a single gear for all speeds, can also be surprisingly responsive and powerful. What s more, electric cars use no gasoline and emit no pollution. Even when you factor in the carbon emissions and pollution from the power plants that produce the electricity to power the cars, and from manufacturing and disposal, electric cars produce about 40 percent less carbon dioxide and ozone than conventional cars. But for all their attributes, electric cars still are haunted by two damning factors: high costs and less-than-optimal batteries. That s where Tesla hopes to make a difference. The company s innovative battery and charging technology has given it a substantial lead in making batteries cheaper and recharging quicker, and it s also helping Tesla lower costs faster than its competitors

9 The Equilibrium and the Market Mechanism Market Equilibrium A market brings together those who are willing and able to supply the good and those who are willing and able to purchase the good. In a competitive market, where there are many buyers and sellers, the price of the good serves as a rationing mechanism. Since the demand curve shows the quantity demanded at each price and the supply curve shows the quantity supplied, the point at which the supply curve and demand curve intersect is the point at where the quantity supplied equals the quantity demanded. This is call the market equilibrium. 55 The Equilibrium and the Market Mechanism Disequilibrium If the market price is above the equilibrium, the quantity supplied will be greater than the quantity demanded. The resulting surplus in the market will lead producers to cut back on production and lower the price. As the price falls, the quantity demanded increases since consumers are willing to buy more of the product at the lower price. In a competitive market, this process continues till the market reaches equilibrium. P + Q D Q O 56 9

10 The Equilibrium and the Market Mechanism Disequilibrium If the market price is too low, consumers are not able to purchase the amount of the product they desire at that price. As a result of this shortage, consumers will offer a higher price for the product. As the price increases, producers are willing to supply more of the good, but the quantity demanded by consumers will P - decrease. Q O Q D 57 The Equilibrium and the Market Mechanism Perfect Competitive Market Equilibrium (or market clearing) price: price that equates the quantity supplied to the quantity demanded. Market Mechanism: tendency in a free market for price to change until the market clears. Surplus: situation in which the quantity supplied exceeds the quantity demanded (stocks increae) Shortage Situation in which the quantity demanded exceeds the quantity supplied. Q D Q O 58 10

11 The Equilibrium and the Market Mechanism When Can We Use the Supply-Demand Model? Assumption: We are assuming that at any given price, a given quantity will be produced and sold. This assumption makes sense only if a market is at least roughly competitive. By this we mean that both sellers and buyers should have little market power i.e., little ability individually to affect the market price. Demand and Supply factors are crucials Demand Tastes and preferences Income Prices of related goods Number of buyers Supply Resource Price Technology Prices of related inputs Number of sellers 59 The Equilibrium and the Market Mechanism Supply shift When the supply curve shifts to the left, the market clears at a higher price P 3 and a larger quantity Q 3. P 1 S P

12 The Equilibrium and the Market Mechanism Supply and demand shifts When demand and supply are changing at the same time, the analysis becomes more complex. In such cases, we are still able to say whether one of the two variables (equilibrium price or quantity) will increase or decrease, but we may not be able to say how both will change.. D - D + O - Q (P?) P (Q?) O + P (Q?) Q (P?) 61 The Equilibrium and the Market Mechanism Practice Consider the slide # 25 (Introduction) and describe what has happened in the eggs market from 1970to 2007 a) Perform the analysis at nominal price b) Perform the analysis at real price (base=1970) What are your conclusions? Repeat the analysis for the education market 62 12

13 The Equilibrium and the Market Mechanism Example 1: Long-Run Movements of Supply and Demand for Mineral Resources Although demand for most resources has increased dramatically over the past century, prices have fallen or risen only slightly in real (inflation-adjusted) terms because cost reductions have shifted the supply curve to the right just as dramatically. 63 The Equilibrium and the Market Mechanism Example 3: Solar Pannel Despite a strong rise in demand, the market price of solar panels has fallen before With the help of a supply and demand diagram, explain what has happend in the period ? What is your prevision for 2014? Discuss the market implication of government incentives to household in 2014? Endogeneous factors Price of energy Cost of panel Switching Costs Incentives 13

14 The Equilibrium and the Market Mechanism Price of solar panels S 2005 S 2007 P 2005 P 2007 D 2007 But Despite a strong rise in demand, the market price of solar panels has fallen before 2008 Q 2005 D 2005 Q 2007 Quantity 65 The Equilibrium and the Market Mechanism Price of solar panels D 2014 S 2014 P 2007 P 2014 D 2007 Q 2014 Q 2007 Quantity 66 14

15 The Equilibrium and the Market Mechanism Price of solar panels D 2014 S 2014 P IF 2014 P 2014 Incentive Discuss the market implication of government incentives to household in 2014 Incentives P IH 2014 Q 2014 Q 2007 Quantity 67 Price Elasticities Marketing managers understand the law of demand. They know that if they set a higher price, they can expect to sell less output. But this is not enough information for good decision making. Managers need to know whether their customers demand is very sensitive or relatively insensitive to changes in the price. Put differently, they need to know if the demand curve is steep (a change in price will lead to a small change in output) or flat (a change in price will lead to a big change in output). The slope of a demand function is the change in quantity demanded divided by the change in price: Q D P = QD (P)<0; and that certainly looks like a measure of responsiveness. The main drawback is that the slope of a demand function depends on the units in which you measure price and quantity

16 Price Elasticities To avoid such a problem the economists have chosen to use a measure known as elasticity: ε P D = θqd Q D θp P = θqd θp P Q D<0; The price elasticity of demand, is defined to be the percent change in quantity divided by the percent change in price. The price elasticity of demand depends not only on the slope of the demand curve but also on the price and quantity. The elasticity, therefore, varies along the curve as price and quantity change. Near the top, because price is high and quantity is small, the elasticity is large in magnitude. The elasticity becomes smaller as we move down the curve. P 3 P 2 P 1 Q 3 Q 2 Q 1 69 Price Elasticities Consider the linear demand curve, Q = a bp, depicted in Figure. The slope of this demand curve is a constant, b. Plugging this into the formula for elasticity we have: P=a/b ε P D =- ε P D = b P Q = b P ; a bp P 2 ε P D =-b When P = 0, the elasticity of demand is zero. When Q = 0, the elasticity of demand is (negative) infinity. When P=Q elasticity of demand equal to 1? P 1 45 Q=a ε P D =

17 Price Elasticities (a) For a horizontal demand curve, ΔQ/ΔP is infinite. Because a tiny change in price leads to an enormous change in demand, the elasticity of demand is infinite. Infinitely elastic demand: Principle that consumers will buy as much of a good as they can get at a single price, but for any higher price the quantity demanded drops to zero, while for any lower price the quantity demanded increases without limit. 71 Price Elasticities (b) For a vertical demand curve, ΔQ/ΔP is zero. Because the quantity demanded is the same no matter what the price, the elasticity of demand is zero. completely inelastic demand: Principle that consumers will buy a fixed quantity of a good regardless of its price

18 Price Elasticities: a taxonomy D ε P Economic Implication Classification 0 Quantity demanded is not sensitive to price variations Demand is perfectly inelastic (0,-1) Price variations have slight impact on quantities Demand is elastic -1 Quantity variations is equal to price variations Unitary elastic demand (-1,- ) Quantity variations is grether than price variations Relatively elastic demand - High variations in quantities in respose to slight variations in prices Perfect elastic demand 73 Price Elasticities: cross price elasticity The cross price elasticity measures the percentage change in the quantity demanded for one good, say good Q a, given the percentage change in the price of another good, say P b. P b D a (P b, complements) D a (P b, substitutes) If the price of good b increases and the quantity demanded for good a increases, the cross price elasticity would have a positive sign and the goods are considered substitutes. If the cross price elasticity of the two goods is negative, they are considered complements. Q a 74 18

19 Price Elasticities: arc or mid point formula P A simple technique for calculating the coefficient of elasticity by estimating the average elasticity for discrete changes in two variables (price and quantity): ε D P = (Q 1 Q 2 ) (P 1 +P 2 )0.5 (P 1 P 2 ) (Q 1 +Q 2 )0.5 = ΔQ ΔP (P 1 +P 2 ) (Q 1 +Q 2 ) P 1 (P 1 +P 2 )*0.5 P 2 D(P) Q 1 Q 2 Q (Q 1 +Q 2 )* Price Elasticities: Hyperbolic demand function and costant elasticity P The price elasticity varies along most demand and supply curves. Along a special type of demand or supply curve, however, the price elasticity is the same at every point: Q = ap b. Calculating the elasticity we obtain: ε = abp b+1 P Q = abp b+1 ap b=-b P D(P)=aP b Q 76 19

20 Price Elasticities: Supply The elasticity of supply is the same basic formula as the demand elasticity, but looks at the percentage change in quantity P supplied instead of percentage change in quantity demanded. The measure looks at the responsiveness of producer to changes D s (P) in the price of the good produced. The law of supply states that as the price increases (decreases) the quantity supplied increases (decreases). Since the relationship between price and quantity supplied is positive or direct, we don t need to take the absolute value. The elasticity of supply is compared to one and has a similar interpretation to that of the elasticity of demand. Q ε S P = θq P θp Q =Q P P 0 Q 77 Income Elasticities The last elasticity measure is income elasticity which measures the percentage change in quantity demanded given a percentage change in income (I). Goods and services with negative income elasticities are inferior goods and include items such as dry milk and second-hand clothing. As incomes rise people buy less of these goods. Goods with positive income elasticities are normal goods and can be divided into two additional categories Goods with income elasticities between 0 and 1 are necessities Goods with income elasticities greater than 1 are luxury items. ε D I = θq I θi Q I D(I) Q 78 20

21 Income Elasticities Inferior I ε I D =0 ε I D =1 ε I D 0 Good type Inferior >0 Normal (0,1] Necessity >1 Luxury Q 79 Market and elasticities Practice: wheat market analysis During recent decades, changes in the wheat market had major implications for both American farmers and U.S. agricultural policy. To understand what happened, let s examine the behavior of supply and demand beginning in 1981: By setting the quantity supplied equal to the quantity demanded, we can determine the marketclearing price of wheat for 1981: 80 21

22 Market and elasticities Practice: wheat market analysis Once we have computed the market clearing price we have to analyze the demand and price elasticities. price elasticity of demand: price elasticity of supply: E S P P QS 3.46 (240) 0.32 Q P 2630 Both function are inelastics. What are the economic implications 81 Market and elasticities Practice: wheat market analysis Given the price per bushel in 2015, 5.20$ determine the equilibrium price and the elestacities of demand and supplies. Hint assume no changes in the factors that influence the supply and that the demand function does not change the slope From the supply function we obtain the volume of wheat: Q 2015 S = = 3048 Thus (rember the equation of line when the slope and a point are known): P 5.20 = 1 (Q 3048) E P D = (-266)=-0.45; 266 Q 2015 D = p Elasticities E P D = (240)=0.41 A moderate increase in elasticities due to price increase 82 22

23 From elasticities to demand function Demand: Q = a bp Demand: E* D = b(p*/q*)=>b*= -E* D Q*/P* a* = Q* + b*p* Supply: Q = c + dp Supply: E* S = d(p*/q*)=>d*= E* D Q*/P* c* = Q* - d*p* Uknown Price, quantities and elasticities are known Q* = a* - b*p* Q* = c* + d*p* 83 Determinant of elasticities of demand Factor that influences the elasticity: 1. Existence of substitutes. The greater the number of close substitutes that are available for a good, the more elastic it becomes. If there are many bread stores in the city and one bread store raises its price, the quantity demanded decreases since there are many other stores producing a similar product. 2. Percent of Income. The percent of income spent on the good influences the elasticity of demand. Think of your annual expenditures on toothpicks or pencils. If the price of those items increased, by say 20 percent, the quantity demanded would likely decrease very little due to your annual expenditures on the item. 3. Percent of Income. The percent of income spent on the good influences the elasticity of demand. Think of your annual expenditures on toothpicks or pencils. If the price of those items increased, by say 20 percent, the quantity demanded would likely decrease very little due to your annual expenditures on the item. 4. Luxury or necessity. Those items that are a necessities in life are more inelastic than items that are a luxury. Food in general, salt, and life saving medical care are examples of necessities and have lower price elasicities than luxury items such as: jewelry, yachts, or vacation travel. 5. Time period. The longer the time period, the more elastic a good becomes as more substitutes become available. If the price of gas doubled, car owners would still need to buy gas. 6. Type of good. Consumer durable goods include items like furniture, jewelry and cars. Large appliances such as stoves and washing machines are durable goods, etc. Non-durable goods include food, medicines and other consumables, as well as products that last a limited lifetime such as clothing, shoes and small electronic devices

24 Determinant of elasticities of demand Price elasticity of demand in the short run -D S (P)- and long run -D L (P)-for a Durable Good Price elasticity of demand in the short run -D S (P)- and long run -D L (P)- for a Non Durable Good Price D L (P) Price D S (P) D S (P) D l (P) Quantity The price elasticity in the short run is higher than in the long run. Quantity The price elasticity in the long run is higher than in the short run. 85 Determinant of elasticities of demand Income elasticity of demand in the short run - D S (I)- and long run -D L (I)- for a Durable Good Income elasticity of demand in the short run -D S (I)- and long run -D L (I)- for a Non Durable Good Income D S (I) Income D S (I) D L (I) D L (I) Quantity The income elasticity in the short run is higher than in the long run. Quantity The income elasticity in the long run is higher than in the short run

25 Empirical evidence: demand Background Cyclical industries. Industries in which sales tend to magnify cyclical changes in gross domestic product and national income. Annual growth rates are compared for GDP and investment in durable equipment. Because the short-run GDP elasticity of demand is larger than the long-run elasticity for long-lived capital equipment, changes in investment in equipment magnify changes in GDP. Thus capital goods industries are considered cyclical. 87 Empirical evidence: demand Durable and non durable goods Annual growth rates are compared for GDP, consumer expenditures on durable goods (automobiles, appliances, furniture, etc.), and consumer expenditures on nondurable goods (food, clothing, services, etc.). Because the stock of durables is large compared with annual demand, short-run demand elasticities are larger than long-run elasticities. Like capital equipment, industries that produce consumer durables are cyclical (i.e., changes in GDP are magnified). This is not true for producers of nondurables

26 Empirical evidence: demand Durable and non durable goods Demand for Gasoline Number of Years Allowed to Pass Following a Price or Income Change Elasticity Price Income Demand for Automobiles Number of Years Allowed to Pass Following a Price or Income Change Elasticity Price Income Determinant of elasticities of supply Price elasticity of supply in the short run -S S (P)- and long run -S L (P)-for a Durable Good and Non durable good Primary market Price D S (P) D L (P) Capacity and time If a firm is already operating at full capacity, then to increase supply would require building additional facilities and purchasing new equipments. A firm that is operating at below full capacity, can respond to a price increase quicker than a firm that is already at full capacity Input substitution In the production of coke industry quicly can substitute sugar with corn syrup Quantity The price elasticity in the short run is lower than in the long run

27 Determinant of elasticities of supply Price elasticity of supply in the short run -S S (P)- and long run -S L (P)-for a Durable Good and Non durable good Price Secondary market D L (P) D S (P) The growing importance of the secondary market With increased demand for finite resources, the evolving need of a formal marketplace to facilitate the international trade of secondary commodities is escalating. The establishment of an orderly market to shepherd transactions to successful completion on behalf of both the buyer and the seller provides a unique business opportunity. The scope of the exchange includes anything scrap or used, including scrap metals, waste paper recovery, rubber & plastic recycling, wood and organic materials, by-products, waste materials, used or secondhand items, surplus inventories, used equipment, asset recovery, waste electronics & electrical equipment (WEEE). The exchange can accomodate environmental emission credits (carbon trading) to offset carbon footprints. RecycleNet has established a program to recognize and reward companies for their recycling efforts, with Recycling Offset Credits ROCs. Quantity The price elasticity in the short run is lower than in the long run Determinant of elasticities of supply Price elasticity of supply in the short run -S S (P)- and long run -S L (P)-for a Durable Good and Non durable good Price Secondary market D L (P) D S (P) The growing importance of the secondary market With increased demand for finite resources, the evolving need of a formal marketplace to facilitate the international trade of secondary commodities is escalating. The establishment of an orderly market to shepherd transactions to successful completion on behalf of both the buyer and the seller provides a unique business opportunity. The scope of the exchange includes anything scrap or used, including scrap metals, waste paper recovery, rubber & plastic recycling, wood and organic materials, by-products, waste materials, used or secondhand items, surplus inventories, used equipment, asset recovery, waste electronics & electrical equipment (WEEE). The exchange can accomodate environmental emission credits (carbon trading) to offset carbon footprints. RecycleNet has established a program to recognize and reward companies for their recycling efforts, with Recycling Offset Credits ROCs. Quantity The price elasticity in the short run is lower than in the long run

28 Real World Market Example Rare elements and secondary market Neodymium, shown here, is used in high-performance magnets (permanent magnet motors or PMs) for hybrid vehicles, offshore turbines, and defense guidance systems. According to a new IHS Chemical global market research report, a growing global dependence upon a multitude of diverse technologies from lighting systems to windpower turbines has left manufacturers and countries vulnerable to the availability and uninterrupted supply (largely from China) of some key elements used to produce these technologies called rare earths. In the report, the IHS Chemical CEH Rare Earth Minerals and Products Report, production and consumption of these industrial minerals in 2012 was more than 100 thousand metric tons (KMT). During the study period of 2012 to 2017, IHS estimates average global demand for rare earth products will grow by 7.6% annually, reaching more than 150 KMT of consumption, with China leading consumption growth at 8.3% annually. Read the full paper (download it on didattica web 2.0: Rare earths, minerals) and try to understand what will occur in the long run in the market of turbine and hybrid car. 93 Empirical evidence: supply Supply of Copper Price Elasticity of: Short-Run Long-Run Primary supply Secondary supply Total supply Copper market Steady depletion of the world s primary copper reserves (i.e. from concentrates), coupled with a meteoric rise in electronic waste (e-waste) generation, has led to secondary copper processing assuming an ever-increasing importance within the global copper industry. This article talks about the pyrometallurgical processing (smelting) of copper secondaries and some of the unique issues facing secondary copper smelters. Secondary copper refers to all non-primary sources, such as metallurgical wastes (low grade slags, anode slimes), industrial wastes, (copper sheeting, bars, pipes etc) consumer wastes (brass and bronzeapplications) and e-waste (domestic electrical, audiovisual, telecoms appliances, computers etc). The contribution from secondary copper to global copper production has steadily increased in the last years and is currently around 35%, as per the International Copper Study Group,

29 Real World Market Example Copper market Copper prices are shown in both nominal (no adjustment for inflation) and real (inflationadjusted) terms. In real terms, copper prices declined steeply from the early 1970s through the mid-1980s as demand fell. In , copper prices rose in response to supply disruptions caused by strikes in Peru and Canada but later fell after the strikes ended. Prices declined during the period but then increased sharply during Why did the price increase sharply in ? First, the demand for copper from China and other Asian countries began increasing dramatically. Second, because prices had dropped so much from 1996 through 2003, producers closed unprofitable mines and cut production. 95 Real World Market Example Supply of Copper Price Elasticity of: Short-Run Long-Run Primary supply Secondary supply Total supply About 60 cents per pound About 16 Milions of metric tons Practice What would a decline of 10% in demand do to the real price of copper in the short run? Describe your analysis through a graphic? Looking at the figure on the left what do you attend in the long run 96 29

30 Real World Market Example Oil market Since the early 1970s, the world oil market has been buffeted by the OPEC cartel and by political turmoil in the Persian Gulf. The OPEC cartel and political events caused the price of oil to rise sharply at times. 97 Real World Market Example Oil market Taking as reference the period try to understand what happen if OPEC cut its production of 3bb/year. It is the same situation that it will occur since Some starting key elements: world price = $50 per barrel World demand and total supply = 34 billion barrels per year (bb/yr) OPEC supply = 14 bb/yr Competitive (non-opec) supply = 20 bb/yr The prices are measured in 2005 dollars. Estimated elasticities for oil supply and demand: Short Run Long Run World Demand: World supply:

31 Real World Market Example Oil market: short run analysis The total supply (S T ) is the sum of competitive (non-opec) supply (S C ) and the 14 bb/yr of OPEC supply. If Saudi Arabia stops producing, the supply curve will shift to the left by 3 bb/yr. In the short-run, price will increase sharply. 99 Real World Market Example Oil market: long run analysis In the long run, because demand and competitive supply are much more elastic, the impact on price will be much smaller

32 Real World Market Example Gas market: the impact of price control Natural gas prices rose sharply after 2000, as did the prices of oil and other fuels. Practice In 2007 the US (free-market) wholesale price of natural gas was $6.40 per mcf (thousand cubic feet); Production and consumption of gas were 23 Tcf (trillion cubic feet); The average price of crude oil (which affects the supply and demand for natural gas) was about $50 per barrel. The demand and supply functions are given by: Supply: Q = P G P O Demand: Q = P G P O If US government should set a ceiling price of $3.00 what has happened in the market. 101 Caveat nominal price vs real price Consider the data collected in the table of slide 25 and describe the eggs market between 1970 and 2007 using real price. You know that: the mechanization of poultry farms sharply reduced the cost of producing eggs. more health-conscious population tended to avoid eggs. Repeat your analysis considering the nominal price

33 Caveat nominal price vs real price Consider the data collected in the table of slide 25 and describe the college education market between 1970 and 2007 using real price. You know that: the costs of equipping and maintaining modern classrooms, laboratories, libraries and faculty salaries have increase a larger percentage of a growing number of high school graduates decided that a college education was essential. Now repeat your analysis considering the nominal price. 103 Energy market: some characteristics Practice 1 Espey and Espey (2004) looked at a number of studies of household electricity demand and found out the two following measure of elasticity: and According to your knowledge which is the demand elasticity for the short and the long run? Practice 2 Read on didattica web the document: The Economics of Energy (and Electricity) Demand.pdf