Download Econ 201 Lecture 7 When all relevant production costs are incurred

Econ 201 Lecture 7
When all relevant production costs are incurred by sellers, and when all relevant product benefits accrue to buyers, the market
equilibrium price and quantity are socially optimal.
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When Smart for One is Dumb for All
Production of some goods entails costs that fall on people other than those who sell the good:
Goods whose production generates toxic smoke
Goods whose production generates noise
In the market equilibrium for such goods, the benefit to buyers of the last good produced is, as before, equal to the cost
incurred by sellers to produce that good.
But since producing that good also resulted in the costs of the associated pollution, we know that the full marginal cost of the
last unit produced—the seller’s private marginal cost plus the marginal pollution cost borne by others—must be higher than
the benefit of the last unit produced.
So market equilibrium quantity > socially optimal quantity. Total economic surplus would be higher if output of the good
were lower. Yet neither sellers nor buyers have any incentive to alter their behavior.
Increases in production of some goods benefit people other than those who buy them.
Honey and apples
More bees => more apples
More apple trees => more honey
Market equilibrium results in too little production of such goods.
“Change in demand” vs. “Change in the quantity demanded”
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Increase in demand
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Increase in the
quantity demanded
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Newspaper story: “Producers raised prices, and the resulting fall in demand caused prices to fall back to their original level.”
WRONG!!
A rise in price causes a fall in the quantity demanded, not a fall in demand.
“If it did it wouldn’t.”
“An increase in supply”: At every price, there is an increase in the quantity supplied.
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Quantity
“An increase in the quantity supplied”: For an upward sloping supply curve, an increase in price leads to an increase in the
quantity supplied.
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Price ($/lobster)
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Quantity
(1000s of lobsters/day)
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Predicting and Explaining Changes in Price and Quantity
An increase in demand will lead to an increase
in both the equilibrium price and quantity.
Price
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A decrease in demand will lead to a decrease
in both the equilibrium price and quantity.
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An increase in supply will lead to
a decrease in the equilibrium price
and an increase in the equilibrium quantity.
A decrease in supply will lead to
an increase in the equilibrium price
and a decrease in the equilibrium quantity.
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Price
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Determinants of Demand
•Incomes
For most goods, the quantity demanded at any price will rise with income. Goods that have this property are called
normal goods.
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Income rises, normal good
Income falls, normal good
For inferior goods, the quantity demanded at any price will fall with income. Example: Ground beef with high fat content.
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Income rises, inferior good
Consumers abandon inferior goods in favor of higher quality substitutes (such as leaner grades of meat in the ground
beef case) as soon as they can afford to.
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•Tastes
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Tastes shift in favor
Example: Following the release of Jurassic Park and The Lost World, tastes in children’s toys shifted toward designs
involving prehistoric reptiles.
•Prices of substitutes and complements
Substitutes: e.g., coffee and tea
Price of tea
Complements: e.g., coffee and cream
Price of
coffee
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Quantity of
coffee
Quantity of tea
Price of cream falls
Price of coffee falls
Determinants of Supply
•Technology.
A more efficient lobster trap is invented:
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Quantity
•Factor Prices
The price of diesel fuel rises:
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Quantity
Interest rates fall
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Example 7.1. Why do the prices of some goods, like apples, go down during the months of heaviest consumption, while
others, like beachfront cottages, go up?
The seasonal consumption increase is the result of a supply increase in the case of apples, a demand increase in the
case of cottages.
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Beachfront Cottages
Apples
Example 7.2. What will happen to the equilibrium price and quantity in the fresh seafood market if both of the following
events occur: (1) a scientific report is issued saying that fish contains mercury, which is toxic to humans; and (2) the price of
diesel fuel falls significantly?
The equilibrium price will go down, but the equilibrium quantity may go either up (right panel) or down (left panel).
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