Download Chapter 8 The Basic Market Equation

Chapter 9
Supply and Demand
Geog 3890: ecological economics
You can turn a parrot into an economist by
getting it to squawk: “Supply and Demand!”
Demand Curve Changes
Shift in Curve vs. Movement Along Curve
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Shift Along Curve – Caused by Change in Price
Change in Curve – Caused by changes in income, changes
in preferences, changes in costs of substitutes
Goods are Related as Substitutes or Complements
Substitutes: Ham and Bacon, Coffee and Tea
Complements: Ham and Eggs, Stapler and Staples
Changes in P change Q demanded (movement along curve)
Changes in relationship between P & Q (shift of curve itself)
Shifting Demand & Supply Curves
E. coli tainted
beef outbreak.
► Bad Processing
plant closes.
► S1 -> S2
► P1 -> P2
► Q1 -> Q2
► Public goes
soft on beef
► D1 -> D2
► Q2 -> Q3
► P2 -> P3
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Shortage, Surplus, & Equilibrium
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P*, Q* is market
equilibrium.
Movement away
from equilibrium
forces market
back to P*, Q*
Price at P1
AB is a ‘Surplus’
Price at P2
CE is a ‘Shortage’
When people complain about a shortage of petroleum or of labor they are really
Complaining about a shortage of cheap petroleum or cheap labor.
The free market will always fix those ‘shortages’ won’t it? Yes. By raising the Price.
Consumer Surplus & ‘Normal Profit’
► Consumer
Surplus
►
Very large for
necessities
► Producer
Surplus
► aka
Rent, &
Differential
Rent, &
‘Normal
Profit’ “Tax Bads not Goods” where ‘bads’ are depletion and pollution
(throughput), and ‘goods’ are value added by capital and labor
(e.g. ‘earned income’).
Explanations of Terms
► Consumer
surplus is enormous for
necessities (water for example).
► Many environmental goods and services have
infinite consumer surplus.
► Rent is equivalent to producer surplus and is
defined as payment over and above minimum
necessary supply price.
► Normal Profit is defined as the opportunity
cost of the time and money the entrepreneur
has put into the enterprise.
Elasticity of Demand & Supply
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Price Elasticity of Demand = % ∆ in QD / % ∆ in Price
(where ∆ = change, QD = Quantity Demanded)
As the price rises, the quantity demanded decreases and vice versa.
Due to this concept, "% ∆ in QD" and "% ∆ in Price" will always
have different sign, which always results the price elasticity of
demand into negative sign.
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Based on the above formula, there are three responses.
1. Elastic: QD greatly responds to change in Price ;
numerator > denominator ; Elasticity > 1
2. Inelastic: QD slightly responds to change in Price ;
numerator < denominator ; Elasticity < 1
3. Unit Elastic: QD equally responds to change in Price ;
numerator = denominator ; Elasticity = 1
Elasticity
https://mrski-apecon-2008.wikispaces.com/Chapter+5+Elasticity+and+Its+Application
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Examples of different responses.
- Goods with close substitutes are elastic because consumers have more options of goods to
choose from. So when the price increases, they can buy the substitutes of that good.
- Luxuries are also elastic because consumers only enjoy luxuries when the price doesn't
change immensely.
- Necessities are inelastic because consumers will have to buy necessities regardless of their
price.
Inelasticity & Profit:
Peak Oil, Peak Food, & Peak Water
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What happens to total
revenue as supplies
diminish for a product
with inelastic demand?
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What happens to
elasticity of demand for
gasoline as alternative
energy is developed?
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Why might food and
water be very lucrative
products to supply as
global population grows?
Could driving
Down agricultural
productivity
actually raise
GDP?
The Production Function
(The NCE version - economists love these number free equations)
Q = F(a, b, c)
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► The
quantity produced is a function of the
quantities of the factors of producton a, b, and c.
► Diminishing
MPP still holds.
► MPPa
is a
Partial derivative
What is the law of increasing marginal cost?
Substitutability & Complementarity
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Production functions exhibit both substitutability and
complementarity between factors. But standard economists tend
to see mostly substitution, whereas ecological economists
emphasize complementarity. Why is this so?
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Because Ecological Economists put different things in the
production function and assign different qualitative roles to the
different factors in the production process. For instance,
neoclassical economists treat all inputs the same – labor, capital,
and resources. Ecological economists insist on a qualitative
difference. The NCE production function abstracts from the
difference between material (resources) and efficient (labor and
capital) causes of production, and considers both to be
equivalent. Ecological economists insist on the distinction.
The Ecological Economics
Production Function
Q = F(N, K, L; r)
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► This
function embodies the fund-flow distinction
► ‘K’
& ‘L’ are funds of Capital and Labor
► ‘r’
represents flows of natural resources
► ‘N’
stands for natural capital which exists both as a
stock that yields a flow of resources and as a fund
providing various ecosystem services.
How we think about it matters
► Question:
A stock of cattle yield a flow of new
cattle in a sustained yield fashion. Isn’t that a
physical stock yielding a physical flow?
► Answer:
Not really. It is a stock (livestock)
converting a flow of inputs (grass, grain) into a
flow of outputs (new cattle & Waste products).
► The
correct description of “production” is
transformation of a resource inflow into product
outflows, with stocks (funds) of capital and labor
functioning as the transforming agents.
“Money Fetishism” and Fungibility
► Why
are such basic facts excluded from
neoclassical economics? Why does NCE choose
to ignore them, to exclude natural resources
from theoretical analysis right from the start?
Perhaps it is a case of “money fetishism” –
assuming that what is true for money in the
bank, the symbol and measure of wealth, ‘must’
be true for the wealth that it symbolizes.
What does “Fungibility” mean? Hint – Money is very very “fungible”
The Cobb-Douglas
Production Function
4 & 8 minute videos – this is what economics sounds like
here: http://www.youtube.com/watch?v=SJMwcP1pLEQ
and here: http://www.youtube.com/watch?v=3EYvdW_JBIs
Most production functions are multiplicative forms – that is the
relationship F among the factors is one of multiplication. After
all, what could be more natural than “multiplying” together things
that we call “Factors” to produce something that we call a
“Product”. Unfortunately there is nothing in the real world
process of production that corresponds at all to multiplication.
There is only transformation.
► This means that substitutability is built into these production
functions from the beginning as a mathematical artifact, including
substitutability between r and K, and r and L (between funds and
flows).
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Key Message
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As we move from the empty world to the full world
economy, natural resource flows and services generated by
natural capital stocks and funds become the limiting factor.
Fish catches are no longer limited by the manmade capital
of fishing boats, but by remaining natural capital of stocks
of fish in the sea and the natural funds that support their
existence. We need to economize on and invest in the
limiting factor. Economic logic has not changed, but the
identity of the limiting factor has.
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Because our basic NCE theory of production, when it
considers natural resources at all, cannot distinguish funds
from flows or recognize complementarity between them, we
have been slow to recognize this change.
The Utility Function
►U
= F(x, y, z, …)
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Our happiness depends on
what we consume (and not
on our freedom, creativity,
social relationships etc.)
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We experience diminishing
marginal utility with
increasing consumption.
The neoclassical production function only contains flows of goods or services
The EE Utility Function
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U = F(N; x, y, z, …)
► If ‘x’ is a pair of hiking boots then utility is
dependent upon good places to hike (‘N’).
► If ‘y’ is a snorkeling mask, its utility depends on
reefs and clean water to swim in (‘N’).
► Not to mention prior dependence on breathable air,
drinkable water, sunlight filtered of UV etc.
► Natural Capital (‘N’) provides a complementary
service without which the utilities of most consumer
goods are not very great.
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Will ‘U’ increase if x, y, and z increase as ‘N’ goes down?
Summary of Chapter 9’s Key Points