Olds – Chapter notes: Cowen & Tabarrock
Chapter 2: Supply and Demand
The Demand Curve (for oil)
A demand curve is a function that shows the different quantities demanded at different prices. See Fig. 2.1, p. 14. A demand curve can be read two ways: o Horizontally, the curve shows the quantity demanded at a given price. o Vertically, the curve shows the maximum price consumers would pay for a given amount of product.
The curve is “negatively sloped” (upper left falling to lower right) because consumers tend to buy more of the product at lower prices than at higher prices. o Oil is not equally valuable in all of its uses: oil as gasoline and jet fuel has greater value than oil as lubricant, plastic, or home heating fuel o When price of oil is high, consumes will choose to use oil only in its most valuable uses; as oil prices fall, consumers will also choose to use oil in its less valued uses. o The negative slope represents the “law of demand.”
Consumer surplus is the consumer’s gain from exchange—the difference between the maximum price a consumer is willing to pay for a certain quantity and the market price. o On a graph (Fig. 2.4, p. 16) consumer surplus is the area beneath the demand curve and above the market price. (To measure, use formula for area of triangle.) What shifts the demand curve?
An “increase in demand” shifts the demand curve outward, up and to the right.
A “decrease in demand” shifts the demand curve inward, down and to the left.
Important demand shifters o Changes in income
If increases in income result in increases in demand, the good is a normal good. E.g., most goods
If increases in income result in decreases in demand, the good is an inferior good. E.g., hamburger v. steak, riding buses v. buying cars, o Changes in population o Changes in prices of related products—substitutes and or complements
Decrease in price of Good A (peanut butter) will decrease demand for
Good B (ham slices, a substitute for Good A)
Decrease in price of Good A (peanut butter) will increase the demand for
Good B (bread, a complement for Good A.) o Changes in consumer expectations o Changes in consumer tastes
Last resort excuse to explain demand shift
The Supply Curve (for oil)
The supply curve is a function that shows the different quantities supplied at different prices. See Fig. 2.7, p. 21. Supply curve can be read two ways. o Horizontally, supply curve shows how much of a product producers are willing to supply at a given price. o Vertically, supply curve shows the minimum price at which producers will supply a given quantity of product.
Supply curves are “positively sloped” (from lower left rising to upper right) because producers are willing to supply more of a product at higher prices than at lower prices. o Oil sources are not equally exploitable: some oil patches are easy to extract from; others are remote, technically difficult to extract, or in politically unstable regions, thus costs more to obtain (e.g., shale & tar sands)
Producer surplus is the producer’s gain from exchange—the difference between the market price and the minimum price at which a producer would be willing to sell a particular quantity. (aka. Profit) o On graph (Fig. 2.10, p. 23) producer surplus is the area above the supply curve and below the market price for the product
What shift the supply curve?
Major source of supply shift is the cost of production: increases in production costs shift supply curves to the left (decrease in supply); reductions in costs shifts supply curves to the right (increase in supply).
Important supply shifters o Technological innovations o Changes in the price of inputs o Changes in taxes and subsidies
Nb., these change the