Exec SupplyDemand
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Transcript of Exec SupplyDemand
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Supply and Demand
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Gas prices at record high
US$
West Texas Intermediate (Bbl)
Prices of Oiland Gasoline
continue to
climb!
What
happens if
Iranian oil is
taken
offline?
http://money.cnn.com/ -
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August 25, 2005
Rising Price of Oil Pushes S.&P. to Negative
Territory
By ERIC DASHOil prices climbed to another record yesterday,
driving stocks lower and leaving the Standard &
Poor's 500-stock index down for the year.
All three major market gauges closed loweryesterday; the S.&. P.'s loss meant that for the first
time since July 7, all three were in negative territory
for the year. "Once oil decided that it was going to
move higher and stay higher, that just took the
starch out of any buyers in the stock market," said
Joseph Liro, the chief equity strategist at Stone &
McCarthy, an economic research firm in Princeton.
"Oil is just the biggest single depressant on the
market except for the oil stocks."
http://query.nytimes.com/search/query?ppds=bylL&v1=ERIC%20DASH&fdq=19960101&td=sysdate&sort=newest&ac=ERIC%20DASH&inline=nyt-perhttp://query.nytimes.com/search/query?ppds=bylL&v1=ERIC%20DASH&fdq=19960101&td=sysdate&sort=newest&ac=ERIC%20DASH&inline=nyt-per -
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To think about commodity prices,
economists first think about the theory
of competitive markets
Competitive Markets have many buyers and
many sellers who compete without barrierspreventing rivals from entering or leaving
the market.
Participants in competitive markets are
price takers, agents who behave as if their
own behavior has no effect on market
prices.
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Law of Demand:There is always an inverserelationship between the price of a good and thequantity that consumers would like to purchase.Reason:
Consumers have limited income.
The price that consumers will pay for an extragood will be no greater than the extra benefitthat they receive from it.
People face diminishing returns from consumingany given good.
Each extra good consumed generates less
marginal benefit than the good before Consumers will be willing to pay less for each
extra good than they were willing to pay for thegood before.
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Representation of a Hypothetical Oil
Demand Schedule
P
Q
US$/bbl Mil. BblP Q
30 31867.11
35 31568.86
40 31312.77
45 31088.650 30889.43
55 30710.37
60 30547.8
65 30399.01
70 30261.9
75 30134.8
80 30016.4
85 29905.6
90 29801.51
95 29703.39
100 29610.59
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Law of Supply: There is a positive relationship
between the price of a good and the quantity
producers bring to the market. In a competitive market place, producers are
willing to sell an extra good as long as the price
is at least as large of the extra cost of producingit (marginal cost).
Producers have decreasing returns to productionand therefore increasing costs. To induce them
to produce greater amounts, they must becompensated for these increasing costs withhigher prices.
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Why do supply curves slope up?
Firms will only increase supply when pricesrise because their costs as production increases.
Producing extra goods generates increasing
costs because some inputs are fixed and theflexible factors of production will have
diminishing returns.
Example: A busy McDonalds can sell more burgersby adding more McWorkers, but effectiveness of
workers is limited by amount of Cash registers,
Ovens, and ultimately Space.
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Representation of a Hypothetical Oil Supply
Schedule
US$/bbl Mil. BblP Q
30 29893.38
35 30078.28
40 30239.36
45 30382.16
50 30510.48
55 30627.02
60 30733.8
65 30832.36
70 30923.89
75 31009.3580 31089.51
85 31164.99
90 31236.32
95 31303.95
100 31368.24
P
Q
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Equilibrium
Equilibrium in the competitive market occurs
when the price is set at a level (P*) such that theamount that consumers want to buy is equal tothe amount that sellers want to sell (Q*).
Excess SupplyIf P were above equilibrium, sellerswould want to sell more goods than buyers wouldwant to buy. Competition between sellers wouldforce prices down.
Excess DemandIf P were below equilibrium,customers would want to buy more goods thanpeople would want to sell. Competition betweenbuyers would force prices up.
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Competitive Market Equilibrium(Geometry)
SDP
Q
P*
Q*
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Excess Supply
SDP
Q
P*
Q*
P
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Excess Demand
SDP
Q
P*
Q*
P
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Market Equilibrium
(Spreadsheet Problem)
Supply Demand
30 29893.38 31867.11
35 30078.28 31568.86
40 30239.36 31312.77
4530382.16 31088.6
50 30510.48 30889.43
55 30627.02 30710.37
60 30733.8 30547.8
65 30832.36 30399.01
70 30923.89 30261.9
75 31009.35 30134.8
80 31089.51 30016.4
85 31164.99 29905.6
90 31236.32 29801.51
95 31303.95 29703.39
100 31368.24 29610.59
At what price and quantity (to
closest $5) will the oil market
clear?
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Elasticity: The Concept
How strong is the effect of a change in priceon the change in quantity supplied or
quantity demand. If the price effect is strong, we say the
supply/demand schedule is elastic.
If the price effect is weak, we say it isinelastic.
Strict definition to come
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Shifting Curves/Changing Equilibrium
Changes in equilibrium result from shifts ineither the demand or supply schedule. Wethink of shifts in the curves as changes insupply or demand that are caused by factors
other than changes in the price of the good. Shifts in the demand curve lead to movements
along the supply curve resulting in changes inprices and quantities that move in the same
direction. Shifts in the supply curve lead to movements
along the demand curve resulting in changes inprices and quantities that move in different
directions.
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What shifts a demand curve?
1. Changes in consumer preferences
2. Changes in consumer income
3. Changes in the prices of other goods.
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Hypothetical Demand Shift
Consider that there is an increase in consumer incomesufficiently large that oil demand would increase by 5% if
the price level stayed the same. This event will increase
the demand for oil at any given price level. Demand
schedule shifts out/up. Equilibrium price and quantity rise.
At the old price level, there is a situation of excess
demand. As consumers, scramble to get more oil,
producers are able to raise prices.
Higher prices induce i) some cutbacks in oil use; and ii)
some additional production until supply is equal to
demand.
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A Shift in the Demand Curve: A parallel increase in
the demand schedule at every price point.
Equilibrium Effect: Movement along the supply curve
S
D
P
Q
P*
Q*
P**
Q**
D
Shift in the
demand curve
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A shift in the demand schedule
(Spreadsheet)
Supply Demand Demand'
30 29893.38 31867.11 33460.47
35 30078.28 31568.86 33147.31
40 30239.36 31312.77 32878.41
4530382.16 31088.6 32643.03
50 30510.48 30889.43 32433.9
55 30627.02 30710.37 32245.88
60 30733.8 30547.8 32075.19
65 30832.36 30399.01 31918.96
70 30923.89 30261.9 31774.99
75 31009.35 30134.8 31641.54
80 31089.51 30016.4 31517.2285 31164.99 29905.6 31400.88
90 31236.32 29801.51 31291.59
95 31303.95 29703.39 31188.56
100 31368.24 29610.59 31091.12
A 5% shift in the demandschedule
If price stayed constant,
demand for oil would
increase 5%.
But to get producers to
produce more, price must
go up which will have a
counter-veiling effect ondemand. .
What is the new equilibrium
price?
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Shifts in Supply Curves Supply curves represent the extra cost of
producing a good which increases in the
number of goods produced. But other factors
may affect cost besides scale.
Cost Shifters
1. Changes in resource prices
2. Changes in Technology
3. Nature and Political Disruptions
4. Changes in Taxes on Producers
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A Shift in the Supply Curve is a Movement
along the Demand curve-
Price and Quantity Move in opposite DirectionsSDP
Q
P*
Q*
P**
Q**
S
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Equilibrium Effects of an Decrease in
Supply When there is some disruption, oil companies
produce less at any given price. Supply scheduleshifts in/up.
Equilibrium price rises/Equilibrium quantity falls. At the current price level, there is a situation of
excess demand. As consumers, scramble to getmore oil, producers are able to raise prices.
Higher prices induce i) some cutbacks in oil use;and ii) some additional production from othersources; until supply is equal to demand.
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Quantity of Oil Use Accelerating
%
Growth in World Oil Consumption
World OECD ROW
Source: BP Statistical Review 2005
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Analysis
Use observed information on oil prices and
quantities to assess strength of supply and
demand shocks in context of world events.
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Learning Outcomes
Solve for equilibrium price and quantities
using graphical supply and demand model
or spreadsheet supply and demandschedules.
Explain qualitatively the likely
consequences of exogenous shifts in supplyand demand the likely causes of shifts in
equilibrium prices and quantities.
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Negative Supply Shock
Negative supply shock like embargo on
Iranian oil would raise prices and reduce
quantity of oil available. But how much?