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Chapter 1
...
1 Introduction to the Study of Economics
1
...
1 Economics is Important and Interesting!
The Economics of food and agriculture is important and interesting! Food and
agricultural markets are in the news and on social media every day
...
As we work through the course
material this semester, please find examples of the economics of food and
agriculture in the news
...


1
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2 Scarcity
Economics can be defined as, “the study of choice
...
Scarcity reflects the human condition: fixed resources
and unlimited wants, needs, and desires
...

Since we have unlimited desires, and only a fixed amount of resources available to
meet those desires, we can’t have everything that we want
...
Since scarcity forces us to choose, and
economics is the study of choice, scarcity is the fundamental concept of all
economics
...
1
...


Microeconomics = The study of individual decision-making units, such as
firms and households
...

This course studies microeconomics, the investigation of firm and household
decision making
...


1
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4 Economic Models and Theories
The real world is enormously complex
...
A Model is a simplified representation of the world, not intended to
be realistic
...

We frequently use models in physical sciences such as biology, chemistry, and
physics
...
No one has ever seen an atom, but there is significant evidence for
this model
...
When we
simplify supply and demand into a model, we can think of many
oversimplifications and limitations of the theory… the real world is complicated
...


1
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4
...

Scientific Method = A body of techniques for investigating phenomena,
acquiring new knowledge, or correcting and integrating previous
knowledge
...
Following this method,
economists will keep a theory as long as evidence backs it up
...
Science, or

knowledge, advances in this imperfect manner
...
” Science is limited, and the human
condition continues to be one of imperfect knowledge, finite lives, and an enduring
search for solutions to poverty, pain, and suffering
...
1
...
Economists have developed two terms to separate factual statements
from value judgments, or opinions
...
“What is
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“What ought to be
...
Our background
and experience can make this challenging
...
” But, the buyer of the corn, a
livestock feedlot operator, might see things differently
...
”
Economists who study food and agriculture seek to be neutral, unbiased, and
professional in their work
...

For example, an economist might be asked to study organic, natural, or local foods
and report eh results to farmers and ranchers of conventional food products
...
Although some individuals may
not like the results of these studies, economists try to be unbiased and objective in
reporting their scientific work
...
2 Supply and Demand
The study of markets is a powerful, informative, and useful method for
understanding the world around us, and interpreting economic events
...
A huge number of diverse
and interesting issues can be usefully analyzed using supply and demand
...
2
...
Supply refers
to how much of a good will be produced at a given price
...

Notice the important term, “ceteris paribus” at the end of the definition of supply
...
Use of the concept, ceteris paribus, allows us to understand
the supply of a good
...

Ceteris Paribus = Holding all else constant (Latin)
...
We must hold everything else constant (ceteris
paribus) to make sure that the other supply determinants are not causing changes in
supply
...
Patagonia spearheaded the
movement into using organic cotton in the production of clothing
...
Interestingly, conventional (non-organic) cotton is
the most chemical-intensive field crop, and can result in agricultural chemical
runoff in the soil and groundwater
...
Notice that this graph has two items on each axis: (1) a label, and (2)
units
...


Figure 1
...
1 is a market supply curve, as it represents the
entire market of organic cotton (note that cotton is sold in bales)
...
This is indicated by the notation Qs = ΣMCi in Figure 1
...
The
individual firm supply curve is the firm’s marginal cost curve (MC) for all prices
above the shut down point, and equal to zero for all prices below the shut down
point
...
2
Since the market supply curve is the sum of all of the individual firms’ marginal
cost curves (ΣMCi), the market supply curve represents the cost of production: the
total amount that a business firm must pay to produce a given quantity of a good
...


Figure 1
...
2
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1 Properties of Supply
1
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Qs = f(P), and
3
...
”

The first property reflects the Law of Supply, which states that there is a direct
relationship between price and quantity supplied
...

The second property demonstrates that price (P) is the independent variable, and
quantity supplied (Qs) is the dependent variable
...
In all

other fields of mathematics and science, when a function such as y=f(x) is graphed,
the independent variable (x) appears on the horizontal axis, and the dependent
variable (y) is drawn on the vertical axis
...
The third
property reflects the need to simplify all of the determinants of supply to isolate the
relationship between price and quantity supplied, using the ceteris
paribus assumption
...
2
...
2 The Determinants of Supply
There are numerous determinants of supply, so we will focus on five important
ones
...
Other
determinants include input prices (Pi), the prices of related goods (Pr), technology
(T), and government taxes and subsidies (G)
...
1) Qs = f(P, Pi, Pr, T, G)
To draw a supply curve, we focus on the most important determinant of supply: the
good’s own price
...
To show this in
equation form, we use a vertical bar to designate ceteris paribus: all variables that
appear to the right of the vertical bar are held constant
...
2 shows the
relationship between quantity supplied and price, holding all else constant
...
1 and in supply and demand
graphs
...
2) Qs = f(P| Pi, Pr, T, G)
Input prices (Pi) are important determinants of supply, since the supply curve
represents the cost of production
...
Substitutes in production are goods
that are produced either/or, such as corn and soybeans
...
Complements in production are goods that are
produced together in a fixed ratio
...

Technology (T) is major driver of supply, as new methods and techniques become
available, they increase the amount of food produced
...
Restated, the same level
of output can be produced with fewer inputs
...


1
...
1
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Shifts In Supply

The supply curve represents the mathematical relationship between the price and
quantity supplied of a good
...
When any of the other supply curve
determinants change, it will shift the entire curve
...
3)
...
3)
...
3 is an increase in supply, since it increases the quantity
supplied at any given price
...
3 Movement Along and Shift in the Supply of Organic Cotton

Notice that the supply curve has shifted down, yet this represents an increase in
supply
...
The shift shown could be the impact
of technological change on organic cotton supply: suppose that biotechnology
allows for higher yielding varieties of organic cotton
...
2
...

Demand refers to how much of a good will be purchased at a given price
...

Figure 1
...
Note that beef is
measured in units of one hundred pounds, or a “hundredweight” (cwt)
...

As with supply, there are three properties of demand
...
4 Market Demand for Beef

1
...
2
...
Downward-sloping: if price increases, quantity demanded decreases,
2
...
Ceteris Paribus, Latin for holding all else constant
...

Law of Demand = There is an inverse relationship between the price of a
good and the quantity supplied, ceteris paribus
...
Price increases lead to smaller quantities of goods purchased
...
The magnitude of
the decrease will depend on the price elasticity of demand for the good, as will be
discussed in Section 1
...


1
...
2
...
Six of the most
important determinants are included in the demand equation in Equation 1
...
The
good’s own price (P) is the most important determinant
...

(1
...
Substitutes in
consumption are goods that are purchased either/or, such as hot dogs and
hamburgers
...
Complements in consumption are goods that
are consumed together, for example hot dogs and hot dog buns
...

Expectations of future prices (Pf) have a large influence on consumption decisions
today
...

This would allow traders to “buy low and sell high,” providing profit from
arbitrage across time
...
Cars, houses, and other
expensive items will be affected by changes in income
...

During the great recession of 2008-2010, Walmart had high profit levels, while
boat manufacturers and country clubs lost profits due to significant decreases in
income
...
Taxes and subsidies,
as well as other government programs, policies, and regulations (G) influence
demand, sometimes significantly
...
4 through 1
...

To draw a demand curve, the most important determinant of demand is isolated:
the good’s own price
...

(1
...
2
...
3 Movements Along vs
...
Therefore, when a good’s own price changes, it is
depicted as a movement along the demand curve
...


Figure 1
...
If any other demand
determinant changes, it causes a shift in demand, called a change in demand
...
5 is an increase in demand, since the
demand curve has shifted upward and to the right
...
Markets are
defined as the interaction of supply and demand
...


1
...
In what follows, the interaction of supply and demand will be
presented
...
The
market model can be used to explain and forecast movements in prices and
quantities of goods and services
...
Markets are the foundation of
all economics!
A market equilibrium can be found at the intersection of supply and demand
curves, as illustrated for the wheat market in Figure 1
...
An equilibrium is defined
as, “a point from which there is no tendency to change
...
6 pounds
...


Figure 1
...
6
...
At any price higher than P*, such as P’ in Figure 1
...
A surplus would result, since quantity supplied is greater than quantity
demanded (Q1 > Q0)
...
7 Wheat Market Surplus

A wheat surplus such as the one shown in Figure 1
...
Wheat producers would lower the price of wheat in order
to sell it
...
Consumers would increase the quantity demanded along Qd and producers
decrease the quantity supplied along Qs until the equilibrium point E was reached
...

Market forces also come into play at prices lower than the equilibrium market
price, as shown in Figure 1
...
At the lower price P’’, producers reduce the quantity
supplied along Qs to Q0, and consumers increase the quantity demanded to Q1
...
The shortage will bring market forces into play, as consumers will bid up
the price in order to purchase more wheat and producers will produce more wheat
along Qs
...

The market mechanism that results in an equilibrium price and quantity performs a
truly amazing function in the economy
...
If
there is a drought, the price of wheat will rise, causing more resources to be
devoted to wheat production, which is desirable, since wheat is in short supply
during a drought
...
In this fashion, the market mechanism allows voluntary trades
between willing parties to allocate resources to the highest return
...

Although markets provide huge benefits to society, not everyone wins from free
market economies, and market changes over time
...
Technological change has provided lowered food prices
enormously over time, but has led to farm and ranch consolidation, and the large
migration of farmers and their families out of rural regions and into urban areas
...
8 Wheat Market Shortage

The market graphs of supply and demand are based on the assumption of perfectly
competitive markets
...
Once again, economists simplify the complex
real world in order to understand it
...


1
...
1 Competitive Market Properties
A competitive market has four properties:
1
...
numerous buyers and sellers,

3
...
perfect information
...
This means
that the consumer can not distinguish any differences in the good, no matter which
firm produced it
...
A John Deere tractor is an example of a
nonhomogeneous good, since the brand is displayed on the machine, not to
mention the company’s well known green paint and deer logo
...
The
word, “numerous” refers to an industry so large that each individual firm can not
affect the price
...

Freedom of entry and exit means that there are no legal, financial, or regulatory
barriers to entering the market
...
Attorneys and physicians, however, do not have freedom of entry
...

Perfect information is an assumption about industries where all firms have access
to information about all input and output prices, and all technologies
...
These
four properties of perfect competition are stringent, and do not reflect real-world
industries and markets
...
Competitive markets have a number of attractive properties
...
3
...
A competitive
market maximizes social welfare, or the total amount of well-being in a market
...
In a market-based economy, no one is forced, or coerced, to do
anything that they do not want to do
...
This idea will be a theme throughout this course: free markets and free trade
lead to superior economic outcomes
...
Income inequality is
an example
...
There are winners and losers to market changes
...


Free trade lowers prices for consumers, but often causes hardships for producers in
importing nations
...
Workers in the
US and the EU will face competition from a larger labor supply, causing
reductions in wages and salaries
...
Corn producers are made better off, but livestock producers, the
major buyers of corn, are made worse off
...


1
...
3 Supply and Demand Shift Examples
Given our knowledge of markets and the market mechanism, current events and
policies can be better understood
...
3
...
1 Demand Increase
China was a command economy until 1986
...
The new policy
worked very well, and China moved from being a net food importer to a net food
exporter
...
The result has been a truly unprecedented increase in
income
...
And, these
growth rates are for the world’s most populous nation: 1
...

This historical income growth in China has been good for US farmers and
ranchers
...
There has been a large increase in beef consumption
in China as incomes increased
...
9
...
This is called an increase in demand (do you remember why this is not an
increase in quantity demanded?)
...
The movement along the supply curve for
beef is called an increase in quantity supplied
...
An increase in demand results in higher prices and higher quantities
...


Figure 1
...
The
major input into the production of beef is corn, sorghum (also called milo), and
soybeans
...
Seven pounds of grain are
required to produce one pound of beef
...


1
...
3
...
) has
decreased in the past few decades
...

The demand for offals has decreased as a result, as in Figure 1
...
This is a

decrease in demand (shift inward), and a decrease in quantity supplied (movement
along the supply curve)
...


Figure 1
...
3
...
3 Supply Decrease
A large share of citrus fruit in the US is grown in Florida and California
...
An early freeze can damage the citrus fruit, resulting in a decrease in
supply (Figure 1
...


Figure 1
...
The
equilibrium price increases, and the equilibrium quantity decreases
...
3
...
4 Supply Increase
Technological change is a constant in global agriculture
...
Biotechnology in field crops has been a recent enhancement
in the world food supply
...
Although GMOs are often in the news media as a potential
health risk or environmental risk, they have been produced and consumed in the
US for many years, with no documented health issues
...
Glyphosate is

the ingredient in “RoundUp,” a widely used herbicide in corn and soybean
production
...
Biotechnology
has increased the availability of food enormously, and is considered the largest
technological change in the history of agriculture
...
12
...
12 Biotechnology Impact on Corn Market

Biotechnology results in an increase in supply, the rightward shift in the supply
curve
...
The equilibrium quantity increases, and the equilibrium
price decreases
...

However, in a global economy, this keeps the US competitive in global grain
markets
...


1
...
4 Mathematics of Supply and Demand
The above market analyses are qualitative, or non-numerical
...
The
numbers used here are simple, but can be replaced with actual estimates of supply
and demand to yield important and interesting quantitative results to market events
...
Let the inverse demand for phones be
given by Equation 1
...
The equation is called, “inverse” because the independent
variable (P) appears on the left-hand side and the dependent variable (Qd) appears
on the right hand side
...
We use inverse supply and demand
equations for easier graphing, since P is on the vertical axis, typically used for the
dependent variable (can you remember why these graphs are backwards?)
...
5) P = 100 – 2Qd
In the inverse demand equation, P is the price of phones in USD/unit, and Q is the
quantity of phones in millions
...
6
...
6) P = 20 + 2Qs
These examples of inverse supply and demand functions are called “pricedependent” for ease of graphing
...
To do this, use simple algebra to isolate Qd or Qs on
the left-hand side of the equations
...
This is the point where the market “clears,”
and supply is equal to demand
...
13),
there is only one price where this can occur: the equilibrium price: P e
...

This result can be checked by plugging Qe = 20 into the inverse supply
equation:
Pe = 20 + 2Qe = 20 + 2*20 = 20 + 40 = 60

The equilibrium price and quantity of phones are:
Pe = USD 60/phones, and Qe = 20 million phones
...


Figure 1
...
If
you have any questions about how to graph the functions, or how to solve for
equilibrium price and quantity, be sure to review the material in this chapter
carefully
...
4 Elasticities

1
...
1 Introduction to Elasticities
An elasticity is a measure of responsiveness
...

An elasticity (E), or responsiveness, is measured by the percentage change of each
variable
...
A percentage change in a variable is defined as the change
in the variable divided by the initial value of the variable: %ΔX = ΔX/X0
...
7 shows the responsiveness of Y to a change in X:
(1
...

Elasticities can be calculated for any two variables
...
Elasticities have a very desirable
property: they do not have units
...
This allows elasticities to be compared to each other, when
prices and quantities cannot be directly compared
...
However, the elasticities of oranges and apples can be compared
directly, since there are no units for elasticities
...
4
...
8:
(1
...

Own Price Elasticity of Demand = the percentage change in quantity
demanded given a one percent change in the good’s own price, ceteris
paribus
...
The price elasticity informs the business about how a change in price
will affect the quantity demanded
...
On the other hand, if consumers are relatively unresponsive to price
changes, the firm may increase the price, and most customers will continue to
purchase the good at the higher price
...


The price elasticity of demand (Ed) depends on the availability of substitutes
...
” Consumers will purchase the good even at a high price
...
Green shirts are an example: if the price of green shirts is increased,
consumers will shift purchases to blue shirts, or shirts of a different color
...


1
...
2
...
Due to the higher price, suppose that wheat millers reduce their
purchases of wheat from 10 million bushels (m bu) to 8 million bushels
...
9
...

(1
...
This
allows the math to be greatly simplified:
Ed = (-2/2)*(4/10) = (-1)/(0
...
4
The price elasticity of demand is always negative, due to the Law of Demand
...
For example,
in this case, Ed= – 0
...
4
...
To interpret the elasticity, it means that for a one percent
increase in price, the quantity demanded of wheat will decrease by 0
...

This is a relatively inelastic response, since the change in quantity demanded is
smaller than the price change
...

Price elastic |Ed| > 1

Price inelastic |Ed| < 1
Unitary elastic |Ed| = 1
Goods that are price elastic have substitutes available, and the percentage change
in quantity demanded will decrease more than the percentage increase change in
price (%ΔQd > %ΔP, therefore |Ed|> 1)
...
For unitary elastic goods, the
percentage change in quantity demanded is equal to the percentage change in price
(%ΔQd = %ΔP, therefore |Ed|= 1)
...
4
...
2 Elastic and Inelastic Demand Examples
To compare elastic and inelastic demands, think of a student who would like to
purchase a pack of cigarettes during a late night study session for an exam
...
The demand for Marlboro cigarettes is price elastic (left panel,
Figure 1
...
The price elasticity of demand depends on the availability of
substitutes
...


Figure 1
...
14)
...
For example, apples are more price elastic than all fruit, and green shirts are
more price elastic than all shirts
...

Figure 1
...


Figure 1
...
Within a certain range of prices, this could be food or electricity
...
An inelastic demand is one where the percentage change in price is larger than
the percentage change in quantity demanded: %ΔQd < %ΔP, and |Ed|< 1
...
Goods that are price elastic exhibit relatively high levels of consumer

responsiveness to price movements
...
A perfectly elastic good is characterized by a horizontal demand curve
...
An individual wheat farmer’s crop is an
example
...
There are a large number of
perfect substitutes available from other wheat farmers, so the price elasticity is
infinite, and the good is called, “perfectly elastic
...
4
...
The formula for the price elasticity of supply is given in Equation 1
...
10) Es = %ΔQs/%ΔP
...

The own price elasticity of supply is always positive, because of the Law of
Supply: there is a direct, positive relationship between the quantity supplied of a
good and the good’s own price, ceteris paribus
...

Price elastic Es > 1
Price inelastic Es < 1
Unitary elastic Es = 1
A good with an elastic supply is one where the percentage change in quantity
supplied is greater than the percentage change in price: %ΔQs > %ΔP, and Es > 1
...
A good
with an inelastic supply has a smaller percentage change in quantity supplied,
given a percent change in price: %ΔQs < %ΔP, and Es < 1
...
Figure 1
...


Figure 1
...
4
...
11:
(1
...

The income elasticity is defined in a similar way as the price elasticities
...

Income elasticities are also categorized into responsiveness classifications
...
There are
two subcategories of normal goods: necessities and luxury goods
...
They represent subgroups of
the normal category, since Ei is positive in both cases
...

A necessity good is a normal good that has a positive, but small, increase in
demand given a one percent increase in income
...
This is shown in Figure
1
...


Figure 1
...
17
...
Inferior goods (Figure 1
...


Figure 1
...
Hamburger (ground beef) is an
example
...
19)
...
Figure 1
...


Figure 1
...
4
...

(1
...

The cross price elasticity is important for two categories of related
goods: substitutes and complements in consumption
...

Complements in consumption are goods that are consumed together, like macaroni
and cheese
...


Substitutes in Consumption Edxy = %ΔQdy/%ΔPx > 0
Complements in Consumption Edxy = %ΔQdy/%ΔPx < 0
Unrelated Goods in Consumption Edxy = %ΔQdy/%ΔPx = 0
Unrelated goods have a cross price elasticity of demand equal to zero
...


1
...
6 Cross Price Elasticity of Supply: Esxy
The cross price elasticity of supply captures the responsiveness of the supply of
one good, given a change in the price of another good
...
13) Esxy = %ΔQsy/%ΔPx
Cross Price Elasticity of Supply = the percentage change in the supply of
one good given a one percent change in a related good’s price, ceteris
paribus
...
The same resources (land, machinery, labor, etc
...
The cross price elasticity of supply of substitutes in
production is negative
...

Substitutes in Production Esxy = %ΔQsy/%ΔPx < 0
Complements in Production Esxy = %ΔQsy/%ΔPx > 0
Unrelated Goods in Production Esxy = %ΔQsy/%ΔPx = 0
Complements in production are goods that are produced together, such as beef and
leather
...
Unrelated goods in production have a cross price elasticity of supply equal
to zero, since the price of an unrelated good has no impact on the demand of the
other unrelated good
...
4
...
In the immediate run (a short time period), the firm can
not adjust the production process, so the supply is typically perfectly inelastic
...
In the long run, all inputs are variable, and the firm can make
adjustments to the production process
...
As more time
passes, the price elasticity of supply increases
...
If the price of a
good increases in the immediate run, there is little consumers can do other than
purchase the good
...
As time
passes, there are more options available to the consumer, and the price elasticity of
demand becomes more elastic with the passage of time
...
4
...
This is
due to the calculation of the own price elasticity of demand as percentage change
in quantity demanded caused by a percentage change in the price of the good
...
20, the slope of the demand function is constant: it does not change over
the entire demand curve
...
In this case, the
vertical intercept (y-intercept) is equal to 10, and the slope is equal to negative one
...

The elasticity of demand, however, changes in value quite dramatically from the yintercept to the x-intercept
...
The cause is the calculation of percentage
change
...
20 The Price Elasticity of Demand along a Linear Demand Curve

Consider an example of a mouse and an elephant
...
Suppose that
the mouse weighs one-tenth of a pound, the elephant weighs 10,000 pounds, and
the total weight gain for both the mouse and the elephant is one pound
...
For the mouse,
(1
...
1 lbs = 10 = 1000 percent!
For the elephant,
(1
...
0001 = 0
...

This is also true of the elasticity of demand along the linear demand curve
...
At this point,

the price is equal to zero
...
The price elasticity of
demand is:
(1
...

At the x-intercept, the percentage change in price (%ΔP) is equal to ΔP/P = 1/0 =
infinity
...

Thus, Ed = 0 at the x-intercept, since dividing any number by infinity is equal to
zero
...
Therefore, the elasticity of demand is equal to the
percentage change in quantity demanded (%ΔQ = infinity) divided by the
percentage change in price (%ΔP)
...

At the midpoint, the price elasticity of demand is equal to negative one
...
17) Ed = %ΔQd/%ΔP = (ΔQd/ΔP)(P/Qd) = -1
At the midpoint, the slope of the demand curve is equal to minus one (ΔQ d/ΔP =
1), and the price is equal to the quantity demanded (P = Qd)
...

A valuable lesson is learned in this example: be careful to distinguish between the
slope of a demand curve and the elasticity of demand
...
The elasticity is related to the slope, but it
is not equal to the slope!

1
...
9 Agricultural Policy Example of Elasticity of Demand
The impact of agricultural policies depends critically on the elasticity of demand
...
This section provides evidence of the importance of
the price elasticity of demand
...
Everyone must eat, and the caloric
intake will not be greatly influenced by the price of food
...
In an open economy that has
international trade, there are many overseas customers for food exports, and many
competing nations that export food
...
Other wheat exporting nations include: Canada, Australia, Argentina, the
European Union (EU), and many of the former Soviet nations in Eastern Europe
such as Ukraine
...
A
global economy changes the effectiveness of price policies enormously
...
21 Price Elasticity and Price Policies

Prior to 1972, the United States agricultural sector could be characterized as a
domestic economy, with less food and agricultural trade
...
21, left
panel)
...
This policy worked well, as long as the surplus was
eliminated
...
21)
...
These policies worked well prior to 1972, since
the US agricultural economy was primarily domestic, characterized by an inelastic
demand curve
...

In 1972, major changes in international exchange rate policies, together with poor
weather in Asia, led to the globalization of US food and agricultural markets
...
21)
...
During the 1980s, the US maintained price supports and production controls in
the seven basic commodities (defined by the USDA as: wheat, corn, sorghum,
sugar, cotton, rice, and tobacco)
...
The US attempted to increase the market
share of wheat trade, only to find that the US price was higher than the other major
wheat exporters
...
21 shows why the policies implemented in 1933 were hurting more than
they were helping
...
In
the domestic economy (left panel of Figure 1
...
This all changed in the
globalized world after 1972 (right panel of Figure 1
...
With an elastic
demand, the decrease in quantity did not result in large price increases
...
These policies were
not working, and in 1996, they were changed to make the US grain industry more
competitive in the global market
...

In summary, policies intended to help producers have greatly divergent outcomes,
depending on the price elasticity of demand
...
In this case, production
controls and price supports will achieve the policy goal of helping producers: the
price increases will be larger than the quantity decreases (left panel, Figure 1
...

In a global economy, the demand for food and agricultural goods is elastic: there
are many nations that export grains (right panel, Figure 1
...
In this case the
policy that helps producers the most is technological change, which will shift the
supply curve to the right
...

This is the same strategy that Walmart utilizes: everyday low prices
...
This is true in any market characterized by an elastic demand
...


1
...
10 Calculation of Market Supply and Demand Elasticities
In Section 1
...
4 above, inverse supply and demand curves were used to calculate
the equilibrium price and quantity of phones
...
18) P = 100 – 2Qd
(1
...
By setting the two equations equal to each other, the intersection of the
inverse supply and demand curves was found, yielding the equilibrium market
price and quantity:
Pe = USD 60/phones, and
Qe = 20 million phones
...
22
...
Recall the definition of the own price elasticity of
demand:
(1
...
This is the same as the
derivative sign, “∂
...
Therefore, the delta signs can be replaced with the
derivative signs in the equation that defines the price elasticity of demand
...
The slope of the function at a given
point on the function is ∂y/∂x
...
At the equilibrium point,
the equilibrium levels of P and Q are known
...
18)
...
21) ∂P/∂Qd = – 2

Figure 1
...
Notice something important: the derivative of the inverse demand equation is
the inverse of what is needed to calculate the price elasticity
...
To
find the derivative ∂Qd/∂P, invert the derivative by dividing one by the derivative
...
22) ∂Qd/∂P = – (1/2)
(1
...
5
The absolute value of the own price elasticity of demand at the equilibrium point
is:
| Ed| = 1
...
The demand for phones is elastic: if the price were increased one
percent, the decrease in phone purchases would be 1
...


The own price elasticity of supply can be found using the same procedure:
(1
...
19)
...
25) ∂P/∂Qs = + 2
Invert this derivative to find the derivative needed to calculate the price elasticity
of supply:
(1
...

Then plug in the ingredients of the own price elasticity of supply:
(1
...
5
The price elasticity of supply is also elastic: a one percent increase in price results
in a 1
...

Two points are worth mentioning here
...
5 and +1
...
The
elasticities depend on the shape of the inverse supply and demand functions
...
22
...
The second important point concerns
the use of inverse supply and demand functions
...
To find the derivative
needed to calculate the price elasticities, the procedure above first took the
derivative of the inverse function, then inverted it to achieve ∂Q/∂P
...
This alternative
procedure will result in the same elasticity calculation as the one used above
...
5 Welfare Economics: Consumer and Producer
Surplus
1
...
1 Introduction to Welfare Economics
Welfare economics is concerned with how well off individuals and groups are
...
In economics, welfare economics is used to see how the

welfare, or well-being of individuals and groups changes with a change in policies,
programs, or current events
...


1
...
2 Consumer Surplus and Producer Surplus
The two most important groups that are studied in welfare economics are
producers and consumers
...

Consumer Surplus (CS) = A measure of how well off consumers are
...

Producer Surplus (PS) = A measure of how well off producers are
...

The intuition of consumer surplus provides a good method of learning the concept
...
” When I arrive at the
store, I find that the price of the hammer is four dollars
...
In this
manner, we can add up all consumers in the market to measure consumer surplus
for all consumers
...
23
...
The demand curve represents the
consumers’ willingness and ability to pay for a good
...
23)
...
If a wheat
producer can produce a bushel of wheat for four dollars, and she receives six
dollars per bushel when she sells her wheat, then her level of producer surplus is
equal to two dollars
...
In Figure 1
...
The market supply curve was derived by summing all individual
firms’ marginal cost curves
...
The PS area is the area identified in Figure 1
...


Figure 1
...
These measures place a dollar value on the wellbeing
of producers and consumers
...
5
...
28) P = 100 – 2Qd, and
(1
...


Where P is the price of phones in dollars/unit, and Q is the quantity of phones in
millions
...
4
...

These values, together with the supply and demand functions, allow us to measure
the well-being of both consumers and producers
...
To calculate CS and PS, multiply the base of
the triangle times the height of the triangle in Figure 1
...
5 (Equations 1
...
31)
...
30) CS = 0
...
5(40)(20) = 400 million USD
(1
...
5(60 – 20)(20) = 0
...


Figure 1
...
These measures
capture how well off consumers and producers are in dollars, or the dollar value of
their happiness, or well-being
...
Notice that the phone units are in both the
numerator and denominator, so they are cancelled, leaving million dollars
...
6 The Motivation for and Consequences of Free
Trade
1
...
1 The Motivation for Free Trade and Globalization

Globalization and free trade result in enormous economic benefits to nations that
trade
...
As with all national policies, there are benefits and
costs to international trade: there are winners and losers to globalization
...
There is a strong motivation to trade, and the nations of the
world continue to become more globalized over time
...
In nations
North of the equator such as the USA, Japan, EU, and China, fresh fruit and
vegetables can be purchased during the winter from nations in the Southern
hemisphere
...

The principle of comparative advantage provides large benefits to individuals,
nations, and firms that specialize in what they do best, and trade for other goods
...
For example, if
Canada specializes in wheat production, and Costa Rica produces bananas, both
nations could be better off through specialization and trade
...

Closed Economy = A nation that does not trade
...
There are no imports or
exports
...
Imports and exports exist
...
In this case, quantity supplied must equal quantity
demanded (Qs = Qd)
...
The concepts of Excess
Supply and Excess Demand will be introduced in the next section to aid in
understanding the motivation and consequences of free trade
...
6
...
We will
investigate wheat trade between the USA and Japan
...
The USA is a wheat exporter
...
25 show the USA wheat market
...
At price Pe, domestic consumption (Qd) is
equal to domestic production (Qs)
...
25 The Excess Supply of Wheat

Excess supply is defined to be the quantity of exportable surplus, or Qs – Qd
...


Excess Supply (ES) = Quantity supplied minus quantity demanded at a
given price, Qs – Qd
...
Wheat consumers decrease purchases of
wheat along the demand curve Qd, due to the Law of Demand
...
If excess supply existed in a closed
economy, market forces would come into play to bring the higher price back down
to the market equilibrium level, Pe
...
In the right-hand panel of Figure
1
...
Note that ES = 0 at Pe, and becomes
larger as the price of wheat increases
...
Trade
also provides the opportunity to buy imported goods from other nations
...
26 The Excess Demand of Wheat

Define Pi to be the price of wheat in the importing nation (Japan in this case)
...
26)
...
If the price is lower than Pi in Figure 1
...
This
results in an Excess Demand for the good
...

Note that any shift in either supply or demand of wheat in the importing nation will
shift the ED curve
...
What happens in China has a large impact on USA
wheat producers
...

The ED curve shown in the right-hand panel of Figure 1
...

Note that ED = 0 at Pi, and becomes larger as the price of wheat decreases
...
6
...
27
...
27)
...

Excess demand (ED) is downward sloping, and is derived from the domestic
supply (Qsi) and demand (Qdi) in the importing nation, Japan in this case
...
In reality, the right panel is composed of
many nations: all countries that import wheat
...
As price (Pi) decreases in Japan,
quantity demanded (Qdi) increases and quantity supplied (Qsi) decreases, causing
ED to have a negative slope
...
Equilibrium in the global wheat market is found in the center
panel at the point where ED = ES
...
Note that it must be true that ED=ES: any
imported goods in one nation must be exported by the other nation
...

In a multi-nation model, this equilibrium would occur when the sum of all wheat
supplied from all exporting nations (= ΣES = Qse – Qde) is equal to the sum of all
wheat demanded from all importing nations (= ΣED = Qdi -Qsi)
...
This equilibrium in the world market determines the

world price (Pw), which is the price of wheat for all trading partners, Japan and the
USA in this model
...
27 International Trade in Wheat: USA and Japan

The three-panel diagram demonstrates two important characteristics about free
trade
...
” If a price
difference exists between two locations, arbitrage provides profit opportunities for
traders
...
Note that this simple model
ignores transportation costs and exchange rates
...
Therefore, all consumers and producers of a good are
interconnected: the welfare of all wheat producers and consumers is affected by
weather, growing conditions, food trends, and all other supply and demand
determinants in all trading nations
...
The three-panel diagram is useful in understanding the
determinants of food and agricultural exports: all supply and demand shifters in all
wheat exporting and importing nations

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