Lecture 6 Comparative Statics Methodology “Comparative statics” mean comparing static (stationary) equilibria, before and after “Comparative statics” mean comparing static (stationary) equilibria, before and after The method… The method… –Begin in equilibrium … always! –Change ceteris paribus condition(s) –Determine effect(s) on demand/supply –Examine incentives of competitors Excess demand or supply? Excess demand or supply? How will price move How will price move –End in new equilibrium…always!

Start in equilibrium… Initial values of ceteris paribus conditions determine Initial values of ceteris paribus conditions determine –Initial position of demand and supply curves, and thus –Initial equilibrium values of P* and Q* S (w, t, z) D (Ps, Pc, I, X)

An increase in demand Could be caused by: Could be caused by: Higher Ps Lower Pc Higher income if normal good Lower income if inferior good The results: Higher P and Q

A decrease in demand Could be caused by: Could be caused by: Lower Ps Higher Pc Lower income if Normal good Higher income if inferior good The results: Lower P and Q

A decease in supply Could be caused by: Could be caused by: Higher input prices Degradation in technology Other changes that raise costs The results: Higher P and lower Q

An increase in supply Could be caused by: Could be caused by: Lower input prices Improvement in technology Other changes that lower costs The results: Lower P and higher Q higher Q

Unclear: What happens if BOTH demand and supply change? Consider new trucking safety regulations in U.S. Consider new trucking safety regulations in U.S. –Costs of production forced up, so reduced supply Tends to push price up, quantity down Tends to push price up, quantity down –But, if shipping is better, then higher demand Tends to push price up, quantity down Tends to push price up, quantity down –Both push price up, thus higher equilibrium price –Opposing effects on quantity, thus unclear effects on equilibrium quantity without more information –Questions: What substitutes are affected by this? What complements are affected by this.

Another case AIDS and the labor market in Africa AIDS may kill 20% of the population in some African countries AIDS may kill 20% of the population in some African countries –If it does, that reduces the supply of labor This tends to push price up, quantity down This tends to push price up, quantity down –Quantity demanded of labor declines as price of labor rises and demand for labor may fall if employers afraid to operate there due to risk posed by disease –Both push quantity down, thus lower equilibrium quantity –Opposing effects on price, so unclear change in equilibrium price, without more information

Question: Comparative Statics In the summer in the U.S., more gasoline and more tomatoes are bought than during other times of the year. The price of gasoline rises; the price of tomatoes fall. Why do these prices move in opposite directions? In the summer in the U.S., more gasoline and more tomatoes are bought than during other times of the year. The price of gasoline rises; the price of tomatoes fall. Why do these prices move in opposite directions?

Question: Comparative Statics In the 1800s in England, when there were bad harvests and the supply of food was lower, rich people who were worried about the poor people having enough food to eat would buy large amounts of the crops and sell them to poor people at low prices. In the 1800s in England, when there were bad harvests and the supply of food was lower, rich people who were worried about the poor people having enough food to eat would buy large amounts of the crops and sell them to poor people at low prices. –Did the poor get more food? –Were the poor made better off by rich? –Did anyone else care?

Question: Comparative Statics Suppose consumers think the price of beef is too high. Suppose consumers think the price of beef is too high. Consumer “advocates” urge consumers to stop buying beef to punish the sellers and force them to lower the price. Consumer “advocates” urge consumers to stop buying beef to punish the sellers and force them to lower the price. –This, it is said will enable consumers to afford the beef they want. –Is that logic correct?

Question: Comparative Statics The political relationship between the U.S. and Saudi Arabia has worsened since the terrorist attacks occurred and problems in Israel grew. Saudi billionaires began to pull their money out of the U.S. stock market and other investments. This has caused concern that the U.S. economy will be hurt by the reduction in the supply of investment funds. True? The political relationship between the U.S. and Saudi Arabia has worsened since the terrorist attacks occurred and problems in Israel grew. Saudi billionaires began to pull their money out of the U.S. stock market and other investments. This has caused concern that the U.S. economy will be hurt by the reduction in the supply of investment funds. True?

Comparative Statics ? Suppose—perhaps because of localized global cooling-- North African countries begin to grow much more cotton than they do now. What will be the likely effects? Suppose—perhaps because of localized global cooling-- North African countries begin to grow much more cotton than they do now. What will be the likely effects?

Question: Comparative Statics Sheep supply both wool and mutton. Sheep supply both wool and mutton. Suppose—perhaps due to a sudden scare over Mad Sheep Disease— people suddenly refuse to eat mutton. What will happen in the sheep market? (Assume the demand for wool does not change) Suppose—perhaps due to a sudden scare over Mad Sheep Disease— people suddenly refuse to eat mutton. What will happen in the sheep market? (Assume the demand for wool does not change)

Comparative Statics ? Slavery is common in the Sudan. There are estimated to be 100,000 slaves, used as domestic servants. Most of the slaves come from African tribes in the southern Sudan. Slave traders capture them and take them to the Arab northern part of Sudan. Market price is about $50 per slave. Anti-slave groups buy slaves their freedom and return them home. How does that affect the market for slavery? Slavery is common in the Sudan. There are estimated to be 100,000 slaves, used as domestic servants. Most of the slaves come from African tribes in the southern Sudan. Slave traders capture them and take them to the Arab northern part of Sudan. Market price is about $50 per slave. Anti-slave groups buy slaves their freedom and return them home. How does that affect the market for slavery?