1. Basic Demand and Supply Model
Tutorial 2

2. Review
What is an individual demand function? What assumption is used in obtaining the consumer demand curve from the demand function?
Why is a demand curve downward sloping?
How to derive the market demand curve from individual demand curves? p Q 20 D1
Consumer 1 5 D2
Consumer 2 10 D
Market 30
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3. Example
During the summer 2001, the anti-pirate program built in the Playstation2 (PS2) was resolved. Once the default setting of the PS2 is altered, consumers can play pirate games for PS2 illegally at a much lower price. How would it affect the market demand for PS2?
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4. Example: Substitutes
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5. Example
We seldom see these shops during economic boom, but they usually appear when HK is in recession. What do these shops sell? Why it usually appears in recession only?
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6. Discussion Question 1
Suppose the supply curve for wool is given by Qs = P, where Qs is the quantity supplied of wool and P is the price of wool. The demand for wool is given by Qd = 10 – P + I, where Qd is the quantity demanded for wool and I is the level of income.
Suppose I = 20. Graph the supply and demand curves, and indicate the equilibrium levels of price and quantity on your graph.
When I = 20 (keeping I constant), the demand curve is:
Qd = 10 – P + (20) = 30 – P
In equilibrium, Qd = Qs:
30 – P = P
P* = 15
Q* = 15
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7. Discussion Question 1 S: Qs = P D: Qd = 10 – P + I (given I = 20)
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8. Discussion Question 1
What would happen if sellers set the price at $25? Explain the market adjustment process. What if the price is set to be $5?
S: Qs = P
Surplus (Qd < Qs)
D: Qd = 10 – P + I (given I = 20)
Shortage (Qd > Qs)
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9. Discussion Question 1
Suppose income rises from I1 = 20 to I2 = 25. Find the impact of the change in income on the equilibrium price and quantity of wool.
When I2 = 25 (keeping I constant), the demand curve is:
Qd = 10 – P + (25) = 35 – P
In equilibrium, Qd = Qs:
35 – P = P
P* = 17.5
Q* = 17.5
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10. Discussion Question 1 S: Qs = P 17.5 17.5
D2: Qd = 35 – P (given I = 20)
D1: Qd = 30 – P (given I = 20)
17.5
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11. Discussion Question 2
A flood in South China severely damaged crops in July, Using the demand and supply model to explain what would happen to the vegetables market in Hong Kong. (Source: Hong Kong Economics Times, July, 2008) P S2 S1
“… It reduced the supply of vegetables in HK, leading to a 25% increase in vegetable prices. Mrs. Leung said that she reduced vegetable consumptions from 1 catty to 0.75 catty per day …” D
Q (Vegetables)
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12. Discussion Question 3
In June, 2008, it was reported that bad weather and earthquake adversely affected lemon harvest. How would it affect the lemon market? (Source: Hong Kong Economics Times, 4 June, 2008) P S2 S1
“…The price of lemon went up to HK$4 each. Restaurants responded by cutting the lemon into thinner pieces to reduce the amount of lemon used …” D
Q (Vegetables)
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13. Discussion Question 4: Biofuels Case Study
Food prices have accelerated sharply in Grain prices have more than doubled since January 2006, with over 60% of the rise in food prices occurring since January 2008.
Wheat prices doubled since January 2006.
Rice prices more than tripled between January and May 2008.
How did these happen?
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14. What causes the high grain prices?
Increasing demand from emerging economies, particularly China and India
Increase in oil price (persistently above $100 per barrel now!)
Bad weather in key growing areas, particularly successive drought in Australia
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15. Other causes?
A recent World Bank report suggested biofuels was the main cause of the food price rise.
Increasing crude oil price
Government Policy incentives on ethanol to promote energy independence and help limit global warming.
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16. Ethanol’s Effect on Agriculture Markets
What is the major feedstock used in ethanol production in U.S.?
Corn!
About 14% of corn use went to ethanol production in 2005/06.
Last year, American farmers grew a record 13.1 billion bushels of corn on 85 million acres of land. Of that, 22% went to make 7 billion gallons of ethanol.
How would it affect the world corn market?
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17. Direct Effects on the Corn Market
The expansion in ethanol production increases corn demand. It results in higher corn price. While quantity of corn produced would also increase, they are mainly used to produce ethanol.
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18. Indirect Effects on Other Crops
Higher corn prices favor corn production over production of other crops in terms of the use of farmland.
Which crop is the closest production substitutes of corn?
Corn and soybeans are frequently used in rotations, planting corn one year and soybeans the next.
With higher corn prices, the rotation might be changed to planting corn for 2 years successively, with soybeans planted every third year.
How would it affect the soybeans market?
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19. Indirect Effects on Other Crops
The expansion in ethanol production lowers soybeans supply. It results in higher soybeans price. The quantity of soybeans produced would also decrease.
Shifts for other crops, such as wheat and rice, would be smaller, so price impacts would be smaller too.
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20. Indirect Effects on Livestock
Livestock feeding is the largest use of U.S. corn, typically accounting for 50 – 60% of the total.
How would higher corn prices affect the livestock market?
Higher corn prices increase the costs of livestock rations, lowering the supply of livestock. Therefore, prices of meats would also go up.
The effect on prices of different meats depends on the availability of substitutes of corn as a livestock feed. A coproduct of dry-mill ethanol production, distilled grains (How about the price of distilled grains?) can be used as a livestock feed, particular for ruminant animals such as beef cattle and dairy cows. Monogastric animals, such as hogs and poultry are more limited in their ability to use distilled grains in rations.
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21. Price Controls Price Ceiling: Price Floor:
A maximum allowable price in the market,
It is binding if
Example: Auto LPG (liquefied petroleum gas)
Price Floor:
A minimum allowable price in the market,
Example: Minimum wage for oversea maids (HK$3580)
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22. Price Controls Surplus (Qd < Qs) Price Floor Price Ceiling
Shortage (Qd > Qs) D
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23. Discussion Question 5
Thousands of people were queuing outside Bank of China branches for two days for the commemorative Olympic banknotes (limited to 20,000 sets). A complete set of five packages, containing one or more of the HK$20 Olympic banknotes, were available at a price of HK$3,050.
A complete set of five packages were reportedly being sold on the secondary market at a price between HK$5,000 to HK$15,000.
(Source: SCMP, 15 July, 2008 & HK Economics Times, 17 July, 2008) P S e p*
$3,050
Shortage D Q
20,000 Qd
Primary market
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24. Discussion Question 6
Starting 10 July, 2008, the minimum wage for foreign domestic helpers increased by $100 to $3580. How would the increase in minimum wage affect the overseas domestic worker market? P S
3580
3480 D1
Q (Overseas maids)
Shortage (old)
Shortage (new)
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25. Discussion Question 6
The HK Government announced to waive the HK$400-a-month foreign domestic helper levy for two years, starting from August 1, Explain why foreign maids “can finally breathe a sigh of relief”. (Source: The Standard, 31 July, 2008 and Hong Kong Economics Times, June, 2008) S
3580 D2 D1
Q (Overseas maids) Q1
Shortage
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