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Lecture 20

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Economics 2150A/B
Kristin Denniston

Economics 2151B Monday March 24 Lecture 20 Chapter 16 – General Equilibrium Homework 4 • Due tonight on OWL Partial vs. General Equilibrium Modelling • Partial Equilibrium: looking at a single market o What happens to price and quantity in a single market when there is an exogenous change outside the system? o eg. What happens to the market for cigarettes when we impose a cigarette tax?  The tax should move the supply curve up by the amount of the tax • General Equilibrium: the determination of prices and quantities in several interconnected markets o These prices are determined simultaneously o eg. Demand in the corn market is: Q = 12-2P + P c s Supply in the corn market: Q = 4 + P d c Demand for soybeans: Q = s-4P + P s c Supply for soybeans: Q = 4 + P s  There is a negative relationship between the quantity demanded for corn and the price of corn. As the price of corn goes up by 1 unit, the quantity of corn goes down by 2 units.  If there is an exogenous change (coming from outside the system) such as the government mandating that all gasoline contains 10% corn ethanol (this passed in the U.S., but not Ontario because there is no environmental benefit as it actually increases carbon emissions to produce and ship it).  Corn and soybeans are substitutes for one another, so as the price of corn goes up, we will substitute into soybeans. This will cause an increase in the quantity demanded for soybeans, and an increase in the price of soybeans.  Is there a third market being affected? • If the price of corn and soybeans are going up, the price of beef, cereal, and many other foods will also go up because the cost of an input has increased. • The price of agricultural land will also increase because the farmer’s demand for land has gone up. • These reasons also contributed to the reasons why Ontario did not pass the law regarding corn ethanol in gasoline. Circular Flow Model • You have to take all of these markets into account Pareto Efficiency (= economic efficiency) • There is no other feasible allocation of X and Y (our goods and services) that will make some consumers better off without making others worse off Pareto Inefficiency • At an inefficient allocation, there is a trade that can make some consumers better off than they were before General Equilibrium Outcome • Pareto efficient as long
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