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Chapter 8

Chapter 8 Full Notes

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Boston College
ECON 1131

Chapter 8:Applications of Supply and Demand Agriculture  Agriculture at the level of the farm is the most highly competitive sector in the United States economy  Most agricultural commodities exhibit the four requirements for a competitive market: identical products, good information about prices, a large number of farms, and free flow of resources into and out of the industry The Demand for Agricultural Products  Domestic Demand o The demand for agricultural products is highly price and income inelastic o The market demand curve is extremely steep (price inelastic) and shifts out slowly over time (income inelastic)  Export Demand o The export component of total demand is considerably different- it is price elastic because of the competition from around the world  Overall Market Demand o The market demand curve is price inelastic and shifts out slowly over time, subject to occasional bursts and declines from its trend rate of growth caused by the volatility of the export component The Supply ofAgricultural Products  The supply of most agricultural commodities has three characteristics of note: o (1) Increasing price elasticity over time o (2) Substantial advances in productivity over time o (3) Considerable instability in the short run  Supply elasticities o The price elasticity of supply increases substantially with the passage of time o Agriculture experiences a long momentary run during which supply responses to changing market conditions are minimal o Supply elasticity increases as the momentary run gives way to the short run but not by very much o Supply responses are considerable once land can be varied and the short run gives way to the long run  Increases in productivity over time o The market supply curve for nearly all agricultural commodities shifted out steadily and substantially year after year throughout the 20 century o Gains in labor productivity came from two sources: the substitution of other inputs for labor and continued technological change  Short-run instability o Weather dependent Market Equilibrium  Long Run Price Behavior o Over the long run, prices of agricultural products have fallen relative to prices generally o Agriculture follows long run price trends by means of a concept called parity  Parity = output prices received by farmers Input prices paid by farmers o Large shifts in the supply curve caused by productivity growth far outpace the fairly modest shifts in the demand curve that arise mostly from population growth  Net result of this is persistent downward pressure on agricultural prices o Demand increases less than supply increases- but the increase in demand puts upward pressure on price and the increase in supply puts downward pressure on price  Supply effect dominates here o The decline in price is large because demand is so inelastic  Short Run Price Behavior o Volatile o The volatility of farm prices results primarily from a combination of two factors, the short-run instability of the market supply curve caused by periods of good and bad weather, and the price inelasticity of both the market supply and demand curves o The instability of prices translates into fairly large price changes because demand is so inelastic o When a supply curve shifts along an inelastic demand curve, price and total revenues move together Nonclearing Markets  People often become distressed when markets malfunction because their instincts are to trust the market system  Capitalistic societies always experience a tension between a desire to have the government do something about a market problem and an inherent distaste for any government intervention into economic affairs Parking on City Streets  Aquantity complaint is the symptom of a pricing problem o For some reason the price is not settling at its equilibrium value as it normally does o If price were at its equilibrium value, consumers and producers would be buying and selling exactly what they want to buy and sell, the equilibrium quantity The Urban Transportation Mess  Underlying all efforts to improve the urban transportation network is a fundamental pricing problem- the price of automobile travel during peak rush hours is far below its marginal cost  Amajor component of that cost is the value of time people lost when they are forced to crawl along congested highways  Quantity solutions by themselves are doomed to fail Unfair Prices Price Ceilings and Price Floors  Price ceiling: a legislated amount above which the market price is not allowed to rise  Must be set below the equilibrium price to have an effect on a market  Rent control is one of the only price ceilings set up in the US- transfers have an advantage over price ceilings because they can be more easily targeted to poor families  Price floor: an amount below which the price is not allowed to fall  Must be set above the equilibrium price to have an effect on the market  US has been more willing to use price floors to protect producers than to use price ceilings to protect consumers o Ex: agriculture Rent Control  Any price ceilings substitutes a state of legislated excess demand for the natural market equilibrium, and whether chronic excess demand is to be preferred to the natural equilibrium is always an open question  Rent control: a price ceiling on the rents that landlords can charge low-income tenants  The equilibrium rent without rent control is Re, a price that the public feels is more than poor families should have to pay o City government r
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