Term 2 Week 2: Equilibrium, Prices and Information Flashcards
What does equilibrium represent, and where does it come from (1,1)
-Equilibrium represent both balance and stability
-Equilibrium comes from the interaction of supply and demand, unless there is fixed supply and demand
How do we interpret linear demand curve, and why would we use it (2)
-On a linear demand curve, the intercept in the function is the x intercept, as quantity is on the x axis (slope = reciprocal of the number before the variable)
-Economists are likely to use linear models, as the equilibria are easy to find
What are comparative statics, and what are the methods of solving it (2,1)
-Comparative statics measures how equilibrium changes if you change the parameters
-You can either solve it with a heuristic informal method, giving a qualitative change, or a formal quantitative model, depending on the validity of the underlying model
-When considering changes in equilibrium due to an event, we have to consider what parameters it’ll impacct (decrease in fuel shifts both supply and demand)
How can we use comparative statics to consider changes in equilibrium (1,3,1)
-When exploring a change in parameter (T) on equilibrium price, we can either solve the system of equations for p directly, or use implicit differentiation to determine the effect
-For implicit differentiation, impose equilibrium condition QD = QS, so A - bp + cT = d + ep + yT (c is how much demand changes when T changes, Y is how much supply changes when T changes)
-Take p as an implicit function of T, and differentiate then rearrange to get (dp/dT) = (c - Y/e + b)
-if c > y, price rises, and if c < y, price falls
-dP/dT = (partially differentiate Qd with respect to T - PD Qs with respect to T)/(PD Qs with respect to P - PD Qd with respect to P*)
How do we model durable goods (2,2,2)
-Durable goods are ones where you either buy one unit or none (tickets to a game)
-Demand only changes along the extensive margin
-This is modelled by consumers having their own willingness to pay (valuation/reservation price), with θi representing each consumers WTP
-Consumers purchase if θi >= p, and market demand is the amount of consumers with θi >= p
-As N gets large, market demand is given by N(1 - Fθi(p)), where Fθi is the cumulative distribution function
-A linear demand curve is if probability is constant for θi, and a convex demand curve is if probability falls as θi rises
How can changes in price signal new information (2,2)
-Producers are driven to produce the goods which are most profitable
-Production levels are coordinated by price changes
-For producers, a price rise signals that demand is rising, so production should be expanded
-For consumers, a price increase signals that others are buying, so people should act quickly
What is Hayek’s free market argument (2,1)
-Hayek spoke about how information is localised in an economy, as retailers need to coordinate with a number of intermediate producers
-Rather than communicating directly, they react to prices, thus making the market a mechanism for aggregating information
-Although, this doesn’t claim markets are always successful in maximising welfare or organising economic activity
What is the Efficient Market Hypothesis (3)
-The EMH is that “prices reflect all available information”
-Although prices may look wrong ex-post (after), it is a lot harder to judge whether prices were wrong ex-ante (before) (leicester winning league, how likely)
-Although it could be argued the EMH disputes the existence of market bubbles
