Economics Lecture: Supply and Demand Model

Overview

• Examination of the effectiveness of the supply and demand model.
• Introduction to experimental economics and Vernon Smith's contributions.

Vernon Smith's Experiments

• Conducted in 1956, aimed to disprove the model but ended up supporting it.
• Smith awarded Nobel Prize in Economics in 2002.

Experiment Setup

• Participants: Buyers and Sellers
• Buyers received cards indicating the maximum price they would pay.
• Sellers received cards indicating the minimum price they would accept.
• Cards allowed calculation of demand and supply curves.

Auction Process

• Double oral auction: Traders bid by calling out prices.
• Agreements on trades determined the transaction price.

Profit Calculation

• Sellers' profit: Sale price minus cost.
• Buyers' profit: Value minus price.
• Real monetary incentives given to participants.

Results

• Experiment showed consistent results with the model predictions:
  • Market price at equilibrium ($2).
  • Market quantity close to equilibrium (5-6 units).
  • Efficient allocation: Buyers with highest value bought, sellers with lowest cost sold.

Model Predictions for Market Changes

Demand or Supply Curve Shifts

• Key Insight: Predictions are made by analyzing shifts.

Laptop Market Example

• Cause: Decrease in computer chip prices (Moore's Law).
• Effect: Increase in supply, leading to decreased prices and increased sales.

Portable Generators Market Example

• Cause: Approaching hurricane increases demand.
• Effect: Higher prices and greater quantity exchanged.

Historical Events: Oil Market

Oil Price Changes

• 1973 OPEC Embargo: Reduced supply, increased prices.
• Iranian Revolution/Iraq War: Negative supply shocks, increased prices.
• New Oil Discoveries: North Sea, Mexico led to decreased prices.
• 2000s Demand Increase: Chinese and Indian growth increased demand, raising prices.
• 2008 Financial Crisis: Demand shock decreased oil prices.

Conclusion

• The supply and demand model is a powerful tool for understanding economic trends and historical market changes.

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• Practice and Test: Engage with practice questions to reinforce understanding.
• Next Steps: Proceed to the next video for further learning.