9. Supply and Demand & Consumer/Producer Surplus

Jonathan Gruber begins the lecture by revisiting the foundational concepts of supply and demand introduced in the first lecture. He emphasizes the importance of understanding the origins of supply and demand curves and their role in determining market equilibrium. Gruber uses the market for gasoline as an example, explaining how the supply curve slopes upward due to higher prices incentivizing more supply, and the demand curve slopes downward as higher prices lead to less demand. The lecture aims to explore the implications of shifts in these curves and their impact on market outcomes.

Gruber delves into the dynamics of how supply and demand curves are 'shocked' or shifted by various factors. Using the gasoline market as a reference, he illustrates how changes in consumer tastes, such as a preference for SUVs which consume more fuel, can shift the demand curve outward, leading to an increase in both the quantity of gasoline sold and its price. He explains the concept of equilibrium as the point where consumers' willingness to pay meets suppliers' willingness to supply. Gruber also discusses the effects of a hypothetical war in the Middle East on gasoline supply, highlighting how increased costs for oil would shift the supply curve upward, necessitating higher prices for producers to break even.

The lecture continues with an in-depth analysis of the reasons behind shifts in supply and demand curves. Gruber outlines six factors that can cause demand curves to shift, including changes in tastes, income levels, prices of complementary or substitutable goods, market size, and expectations of the future. On the supply side, he identifies changes in input costs and shifts in technology or production functions as the primary reasons for supply curve shifts. Gruber also uses the example of Kim Kardashian's influence on exercise corset demand to demonstrate how market dynamics respond to demand shocks.

Gruber discusses the impact of elasticity on supply and demand curves, explaining how the shape of these curves influences the market's response to shocks. He contrasts perfectly inelastic and perfectly elastic demand scenarios, illustrating how in the case of inelastic demand, such as insulin, a supply shock results in little change in quantity but significant price increases. Conversely, with elastic demand, a supply shock leads to quantity changes with little effect on price. The lecture also touches on the long-term versus short-term elasticity of demand for gasoline, highlighting consumers' ability to adapt to price changes over time.

The lecture takes a turn towards welfare economics, moving from positive economics, which describes 'is', to normative economics, which prescribes 'ought to be'. Gruber introduces the concept of consumer surplus as a measure of welfare, defined as the difference between what consumers are willing to pay and what they actually pay for a good. He explains the compensating variation approach to measuring well-being, which involves assessing how much consumers would be willing to pay for additional utility or to avoid a loss in utility. The lecture sets the stage for a deeper exploration of welfare economics in subsequent sessions.

Gruber explores the concept of consumer surplus further, using the example of gift-giving during Christmas to illustrate the potential inefficiencies of this tradition. He argues that while gifts may carry emotional value, from an economic standpoint, cash gifts would provide recipients with greater consumer surplus, as they could use the cash to purchase goods they value more highly. The lecture also addresses the impact of price changes on consumer surplus, demonstrating how an increase in price reduces the surplus by creating a gap between the original and new price points.

This section of the lecture examines the specific effects of price changes on consumer surplus. Gruber explains that when the price of a good like gasoline increases, consumer surplus decreases due to two main factors: the loss of surplus for those who stop buying the good because it's no longer worth the higher price, and the reduced surplus for those who continue to buy but at a higher cost. The summary clarifies that the loss in consumer surplus is represented by a trapezoid, reflecting the combined impact of reduced quantity purchased and increased price for the same quantity.

Gruber introduces the concept of producer surplus, which is analogous to consumer surplus but from the perspective of sellers. He explains that producer surplus is the difference between the price received for a good and the marginal cost of producing it. The lecture illustrates how producer surplus can be thought of as profits in the long run, especially when the supply curve is upward sloping due to factors like heterogeneous firms, barriers to entry, or rising input costs. Gruber emphasizes that producer surplus is a key component of welfare economics and provides insight into the distribution of benefits in a market.

The final paragraph of the lecture discusses the conditions under which long-run supply curves may slope upward, leading to producer surplus. Gruber explains that this can occur due to differences in firm efficiency, barriers to entry, or increasing input costs. He distinguishes between situations where an upward-sloping supply curve indicates profits and those where it reflects rising input costs without necessarily implying profits for the firm. The lecture concludes with a note on the importance of understanding these dynamics for a comprehensive view of market economics.