Microeconomics_4__Besanko

Microeconomics_4__Besanko


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combined effect of a shift in supply and a
shift in demand. In particular, the demand curve shifted rightward from D2006 to D2008,
while the supply curve shifted leftward from S2006 to S2008, moving the equilibrium from
point A to point B. The result was an increase in the equilibrium price from $2 per bushel
to $5 per bushel.
Pr
ic
e 
(do
lla
rs 
pe
r b
u
sh
el
)
1210
Quantity (billions of bushels per year)
$2
$5
D2006
A
B
S2008 S2006
D2008
Shifts in Both Supply and Demand
So far, we have focused on what happens when either the supply curve or the de-
mand curve shifts. But sometimes we can better understand the dynamics of prices
and quantities in markets by exploring what happens when both supply and demand
shift.
We return to the example of the U.S. corn market in the 2000s to illustrate this
point. Figure 2.12 shows the difference between the equilibrium in the corn market
in 2006, when the price was around $2 per bushel (point A) and in 2008, when the
price had risen to $5 per bushel (point B). As we discussed in the Introduction, the
change in the price of corn over this period can be attributed to an increase in de-
mand (driven, in particular, by the growth in the market for corn-based ethanol in
the United States) and a decrease in supply (due, in particular, to heavy rains and
flooding in the U.S. Corn Belt in 2008). The combined impact of both shifts was to
increase the equilibrium price. By contrast, the effect of these changes on equilib-
rium quantity is not clear. The increase in demand tends to push the equilibrium
quantity upward, while the increase in supply tends to push the equilibrium quantity
downward. The net impact on the equilibrium quantity would depend on the mag-
nitude of those shifts, as well as the shapes of the demand and supply curves themselves.
c02demandandsupplyanalysis.qxd 6/14/10 1:39 PM Page 40
2.1 DEMAND, SUPPLY, AND MARKET EQUILIBRIUM 41
magnitude of those shifts, as well as the shapes of the demand and supply curves 
themselves. Figure 2.12 shows an increase in the equilibrium quantity (from 10 billion
bushels to 12 billion bushels), which is what happened in the United States between
2006 and 2008.
The data in the figure are a price index showing
how the average price of a computer of similar capa-
bility changed over time. The index is scaled to equal
100 at the end of 1988. Values of the index are calcu-
lated as a computer\u2019s price that month as a percent-
age of the price of a comparable computer at the end
of 1988. For example, suppose that the computer
priced in December 1988 was $5,000. The index\u2019s
value at the end of 1990 was about 90, so a compara-
ble computer would have cost about $4,500 (90 per-
cent of $5,000) that month. The price estimates are
constructed by the Bureau of Labor Statistics (BLS).
Quality and price of computer components changed
so rapidly in recent decades that the BLS had to de-
velop special methods to estimate computer prices
In 1975 Bill Gates and Paul Allen founded Microsoft,
famously declaring that the company\u2019s mission was
\u201ca computer on every desk and in every home.\u201d At
the time only a handful of personal computer models
had been sold in small quantities to hobbyists. Those
computers could do very little. Now, of course,
Microsoft\u2019s goal has largely been realized in advanced
economies worldwide. The primary reason for this is the
dramatically falling price of computers, peripherals, and
software. Figure 2.13 illustrates how the cost of
computers fell in the last 20 years.
A P P L I C A T I O N 2.2
A Computer on Every Desk 
and in Every Home
100
80
60
40
20
0
D
ec
\u20131
98
8
D
ec
\u20131
99
0
D
ec
\u20131
99
2
D
ec
\u20131
99
4
D
ec
\u20131
99
6
D
ec
\u20131
99
8
D
ec
\u20132
00
0
D
ec
\u20132
00
2
D
ec
\u20132
00
4
D
ec
\u20132
00
6
D
ec
\u20132
00
8
FIGURE 2.13 Quality-Adjusted Prices of Computers and Peripheral Equipment, 1988\u20132008
This is the graph of a price index showing how the average price of a computer of similar
capability changed over time. The index is scaled to equal 100 at the end of 1988. By 
2008, the price index had fallen to about 10.
c02demandandsupplyanalysis.qxd 6/21/10 8:50 AM Page 41
42 CHAPTER 2 DEMAND AND SUPPLY ANALYSIS
puter. Along similar lines, many new uses for com-
puters were introduced over time. In addition, con-
sumers became more educated in how to use com-
puters, increasing their productivity from using
them.
We know that an increase in demand, holding
the supply curve fixed, should cause the equilibrium
price to rise. That computer prices fell indicates that
something other than the demand curve must have
shifted. Figure 2.14 shows that the pattern of ob-
served priced and quantities is consistent with a 
simultaneous rightward shift of both the demand
and supply curves.
What caused the increase in supply for comput-
ers? The most important effect was \u201cMoore\u2019s Law\u201d
(named after Intel co-founder Gordon Moore, who
first described it).7 Moore\u2019s Law states that the num-
ber of transistors that can be fit on an integrated
circuit doubles every two years. This has been ap-
proximately true for several decades. This exponen-
tial growth has led to vastly faster and less expen-
sive computer chips. Many other computer
components also saw rapid improvements in quality
and declines in price over same period. These 
over time.6 Briefly, every six months the BLS finds new
computer components or peripherals with functional-
ity similar to those used to construct the most recent
computer price estimate. The price of the new compo-
nents is then used to produce a new estimated com-
puter price.
Figure 2.13 shows an incredible decline in com-
puter prices over time. A computer bought in mid-
1990 would cost about one-tenth of what a com-
puter with similar capabilities would have cost 20
years before! If data on quality-adjusted prices were
available going back to when Microsoft was
founded in 1975, we would see similar trends. At the
same time, the total quantity of computers sold
grew many times over. What explains this pattern of
prices and quantities?
Figure 2.14 illustrates what was happening.
Since personal computers appeared in the 1970s, the 
demand curve for computers shifted rightward. A
combination of factors drove this shift. As computers
became more powerful, companies started develop-
ing a vast array of software and peripherals to work
with them. For consumers, these new complemen-
tary products increased the value of owning a com-
6\u201cHow BLS Measures Price Change for Personal Computers and Peripheral Equipment in the
Consumer Price Index.\u201d U.S Bureau of Labor Statistics, June 2008,
http://www.bls.gov/cpi/cpifaccomp.htm. 
7\u201cCramming More Components onto Integrated Circuits.\u201d Gordon Moore, Electronics Magazine,1965.
Pr
ic
e 
(qu
ali
ty 
ad
jus
ted
)
Quantity (computers sold per year)
D1975
D2009
S2009
Q
P S1975
Path of computer
prices and quantities
over time
FIGURE 2.14 Supply and
Demand for Computers,
1975\u20132009
The pattern of prices in Figure
2.13, as well as rapid growth in
quantities over the same period,
can be explained by rightward
shifts over time in both the
demand and supply curves for
computers. The supply curve
shifted from S1975 to S2009, while
the demand curve shifted from
D1975 to D2009. 
c02demandandsupplyanalysis.qxd 6/14/10 1:39 PM Page 42
2.2 PRICE ELASTICITY OF DEMAND 43
The price elasticity of demand measures the sensitivity of the quantity demanded to
price. The price elasticity of demand (denoted by \ufffdQ,P) is the percentage change in quan-
tity demanded (Q) brought about by a 1 percent change in price (P), which means that
If \ufffdQ is the change in quantity and \ufffdP is the change in price,