Does the Equilibrium Model Work
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Not Synced♪ [music] ♪
-
Not Synced- [Alex] Now that we understand
supply and demand -
Not Syncedand the equilibrium process,
we can ask, "Does the model work?" -
Not SyncedSome of the most impressive
evidence was developed in 1956 -
Not Syncedby Vernon Smith,
one of the founders -
Not Syncedof experimental economics.
-
Not SyncedSmith actually expected
that his lab experiments, -
Not Syncedwhich I'll describe
in more detail shortly, -
Not Syncedhe expected that they
would disprove the model. -
Not SyncedBut he was shocked when time
and time again, -
Not Syncedthe model predicted
exactly what happened. -
Not SyncedVernon Smith
was awarded the Nobel Prize -
Not Syncedin economics in 2002.
-
Not SyncedLet's take a look at what he did.
-
Not SyncedSmith's first experiments
were very simple. -
Not SyncedHe gave a group of students,
called the buyers, -
Not Syncedcards similar to these,
which told them the value -
Not Syncedthat they placed on a good,
the maximum they would be willing -
Not Syncedto pay for the good.
-
Not SyncedHe then did the same thing
for sellers, giving them cards, -
Not Syncedwhich told them their costs,
the minimum price -
Not Syncedat which they would be willing
to sell the good. -
Not SyncedNotice that the distribution
of buyer values -
Not Synceddetermines a demand curve.
-
Not SyncedAt a price of $3.50, for example,
the quantity demanded would be 1. -
Not SyncedBut as the price falls
to let's say just below $3, -
Not Syncedthe quantity demanded
would increase to 2. -
Not SyncedSimilarly, the distribution
of cards for the supplier costs -
Not Synceddetermines a supply curve.
-
Not SyncedMoreover, because Smith
knew the values -
Not Syncedthat he distributed,
he could calculate the demand -
Not Syncedand the supply curves
and the predicted -
Not Syncedequilibrium prices and quantity.
-
Not SyncedSmith let the students make trades
in a double oral auction. -
Not SyncedTraders would call out,
"I'll sell for $2," -
Not Synced"I'll buy for $1," and so forth.
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Not SyncedAny time two traders agreed
to a deal, the price -
Not Syncedwould be called out,
"Sale at a price of $1.50." -
Not SyncedIf a buyer and a seller,
say this buyer and this seller, -
Not Syncedagree to make a trade
at let's say a price of $1, -
Not Syncedthen the seller would earn
the price minus their cost. -
Not SyncedIn this case, the seller
would earn a profit of 25 cents, -
Not Syncedthe price minus their cost.
-
Not SyncedSimilarly, the buyer
would earn their value, -
Not Synced$2.25 in this case,
minus the price, $1, -
Not Syncedfor a profit of $1.25.
-
Not SyncedNow, here was another key
to Smith's market. -
Not SyncedHe actually paid the traders
their profits in real money. -
Not SyncedSo Smith's experimental market
was a real market, -
Not Syncedwith a real demand curve,
a real supply curve, -
Not Syncedand traders who had an incentive
to maximize the gains from trade. -
Not SyncedSo what happened?
-
Not SyncedHere are the results from one
of Smith's remarkable experiments. -
Not SyncedThe demand and supply curve
calculated by Smith -
Not Syncedare shown here on the left.
-
Not SyncedThe model predicts
an equilibrium price of $2, -
Not Syncedand an equilibrium quantity
of 5 or 6 units. -
Not SyncedWhat actually happened
is shown on the right. -
Not SyncedThe actual market price
quickly went to $2 -
Not Syncedor very close to it.
-
Not SyncedThe market quantity
quickly went to 5 or 6 units. -
Not SyncedMoreover, exactly as predicted
by the model, -
Not Syncedthe buyers with the highest
values bought, -
Not Syncedand the sellers
with the lowest costs sold. -
Not SyncedIn short, almost all the gains
from trade were exploited, -
Not Syncedleading to near maximum efficiency,
exactly as predicted by the model. -
Not SyncedAnother way to test the model
is to examine its predictions -
Not Syncedabout what happens
when the demand -
Not Syncedor supply curves shift.
-
Not SyncedIn fact, what makes the demand
and supply curve model so powerful -
Not Syncedis that you can analyze any change
in market conditions -
Not Syncedusing a shift in either the demand
or a shift in the supply curve. -
Not SyncedThat will produce a prediction
about what will happen. -
Not SyncedYou should be very familiar
with demand and supply -
Not Syncedcurve shifts.
-
Not SyncedLet's run through a few examples.
-
Not SyncedThe key here is to understand
the logic, not to try to memorize -
Not Syncedthe results
of every possible shift. -
Not SyncedIf you understand the logic,
then with a few curves, -
Not Syncedyou'll always be able to duplicate
and to understand exactly -
Not Syncedwhat the model predicts.
-
Not SyncedHere's the market for laptops,
for the demand and the supply -
Not Syncedof laptops.
-
Not SyncedWe all know that technology
has reduced the cost -
Not Syncedof computer chips --
Moore's Law and all that. -
Not SyncedThe reduction in the price
of computer chips reduces the cost -
Not Syncedof producing laptops.
-
Not SyncedA reduction in costs is modeled
by an increase in supply. -
Not SyncedThe supply curve moves
to the right and down. -
Not SyncedSo what does the model predict?
-
Not SyncedThe model predicts, therefore,
that the price of laptops will fall -
Not Syncedand the quantity bought
and sold will increase. -
Not SyncedPretty good prediction.
-
Not SyncedNow, let's look at the market
for portable generators. -
Not SyncedLet's suppose that a hurricane
is approaching. -
Not SyncedWhat will the approaching hurricane
do to the demand for generators? -
Not SyncedWell, it will increase the demand,
shifting the demand curve up -
Not Syncedand to the right.
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Not SyncedWhat does the model predict?
-
Not SyncedThe model predicts
an increased price of generators -
Not Syncedand a greater quantity exchanged.
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Not SyncedAlso, pretty good prediction.
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Not SyncedUsing the simple but powerful model
of supply and demand, -
Not Syncedyou can also understand
important events in world history. -
Not SyncedLet's look at the price of oil
over the last 50 or 60 years. -
Not SyncedHere's the price of oil since 1960.
We can see a few key events. -
Not SyncedIn 1973, for example,
OPEC first flexed its power -
Not Syncedby reducing the supply
of oil in an embargo. -
Not SyncedWhat you can see is that the price
of oil skyrocketed. -
Not SyncedThe big price increase makes sense
-
Not Syncedbecause there aren't
many good substitutes for oil -
Not Syncedin the short run.
-
Not SyncedWe're gonna be talking more
about the elasticity of demand -
Not Syncedin future videos.
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Not SyncedThe Iranian revolution
and the Iran-Iraq war -
Not Syncedwere also important supply shocks,
negative supply shocks, -
Not Syncedwhich pushed up the price of oil.
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Not SyncedA higher price, however,
encouraged more exploration. -
Not SyncedAnd as additional sources of oil
were discovered in the North Sea -
Not Syncedand in Mexico,
the price of oil began to fall. -
Not SyncedAnother key event occurred
in the 2000s as growth in China -
Not Syncedand India increased.
-
Not SyncedThat increased the demand for oil,
pushing up the price. -
Not SyncedFor the first time,
millions of people -
Not Syncedwere able to afford a car,
and that increased -
Not Syncedthe demand for oil.
-
Not SyncedYou can see that increased demand
continued until this big drop -
Not Syncedin the price of oil in 2008, 2009.
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Not SyncedWhat's that?
-
Not SyncedThat, of course, is the demand shock
from the big recession -
Not Syncedand the financial crisis,
which hit the United States -
Not Syncedand Europe especially hard,
reducing the demand for oil, -
Not Syncedat least until the recovery
has started to occur. -
Not SyncedWhat you can see here
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Not Syncedis that the simple supply
and demand model -
Not Syncedprovides a very useful framework
for understanding our world. -
Not SyncedThanks.
-
Not Synced- [Narrator] If you want
to test yourself, -
Not Syncedclick "Practice Questions."
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Not SyncedOr, if you're ready to move on,
just click "Next Video." -
Not Synced♪ [music] ♪
- Title:
- Does the Equilibrium Model Work
- Description:
-
{'type': u'plain'}
- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Micro
- Duration:
- 08:01
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