MICRO AND MACRO

Micro and Macro

Micro and Macro

Use supply and demand economic theory to explain why the price of the laptop computers has fallen over the last two years. (50%)

Prices and quantities are determined by both supply and demand. If both curves were the same in every country, broadband prices and use would be the same in every country. However that's not what we observe. Prices and quantities differ across countries. But is this because their supply curves differ or their demand curves differ?

Price is derived by the interaction of supply and demand. The resultant market price is dependant upon both of these fundamental components of a market. An exchange of goods or services will occur whenever buyers and sellers can agree on a price. When an exchange occurs, the agreed upon price is called the "equilibrium price", or a "market clearing price" . This can be graphically illustrated as follows:

If the supply curve differs across countries — perhaps because it is more costly to lay cable in some places — then some countries will be on the leftmost part of the demand curve (high price, low quantity), and others will be on the rightmost part of the demand curve (low price, high quantity), with some in between. This is case 1 in my chart below; in this example, the cross-country data would be where the black crosses are. This must be what Rampell has in mind when she says “As Econ 101 would predict, the two measures are related: prices go down, subscription rates go up.”

But this isn't all that Econ 101 suggests. What about case 2, where the demand curve varies across countries? People in rich countries like the U.S., Western Europe, and Scandinavia are probably willing to pay more for broadband access than people from Poland, Turkey, Mexico, or other poorer countries. My graph shows that poor countries will be on the leftmost part of the supply curve (low price and quantity), and rich countries will be on the right side (high price and quantity), with some in between. This is not just a story just about G.D.P. by the way — there are many other reasons demand may differ across countries. But whatever the reason, the black crosses representing the data would suggest that high prices are associated with high quantities, even though all demand curves are clearly downward-sloping.

So we have two cases, both of which have downward-sloping demand curves, but in one, the quantity of broadband subscribers is low in countries with high broadband prices; and in the alternative case, broadband subscriptions are high in countries with high broadband prices. In reality, the world is a mixture of both cases. The conclusion from this little example: when you plot real-world price and quantity data, you don't learn the slope of the demand curve (unless you are strictly in case 1), and you don't learn the slope of the supply curve (unless you are strictly in case 2). Instead you learn a combination of the slope of ...