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ECON20110 Fall 2013 - Lecture 4: Firm Supply and Duration — Transcript

by Glen Weyl · 12,529 words · 1,824 segments · language en · Watch on YouTube

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0:01okay so for the next two weeks we're
0:03going to be assuming that firms are
0:05price takers which means that uh over
0:09the small range of quantities that a
0:12firm varies uh the prices that will
0:16prevail on the market will not change by
0:18very much that is the demand curve that
0:22the firm faces is uh flat unless the
0:26firm produces a very large amount
0:28relative to what uh would be likely for
0:31it to want to produce and we'll give
0:33some foundations for this in lecture 16
0:36but for the moment we're just going to
0:38assume that price is constant the firm's
0:41take price is
0:43given um and uh in particular in this
0:47case the firm's production function uh
0:50sorry profit function will then be P * Q
0:53minus their total cost and um Adam
0:58where's Adam Adam yeah hey
1:00uh what's going to be the firm's first
1:02order condition
1:04then um it would be where a price equals
1:08marginal cost exactly so you
1:10differentiate that and you get price
1:13from the first because price is fixed
1:15and then the derivative of total cost is
1:17marginal cost and you set those equal to
1:19each other right so then we can derive
1:23the supply function from
1:25this
1:26um so in particular
1:30if we invert the marginal cost
1:33curve then we get that the supply of p
1:36is equal to Q the supply is the inverse
1:38of the marginal cost
1:40curve so let's return again to the cob
1:43Douglas example we had from before so
1:46their marginal cost remember was K * the
1:49output to some uh Power
1:52Alpha um if that marginal cost is not
1:56increasing then there's going to be a
1:58problem because
2:01uh uh well we'll we'll we'll talk about
2:04that in a second but uh let's for the
2:06moment assume that Alpha is greater than
2:08zero um so then what is the supply
2:13function going to be does anyone want
2:15to uh remind me of your name Wesley
2:18Wesley yeah so I guess the alpha root of
2:22marginal cost over K exactly of price
2:26over K right yeah
2:33exactly okay so this is the most
2:36fundamental Supply
2:38equation uh and typically it'll just be
2:42this marginal cost curve that is the
2:44firm Supply however two problems can
2:47arise one is that firms are not going to
2:49produce until they make a profit that is
2:52until their marginal cost curve is above
2:55their average cost curve if they're
2:57asked to produce at a price price where
3:00that's below their uh average cost curve
3:02even if it equals their marginal cost
3:03curve they're not going to want to
3:05produce there so for example
3:08um many airlines will shut down a route
3:13even if the marginal cost of the
3:15additional customer is uh much less than
3:18the price that they're charging if there
3:20aren't enough people traveling on that
3:22route because there's a fixed cost of
3:23traveling that route at all which is
3:25that they have to you know bring the
3:26airine plane to the gate and all that
3:28sort of stuff right
3:31okay the second possibility is that
3:34marginal cost intersects uh price at
3:37multiable points right and in this case
3:40the firm is going to choose the most
3:42profitable
3:43Point um and in particular it must be a
3:47point where the marginal cost intersects
3:50the price from below to above because a
3:53point where it intersects from above to
3:55below is actually a minimum of the
3:57average of the total cost total profit
4:00rather than a maximum but among those
4:03it's going to choose the ones that um
4:06the one that has the most uh area
4:09underneath it let me see if I've got a
4:10picture of that
4:12yep
4:13[Music]
4:14um and this can happen especially if
4:17there's a lot of quasif fixed factors so
4:20it might be that you know my marginal
4:22cost is increasing but then I buy an
4:25additional factor and then the marginal
4:26cost goes back down and so it can have a
4:29wavy pattern like that at least in
4:32principle so um what this says is
4:37that
4:40uh and a competitive firm will never
4:43have increasing returns to scale the
4:46reason is that um let me show you a
4:50picture so um imagine that like the
4:54price is here right well then the firm
4:57is going to produce here but as it
4:58starts to rise there will be another
5:00intersection with there will be two
5:02intersections here now where is the firm
5:06going to produce if the price is down
5:08here it could either produce at this
5:12point
5:13or it could produce at this point or
5:16this point now this point is a
5:18intersection in the wrong direction and
5:20the way you can see that they never want
5:22to do that is that they take losses of
5:25this amount but then they get no gains
5:27so they're never going to want to do
5:28that relative to produce at this point
5:31now would they want to produce over here
5:32well they get this amount of gains and
5:35they take this amount of losses the
5:37losses are bigger than the gains but if
5:40now the um if now the price Rises to
5:47this point well then the amount of gains
5:49that they get from producing over here
5:51about equals the amount of losses they
5:52get over here if it raises higher right
5:56then the losses that they take are only
5:58the small area over here but the gains
6:00are this big area down
6:02here so then they'd want to produce over
6:05here so what this is actually going to
6:07look like the supply function is not
6:09going to be the marginal cost curve
6:11instead it's going to be marginal cost
6:13up to this point then it's going to be
6:15flat and then it's going to go over here
6:18and then it's going to be flat again at
6:19some point where those two areas are
6:21equal and up again and so even though it
6:25has a marginal cost curve that's
6:28decreasing in certain points it's never
6:31going to act as if it has a marginal
6:33cost curve that's decreasing at those
6:34points it will always act as if it has
6:37something that maybe has some flat
6:39sections but that is always weakly
6:44increasing here's a another picture of
6:47what I was saying so the marginal cost
6:49curve um down here if the price was down
6:52here the firm wouldn't produce because
6:54its average costs because it has some
6:57fixed costs are still above
7:00uh the price that's occurring so they're
7:02only going to charge a price they're
7:04only going to produce once they're Above
7:06This average cost
7:10curve okay so
7:15um the reason that a firm can never have
7:18increasing returns to scale throughout
7:19the full range right is then the
7:21marginal cost Curve will only intersect
7:24from above to below the uh price right
7:28and that will be a local minimum so
7:30either the firm will produce nothing or
7:32they'll produce an infinitely large
7:35amount right and uh if they produced an
7:39infinitely large amount they would no
7:41longer be a competitive firm and the
7:42prices would start to move right so
7:45that's a sense in which Market power
7:47acts as a firm of decreasing returns to
7:49scale it offsets those increasing
7:51returns to scale because at some point
7:53as you start producing more uh you start
7:55having to deal with the fact that your
7:57price is going to fall
8:02okay so producer
8:05Surplus is price times quantity minus
8:08total cost we can also reexpress that as
8:12price minus average cost time
8:15quantity or we can reexpress it as the
8:18area between price and the marginal cost
8:22curve let me show you
8:24that um
8:36so if we have price here and we have no
8:39fixed
8:40cost we've got a marginal cost curve
8:42going like that right the area between
8:45price and marginal cost we add all those
8:46up those that's also equal to the
8:49profit
8:51right because that's saying on each unit
8:54how much profit do we make on that unit
8:57and adding that up over all the units
9:01um you can also measure
9:05that by integrating over the
9:10quantities
9:12um yes okay so so that
9:16area can also be measured using uh the
9:21change of variables uh sorry by
9:24integration by parts by um the quantity
9:29times the slope of the marginal cost
9:31curve at that point and that is just
9:34equivalent to adding up rather than
9:38vertically for each price you take the
9:42length of the slice that you need to get
9:45out to the supply
9:47curve so you can integrate the supply
9:50curve along the prices as well because
9:54those are two different equivalent ways
9:56of measuring this area
9:57here so these are are all equivalent
10:00ways of measuring the area that
10:02corresponds to the profits yeah philli
10:05um it somehow seems like the ones that
10:08involve marginal cost the ones that
10:10involve average cost are different
10:13because in like a zero economic profit
10:17equilibrium the ones that in like
10:21definition one could be zero if average
10:24cost is equal to price uh but number two
10:28could be strict
10:33positive well so if there's no fixed
10:35cost these things are completely
10:36equivalent yeah that's true yeah
10:41okay
10:45okay okay so that's that's sort of the
10:48basic stuff and now I'm going to turn to
10:49stuff that I think is quite a bit more
10:51interesting which has to do with
10:53production over time and how we
10:55interpret production over time okay so
10:58when we talk about Supply we're saying
11:01how much do you produce in a given unit
11:04of time right because otherwise how do
11:07we interpret what it means for your
11:10production to be X well it's got to be
11:13over some amount of time and that's not
11:15your production forever that's not your
11:17production just today it's maybe your
11:19production over a month or over a year
11:21or something like that but we didn't
11:23explicitly talk about that so far and
11:26how you respond to a change in thect
11:29depends on what that length of time is
11:32right um for example if uh the price
11:36doubles just today maybe there's nothing
11:40that you can do about that you can't
11:41produce anymore you've already produced
11:44right there's just no nothing you can do
11:46if produ if price increases for a long
11:49period of time maybe you'll build a
11:52bunch of factories to produce more and
11:54hire a bunch of workers if it only
11:56increases for one month right so
11:58depending on the time over which
12:01something changes how many things you
12:03can adjust and therefore how much you
12:06can react to that price change uh can be
12:08very very
12:12different
12:13so whether you are more reactive in the
12:18long term or whether you're less
12:20reactive in the long term that is by a
12:23long term I mean if you have a long
12:26period when you expect the price to have
12:28changed depends on whether the things
12:31that you use to produce are what are
12:34called intertemporal complements or
12:36intertemporal
12:38substitutes um so Barett yeah um what is
12:43the definition of an
12:46intertemporal complement or a durable
12:49good uh so that would be something that
12:52wouldn't be able to change easily um
12:55over a short period of time so like
13:00um that would be like Factory yeah or
13:04relationships with other
13:06people yeah that's right so an
13:09intertemporal compliment or durable is
13:11something that lasts for some fixed
13:14non-trivial period of time and that
13:17while over time it might depreciate you
13:19can't just get rid it would be very
13:21costly to get it and then get rid of it
13:23immediately because it's going to last
13:25for some time and you're just going to
13:27be wasting it basically
13:29otherwise so it something that doesn't
13:32make sense to change uh frequently and
13:35therefore it's cheap to use during its
13:40lifespan but once its lifespan is over
13:42it's very expensive to use again right
13:46so a classic example of this would be
13:47where you choose to live permanently
13:50right it would be very costly if you had
13:52to like move from Chicago to New York
13:56you know every week right
13:59you uh you want to have one place that
14:04you have for some significant duration
14:06of time and then maybe you can make a
14:09costly durable move
14:13right uh and bar Barett what about um
14:17intertemporal substitutes or storable SL
14:20exhaustible Goods how would you define
14:23those so those would be things that you
14:26could
14:27um like change more easily
14:31so uh suppose I guess like input factors
14:35right or more input factors that can be
14:39changed in the short term more
14:41easily yeah so these are actually things
14:44that can be changed more easily in the
14:46short term than they can be in the long
14:48term it's actually costlier to change
14:50them in the long term than in the short
14:51term they're they're the opposite of
14:53these other ones so these are things
14:55that last for you know a very long long
14:59time you can store them for as long as
15:02you want but there's only so many of
15:03them around for you to use if you use it
15:07today you can't use it
15:09tomorrow um this makes short-term
15:12changes cheap because you could always
15:13consume it today rather than consuming
15:15it tomorrow but long-term change is
15:17essentially impossible because you can't
15:18consume more both today and more
15:21tomorrow right and these are things that
15:24are expensive every time you use them
15:27but they last essentially forever ever
15:30so an example of this would be a
15:31vacation it's very cheap for you to like
15:34rather than taking your vacation in a
15:36month's time to take it today but it
15:38would be very expensive for you to take
15:40more vacations both this month and next
15:43month
15:44right because you only have so much
15:46vacation time or you know you'll get
15:48bored of taking vacations
15:52Etc now all of this depends on context
15:55but let me give you some typical example
16:00examples of things that are durable
16:03versus
16:04storable so something that's typically
16:07considered very durable is entry by
16:09firms into countries or Industries or
16:12how much education you get these are
16:14things like if I decide to enter an
16:15industry I'm going to be stuck there for
16:17a while right or if I get an education a
16:19certain thing that's going to last me
16:20for most of my life right uh yeah Rishi
16:24so quick um when you say entry bys into
16:28is that
16:29The Firm like entering its own nich in
16:32the country or is that an individual
16:34entering your firm so is like no no at
16:36fir The Firm like setting up shop in a
16:40country
16:44um another H yeah I'm just wondering for
16:47Education what would be the equivalent
16:50of flying between New York and Chicago
16:52every week it would be like being an
16:54econ educated as an economist today and
16:57being educated as a biologist tomorrow
16:59Tom that's like almost impossible to
17:01imagine you doing right I'm not even
17:04sure it's feasible to do that right
17:05education as an economist is constantly
17:07stored so you're not giving it up when
17:09you move to become a biologist that's
17:10why I'm having difficulty with the parel
17:13well I mean like what I'm saying is
17:17being today educated primarily as an
17:19economist and tomorrow educated
17:20primarily as a biologist is a very hard
17:22thing to do mean you could be educated
17:24as both both for long periods of time
17:27but it would be very hard to like switch
17:29your primary education from day to day
17:31right it sort of like lasts you whatever
17:33it is your whole lifetime okay I get it
17:35yeah so another example of this are like
17:38um cultural or political or economic or
17:43social institutions right um or your
17:46religion these are all things that like
17:49stick with a society for a very long
17:51period of time right if a society is
17:54confusion versus if a society is uh you
17:57know is Islamic those are things that
18:00don't change overnight in response to
18:03transitory factors they're things that
18:05endure for a very very long period of
18:07time and it would be very costly for a
18:09society to completely change over those
18:11things in fact one definition of an
18:13institution versus a policy is a policy
18:16something that can change quickly an
18:17institution is something that changes
18:19very slowly yeah Adam um I a question
18:21like for example education um entry by
18:24firm how does that depreciate over
18:26time well I mean uh education is a
18:30classic example of something that
18:31depreciates over time right if you get
18:33an education in economics right now as
18:35time goes on you are going to fall
18:38behind the what's Cutting Edge in
18:39economics right uh entry by a firm
18:42depreciates over time because you know
18:46if I come into an industry like I may
18:48make a big investment in like being up
18:50on that industry but unless I'm
18:52continually Ren that investment uh you
18:54know I'm not going to be on The Cutting
18:56Edge right
18:59uh remind me of your name again Tanner
19:01Tanner I was wondering about the
19:03religion because religion can last
19:05basically forever yeah
19:07and
19:09so sorry this last for a fix period of
19:12time well so that that that maybe that's
19:15true but I I'm not sure that's really
19:16true because you know people have to
19:18continually make investments in order to
19:20like stay a member of their religion
19:22right and it would be very costly for
19:24them to make the investment to join
19:26another religion but if they did it
19:28would again last you know it would last
19:30a long period of time but again they'd
19:31have to continually renew it so I
19:32actually think religion does depreciate
19:34it's a big investment but it does
19:36depreciate you can people lapse out of
19:38their religions over time but it's not
19:41like using it depreciates it at all I
19:44mean in fact using it probably
19:46appreciates it you know what I mean yeah
19:49so that's from the perspective of like
19:52the individual opposed to
19:54society yeah so in the religion we were
19:57talking about individuals
19:58uh but societies have religions too
20:01usually I mean usually religion is not
20:03just purely an individualistic property
20:05and institutions are definitely a social
20:07property but um like how would that
20:10depreciate more time the the religion
20:14well I mean look at what's happened in
20:16Europe like over the last 100 years to
20:18Christianity like there hasn't been
20:20nearly as much social investment in
20:22renewing people's Christian faith and
20:24it's gradually been
20:25depreciating it takes a long time and it
20:28happens GR ually but but it's definitely
20:31been happening Marxism depreciated as an
20:34ideology in the Soviet Union because
20:37there was initially like huge amount of
20:39like building enthusiasm for Marxism but
20:42then there there was less and less
20:44investment in that and it started to
20:45depreciate Yeah Austin are there any
20:48good like natural experiments that have
20:49been done on like the value of religion
20:51for instance or relative of different
20:54region there's a little bit but not a
20:56ton there's definitely some papers
21:01um somewhat durable factors are like
21:05machines job experience so job
21:08experience is something that you you
21:10forget as we saw uh in those graphs that
21:13I showed you the other day more easily
21:15than you forget your
21:16education um machines
21:19depreciate uh over time uh physical
21:23plants also uh uh depreciate somewhat
21:27but they're less durable
21:29than our um than our entry into an
21:32industry right um yeah um when you're
21:37classifying these from very durable does
21:41durable mean a long period of time or
21:45more of a durable trait meaning it it
21:48lasts and can be used an a pretty much
21:51unlimited amount versus a machine has
21:53maybe a very large I'm trying to
21:56classify them in terms of the strength
21:58of intertemporal complimentarity rather
22:00than the time lag but it gets mixed up
22:04because they're sort of related because
22:06you know the thing is like my durability
22:07from today to tomorrow is stronger the
22:10longer it lasts because it's had less
22:12time to depreciate so they're sort of
22:15mixed up uh in some sense yeah Christen
22:18since we're kind of going on like a
22:19Continuum here from durable to storable
22:21yeah are we taking to account them as
22:23somewhat durable if you depreciates them
22:25at all or are we not worried cuz like
22:27for machines you could depreciate but
22:28job experience not so much well I I
22:30really think it's like what's the
22:31binding constraint you know like if
22:33something is going to be so
22:36durable like if if it's going to last
22:38for such a long period of time that the
22:40main thing that ends up depreciating it
22:42like over its lifetime is it's use then
22:45it's a storable if it's something that
22:47like where use will depreciate it a
22:50little bit but like the main thing that
22:52ends up being like The Binding thing is
22:54that you're going to run out of time to
22:55use it and so you might as well use it
22:57more while it's there then it's really
22:59storable I mean it's a durable yeah yeah
23:03yeah Jo well that's something with the
23:05violin where use appreciates it you
23:08appreciates it that's very
23:10durable that's sort of like the most
23:12extreme version of a durable because
23:14it's something where like you know it it
23:17actually using it adds to the value but
23:21time is really going to depreciate it
23:23because if you don't use it and the time
23:25goes by appreciate either time also
23:26appreciates it what old a violin is the
23:29more valuable it
23:31is ah I see what you're saying oh the
23:34violin itself yeah you think use
23:37appreciates violin I think use
23:38depreciates violin it's supposed to
23:40sound better want to use it more really
23:43just continuously forever people will
23:45say things like if you don't play a
23:47strat various for like years now will
23:48turn into a b
23:54violent yeah but wine clearly
23:56depreciates with use
24:01so it appreciates with use and it
24:04appreciates with time I've never thought
24:06of an example like that hollow body
24:08guitars as well actually any like big
24:10wood it has with the wood of the
24:15instrument I don't know what to say
24:17about that I've never thought of an
24:18example like that before that's very
24:23interesting classic classic
24:26cars I don't think get better with use
24:29though if you take them out they're
24:31going to start rusting but if you don't
24:34use them they'll stop
24:37working you never want a classic car a
24:40lot of miles on it and it's just kind of
24:41though an investment in maintenance in
24:43that case I mean I don't I think that I
24:46would probably classify that as a
24:47durable because the truth is that even
24:49though maybe they last a long time
24:51eventually that violin is going to
24:53break don't you think or Rod I mean like
24:56wood literally doesn't wood doesn't last
24:59forever like off of a tree doesn't even
25:02last forever on a tree but it certainly
25:05doesn't last forever off a tree I mean I
25:08guess you could maintain it but you
25:10could try to maintain it but you have to
25:11make some investment to maintain it yeah
25:13so I would guess that that's basically a
25:15very strong
25:17durable well can durable appreciate it
25:19first and then eventually depreciate
25:21yeah I mean there's lots of temporal
25:23patterns that you can have and we'll
25:24talk actually about the fact that over
25:26different time Horizons things might be
25:28durables versus storables but
25:31yeah um yeah but I I like these types of
25:34questions because the a lot of the point
25:36of this lecture is like there's a lot of
25:37naive stuff in your Varan book which is
25:40like oh everything is more elastic in
25:41the long run than in the short run what
25:43you're starting to realize is like
25:44actually the temporal patterns of these
25:46things are pretty subtle and you really
25:48need to think about what I want you to
25:49be able to do in your minds is think
25:51about the real characteristics of the
25:53good and not just rely on this stupid
25:56claim byian and instead like actually
25:59think through like oh yeah here's how
26:01this good works therefore it's going to
26:03be durable over this duration stable
26:05over that duration that means we should
26:06expect the following things to happen I
26:08want you to be able to use the language
26:09of Economics to do that sort of stuff so
26:13okay uh on the more personal side things
26:16that are um D somewhat durable are
26:20production processes so like if you're
26:22used to doing something some way it
26:24might take a while for that to
26:25depreciate um personal relation ship are
26:28this way too you know they last somewhat
26:31long but you know if you they're not
26:33going to last as long as your education
26:35does right so it's much easier to switch
26:38friends than it is to switch your
26:40education memories like explicit
26:42memories not like things that are
26:44engrained into you like the way your
26:45education is but just like individual
26:47things you remember have a much quicker
26:50die off than yeah I F it uh but don't
26:54explicit memories also have a type of
26:57the ultra durable property when they're
26:59frequently recalled they kind of get
27:01their
27:02duration yeah explicit memories are a
27:05little bit complicated but I but I for
27:09the purposes of
27:10like everyday stuff it can sort of like
27:13pop back up but you don't have like
27:15command over it after you know weeks or
27:18months have passed usually except some
27:20things really get imprinted and then you
27:22can recall them
27:23but um okay then there's things that are
27:27in between which are variable these are
27:29things that are neither durable nor
27:31storable they're things that are totally
27:33you can use them now and then you don't
27:36care whether it's you know one after
27:39another or whether they're separated by
27:40a lot of time that doesn't matter um so
27:43unskilled labor bulky raw
27:46materials uh advertising is like this a
27:50lot of people think like if you remind
27:51if you make someone think that they like
27:53coke uh today that like has essentially
27:56no effect on whether they're going to
27:57like Coke in the future you have to like
27:59remind them again that they like Coke so
28:01a lot of advertising is like that R
28:03anything that's
28:05rentable uh that could be a durable but
28:09rentable uh is no longer a durable think
28:11about it like a car is not a durable if
28:14I can just like rent you know zip car
28:16for example has made uh cars much much
28:19more variable rather than durable
28:23because you it's now really easy to just
28:25get your car for the day and then not
28:26have a car the next day right right so
28:28if you can really easily rent something
28:30it's not a durable anymore um similarly
28:33something won't be a storable if you can
28:36easily buy and sell it with the market
28:39so like something like a great bottle of
28:41wine sounds like it's a dur a storable
28:45right because it you know it lasts
28:47forever maybe even gets better with time
28:49but it um you can only use it a certain
28:52number of times but if you can just sell
28:53that bottle perfectly back to the market
28:55and buy it when you want to consume it
28:57and there's loss to doing that then
28:59there's nothing storable about it right
29:02you can just get it when you want it and
29:03not have it the next day and have as
29:05many as you want and so forth great
29:08especially old ones there's a very fun
29:09at Supply well that's true from the
29:11global perspective but almost no
29:13individual is ever going to drink enough
29:15bottles even of like the rarest wines to
29:18like make a significant impact on their
29:20market price I mean maybe it's the very
29:23very very very extreme if you know
29:26there's some bottles from like the you
29:28know 18th century where there's like
29:30literally like five bottles and there's
29:32like one guy who plans in the course of
29:34his lifetime to drink all of those
29:35bottles but but like that's not a very
29:39common situation the world that we drink
29:41like Yeah from the perspective of the
29:43world they might be yeah yeah but from
29:45the perspective of an individual they're
29:48not okay things that are somewhat
29:50storable are inventories of
29:54goods uh so like you know if a firm uses
29:58up it's current inventory it can't sell
30:01those to people next month it has to
30:03produce more which is a little bit more
30:04costly but you know it can produce more
30:07so it's not that storable favors are
30:09storable they don't last that long like
30:11if you've done a favor for someone they
30:13owe you back but they'll probably forget
30:15if you don't use it pretty soon right um
30:19uh discontinued consumer goods are
30:22somewhat storable so I don't know if
30:23anyone's ever seen that Seinfeld episode
30:26about a lane
30:28and her contraception so there's like a
30:30type of contraception she really likes
30:33and she like doesn't like other types of
30:34contraception and it goes off the market
30:36and she has like a hundred units of this
30:38Contra contraception left and she
30:40basically has to decide like is the guy
30:42good enough to like Merit like her going
30:45to bed with him but she knows that she
30:46only is like a hundred units of this
30:48contraception left uh so that's like a
30:53example of a you know somewhat storable
30:55G but it's not like that storable
30:57because she probably could Somewhere Out
30:59There find it to get more of it if she
31:02really needed to right um some very
31:05storable things are exhaustible
31:07resources for the whole economy so the
31:09greatest bottles of wine might be an
31:11exhaustible resource like that there's
31:12only so much of it out there and we're
31:14just going to use it up but other ex
31:16more standard exhaustible resources are
31:19oil gas copper there's like only so much
31:22of that stuff out there basically from
31:25the perspective of an individual money
31:27is like the ultimate storable right like
31:30if I have only so much money I can use
31:32it today or I can use it tomorrow and
31:34you know that's it great bottles of wine
31:37are are another classic examples we went
31:41through okay so why does all of this
31:43matter to us well the reason oh actually
31:48uh gum is gum here
31:52no um well why does this matter to us
31:56the key point is that the more that you
31:58can adjust things the greater your
32:00reactions will be so Supply is going to
32:03be more elastic to shifts when you can
32:06adjust more things and this is
32:08independent of whether the things that
32:10you're adjusting are literally the thing
32:14that you're consuming or whether they're
32:16a complement for the thing you're
32:18consuming or a substitute for it so
32:21imagine the price of gasoline rises
32:24right now if you can adjust more things
32:28in your life you'll be able to reduce
32:30your consumption of gasoline more so for
32:32example if you can change the amount
32:34that you're traveling which is obviously
32:36a complement for
32:38gasoline then you'll adjust more right
32:41you'll reduce the amount that you travel
32:44and that will uh reduce the amount of
32:46gasoline you need to buy or you could
32:49buy something that's a substitute for
32:51gasoline which is a cleaner car if you
32:54can buy a cleaner car you'll also react
32:57more to the ch change in the price of
32:58gasoline this is called Le chatellier's
33:00principle I don't know how many of you
33:02guys have taken chemistry and remember
33:03Le chatellier's principle but it's the
33:05idea that if you um if a system is like
33:09allowed to adjust more things if you can
33:11like allow more things to get loose and
33:13whatever then it will come it will
33:15absorb more of the other chemical than
33:18it will if things are like more rigid
33:20right because as more things are allowed
33:23to adjust things are trying to
33:25accommodate the new environment right
33:27just like they're trying to accommodate
33:28this higher price the more things it can
33:30adjust the more it will
33:32accommodate okay and this is the driving
33:35force behind our analysis of duration
33:37Supply will be more elastic over time
33:40frames when more things can be adjusted
33:42now the key question is how much
33:45adjustment occurs relative to the market
33:48opportunities because as we said uh if
33:51something is durable but it can be
33:53cheaply rented then it's not really a
33:55durable if it's storable but it can
33:57easily be purchased off the market like
33:59a Lane's contraception or if it can be
34:02uh easily sold back to the market then
34:05it's not really a a storable so in this
34:08sense I think that durables are probably
34:10more common than storables in practice
34:12but not
34:14because they are in principle but
34:16because markets for most storable Goods
34:19exist and as a result of that it's
34:21easier to sell them back and buy them
34:25okay so uh following this we can
34:30Define um the notion of runs runs are
34:34going to be lengths of time over which
34:37you can adjust more or less things
34:40depending on uh how many of those
34:43durable things can be adjusted in the
34:44relevant period of time and each curve
34:48the long run and the short run curves
34:50correspond to a different duration of
34:52time over which a price changes because
34:56a supply curve is just telling you right
34:59uh how much you produce on average per
35:02unit of time and so you need to specify
35:05when you talk about the supply curve are
35:07you talking about you know on average
35:09over one month if the price is this
35:11level what are you going to do or on
35:13average over 10 months if the price is
35:15this level what are you going to do so
35:17what the supply curve really has to
35:19correspond to is the supply curve for a
35:21certain temporal run just as it
35:24corresponds to a certain product
35:27um so more
35:30durables uh can typically be adjusted
35:33the longer the Run of production we're
35:35talking about
35:36is right and there's no Universal
35:39definition but often we say that the
35:41short run corresponds to variable
35:43factors like unskilled labor raw
35:45materials with all things that are more
35:47durable than that being held
35:50fixed the medium term corresponds to you
35:53can adjust plant sizes production
35:55methods Etc
35:58uh but anything that's longer term than
36:00that has to be held fixed whereas the
36:03long run allows new firms to enter into
36:07the industry and the supply of the
36:10factors of production the things that
36:11the firm needs to buy they might also
36:14increase in their availability and
36:17increase their production increase their
36:20plants in order to accommodate
36:22themselves to the change in the uh the
36:26demand so now all of these things of
36:28course are Uris sixs and there are many
36:31counter examples so for example we think
36:33that you know it it's only in the long
36:36term that new firms enter the industry
36:39but you know when Groupon came into the
36:40market and that people saw there was
36:41demand for online coupons there were
36:43like within three months a thousand
36:45competitors for Groupon right and that's
36:47why Groupon didn't do so well um on the
36:51other hand the medical
36:52industry we think that you know adopting
36:56computers shouldn't take that long term
36:59right but the medical industry has taken
37:00forever to adopt computers well other
37:03Industries adopt them like almost as
37:05soon as they're available right so a lot
37:08of things depend on the institutional
37:09and legal context in which things
37:12operate for whether a particular type of
37:14adjustment will happen in a short run or
37:16in the long run and so therefore I think
37:19it's better rather than to say short run
37:21or long run to actually specify how many
37:23years you're talking about so you can
37:25actually say is this a you know
37:28something that in this context will
37:30adjust in this run or in a a a longer
37:33Run Okay so let's take a simple example
37:37yeah Adam well I was just going to ask
37:39um so um for the most part has like
37:42technology reduce what we consider long
37:46term
37:48um I think that that would overall be be
37:51the case but there are certainly some
37:53things that can become more storable
37:58uh sorry uh less storable as well
38:00because of
38:01Technology
38:03uh and some things that might be like
38:07more uh long-term as well so for example
38:11um when you're starting a company now
38:12it's much easier to enter quickly uh if
38:15you're like relying on servers because
38:17you can you don't need to have the
38:18servers physically in your building and
38:21that's a big invest durable investment
38:23you can just buy them from the cloud but
38:26on the other hand to build a server Farm
38:29now is much more of a durable investment
38:31because you're not just buying some
38:33servers for your office you have you buy
38:36this massive server farm that takes like
38:3910 years to build or something like that
38:41right so some things become more uh
38:44variable but other things become more
38:47durable and they sort of shift where the
38:49durability lives in some sense rather
38:51than you know yeah Mike did you have a
38:54question yeah it was kind of tangential
38:56about why uh the medical industry hasn't
38:59implemented computers is it because like
39:01if they have computers you won't like
39:03suddenly need to go to the doctor more I
39:04think it a lot has to do with like the
39:06fact the American Medical Association
39:07has so much power so they can like stand
39:09in the way of a lot of this stuff it's
39:11kind of amazing like you know you like
39:13there you would never I don't know if I
39:15mentioned this to you guys before you
39:17would never want to like go to the
39:20librarian uh and have them deliver your
39:23information to you you go on Google and
39:24you have it do it why don't you do that
39:26with medicals I think I mentioned that
39:28to you guys before right this is kind of
39:30crazy um okay so let's consider a simple
39:33example of Leer's
39:36principle um imagine that uh we have a
39:40production function which is that output
39:44is x to4 * Y
39:47point4 and imagine that both Factor
39:50prices are
39:52$1 so that gives us a total
39:55cost uh if we just use the formulas that
39:58we had from the other day of 2 * the
40:02output to the
40:051.25 because the best thing we can do is
40:07produce equal amounts of these two
40:10things right so then we're if uh because
40:14they have you know equal Factor prices
40:16and equal uh
40:18productivities right and so if we do
40:21that then Y and X are equal right so
40:24it's going to be X or Y to the point 8
40:27power so then we invert that and then it
40:30cost us two times however much we need
40:34right
40:35okay so the marginal cost associated
40:38with that is
40:402.5 times the output to the power uh .25
40:47right so in the long run imagine that
40:51the price is
40:522.5 well then the output is going to be
40:55equal to uh one right because output is
40:59the inverse of the marginal cost right
41:02uh right and we if the price was equal
41:05to 2.5 divide by 2.5 that gives us one
41:08and so the output will be one right and
41:12uh X and Y will both be equal to one
41:15because we use equal amounts of the two
41:17of
41:18them okay now suppose that Y is fixed in
41:22the short
41:23term you can't adjust Y and you it's
41:26chosen to be one match that long-term
41:29equilibrium what is going to be the uh
41:32shortterm marginal cost uh is Jake here
41:37no I think Jake dropped out of the
41:39class um does anyone else want to try to
41:43solve for the uh shortterm marginal
41:47cost yeah t so it be 2.5 time the
41:54output uh so why is that well because
41:57the uh current uh cost the total cost is
42:02to the output to the 2.5 + one the cost
42:06y yeah so you take the Der of that and
42:08you get a
42:102.5 and the reason it's 2.5 is that the
42:13at the Y is held fixed at one and so the
42:16output is equal x to the point4 so then
42:19you have to invert that and you get 2.5
42:21out of that right that's
42:24right um
42:28and then the total cost is output to the
42:302.5 yes plus one which is the cost of
42:33the Y so the marginal cost is 2.5 as
42:36Tanner said uh output to the 1.5 so
42:40there's two things to note here right
42:41note that the long run marginal cost is
42:44much more elastic than the short run one
42:47is right the long run one has you know
42:51to the 0.25 that's going to actually be
42:54concave right and it's going to be very
42:56flat there's one is going to be very
42:58convex because it's to the power
43:001.5 but at equilibrium at that long run
43:03price the supply is exactly the same
43:07right because if it's 2.5 this is
43:09output's going to be equal to one so at
43:11that long run place if we're in the
43:12long-term equilibrium these things are
43:15exactly the same they only differ when
43:18we're out of that long-term equilibrium
43:20right and that last principle is called
43:23the envelope theorem it says that even
43:26if we have something that's fix fixed as
43:28long as it's fixed at its optimal
43:30value the long run and the short run
43:33marginal costs are exactly the
43:37same that's a very general principle of
43:40optimization that will be useful in your
43:43problem sets and so forth that when you
43:45change one thing but you hold the other
43:49thing fixed at its optimal level you can
43:52ignore the effects coming through that
43:54thing or you can treat it as if it
43:56adjusted it doesn't matter it treating
43:59if it adjusts or it doesn't adjust you
44:01get the exact same result if it's at its
44:04optimal
44:05level and we'll see why it's called the
44:08uh envelope theorem in a moment so
44:10here's just graphing on Mathematica what
44:12those things look like right the short
44:14run marginal cost is convex and somewhat
44:18inelastic long run is very elastic you
44:21see how flat it
44:23is okay so I understand why it's called
44:27the the envelope theorem let's compare
44:29the short and the long run average
44:31rather than marginal cost
44:33curves
44:35okay so the long run average cost
44:39curve uh
44:41is um 2 times the output to the
44:47.25 right how can we see that well the
44:50total cost was 2 * the output to the
44:521.25 if we divide that by the output we
44:55get to the .25
44:58how about the short run um the short run
45:02average cost curve does anyone want
45:04to give that so uh remind me of your
45:08name um Julian Julian Julian so it
45:11should be um uh 2.5 to the 1.5 +
45:181/0
45:21exactly
45:24exactly uh we're y i' I've put it
45:28slightly more General so rather than one
45:30I put y there
45:33right so what the envelope theorem says
45:37is that the long
45:39run uh average cost is the envelope of
45:43the short run average cost so what do I
45:44mean by
45:45that so here are the short run average
45:48costs for different values of Y and I've
45:51highlighted the optimal value of y
45:54that's chosen along the long run curve
45:57at different points and what you'll
45:59notice is that the when the Y is equal
46:03to its optimal value these thing just
46:06just kiss each other right they're just
46:08tangent at that point so this thing is
46:11the envelope of all of these what's the
46:13envelope it's like you take all the
46:14tangent points as you run along it at
46:16the minimum and that traces out the long
46:19run average cost curve does that make
46:23sense and that principle exactly
46:25corresponds to what you we we said
46:29before which is that at the optimum the
46:31long and the short run marginal costs
46:33are identical that exactly corresponds
46:36to the average cost being tangent at
46:38those
46:41points
46:42okay and this is a really powerful
46:45principle that throws shows up all over
46:47the place in economics this is one of
46:48the most I think important principles in
46:50all of Economics so it's it's very
46:53useful to pay attention to it okay
46:57so um again I want to try to interpret
47:02these different responses in terms of
47:04different duration shifts in price
47:08right so the reason when we say things
47:11are more elastic in the long run what we
47:13mean is that if the price were to change
47:15for a long
47:17period the quantity supplied on average
47:20over that period would change by more
47:22than if the prices were to change for a
47:24short period and that's all that are run
47:27means when you you know long run what
47:29does that mean what what does run mean
47:31run means a run of
47:33production right I mean You' you've
47:36heard people say oh we're going to do a
47:37run for three months of this thing or
47:40this movie will run for four months a
47:42short run is a short run a long run is a
47:46long run I mean it's it's it's very
47:48simple actually but uh I think people
47:51don't really know what run means usually
47:54and and that that's the right way to uh
47:58to interpret it okay so um but if we
48:02take things seriously in terms of time
48:04if we really want to talk about time uh
48:07we need to ask some basic questions so
48:10like what is the relationship between
48:13the
48:13length uh of the of time and whether a
48:18good is durable or
48:20not um what would be shortterm reactions
48:24to a long-term shift
48:28so what do I mean by that what happens
48:30in like the first few months after we
48:32learn that things are going to be
48:33different for a long
48:35time um what are what's the long-term
48:38effect of there being many short-term
48:43shifts uh what happens if it's unclear
48:46how long a short-term shift is going to
48:50endure or whether it is shortterm or
48:53long term right what does the actual
48:56path over time of people adjusting to a
48:59shift look
49:00like now it's popular in economics and
49:04you'll learn in your next two courses in
49:06macro how to study these things using
49:09Dynamic models Dynamic models are ones
49:11that explicitly include time you know
49:14there's today there's tomorrow etc etc
49:16we don't do that in our models all the
49:17models in this class we're going to
49:18study are going to be static they're
49:20going to just say here is what the price
49:23is here is what the quantity is right
49:26now those model models are much simpler
49:27you don't have to worry in all these
49:29complicated ways about time um and it
49:33can get very confusing to keep track of
49:35what's going on in all these different
49:36periods so what I'm going to try to do
49:38today is give you a sense of how you can
49:40think in a quite interesting and
49:42Powerful way about what goes on over
49:43time just using static models with
49:46different temporal durations and you'll
49:48see that a lot of the things we can say
49:50about goes on over time you can
49:52understand just by thinking about static
49:54models with different temporal durations
49:56using the analysis we did in the
49:58class okay and in fact when you go into
50:01macro and you're doing all these really
50:03really complicated dynamic programming
50:04problems you may want to come back to
50:06some of the principles that you learned
50:08in this class and just think about well
50:10that's a long term this is a short term
50:13and how should we think from our basic
50:16intuitions from static models about
50:18what's going to
50:21happen Okay the basic key to this is to
50:24realize that all a static model is is an
50:28average of a dynamic World remember how
50:30I said that price Theory tends to think
50:33about things in a way that's aggregated
50:35up thinks about averages of things well
50:39time is really just something that you
50:41can either take an average over a long
50:42period of time or you can chop time up
50:46finely what price Theory does is it
50:48averages over time periods dyamic
50:51theories tend to chop things up and want
50:53to think about what goes on at each
50:54period individually so really Dynamic
50:57models and static model static models it
51:00sounds static it sounds like it's a very
51:01short period of time that's not right
51:03static model means an average over a
51:06long period of time whereas Dynamic
51:09models want to think about each moment
51:12separately okay so let's talk about some
51:15types of um shifts that can occur in
51:18demand and how firms will react to those
51:21different types of shifts so one type of
51:24shift is a onetime permanent change
51:26demand so like when the iPad came into
51:29fashion that just permanently reduced
51:31the demand for paper
51:33right and people sort of knew that that
51:35would last
51:36forever there can also be one-time
51:38temporary shifts such as the like recent
51:41trends for cupcakes though I think this
51:43is getting a little dated now I think
51:44cupcakes have already gone out of
51:45fashion uh but
51:49uh uh but I don't know what the like
51:51current trendy dessert is maybe Donuts
51:54oron cronuts cronuts right so that's a
51:56onetime temporary increase in demand
52:00things can also increase in What's
52:02called the secular Trend what secular
52:04Trend means it has nothing to do with
52:05whether it's religious or not secular
52:07Trend means that it's like gradually
52:09going up over time for a long period of
52:12time so like for example the demand for
52:14medical care people are living longer
52:17there's just a gradual and people are
52:18getting wealthier they're willing to
52:19spend more to stay alive longer there's
52:21gradual increase in demand for medical
52:24care as well as for Education because
52:25people in theel veloping world are now
52:27coming into the educational Market
52:29wanting to get top degrees that's a
52:31that's a secular Trend things can also
52:34move in predictable Cycles so for
52:37example the demand for vacations is a
52:39very famous cyclical Demand right
52:42because people want to take vacations
52:44during like the school vacation times
52:46and not during the term and electricity
52:49has high demand during the summer and
52:51somewhat high demand during the winter
52:53and low demand during the fall and
52:55spring
52:58now a thing to notice is that if
53:00something is durable and the demand for
53:03it has predictable cycles that will make
53:06it much
53:08costlier why durables don't like to have
53:11rapid changes right and so it's going to
53:13be costly to have rapid changes with the
53:16durable so how does that play out here
53:19well how Mike do you want to say
53:22something about that or no did yeah
53:24Philip well I think I know something
53:27about electricity what often companies
53:30do was they'll use some relatively
53:34predictable very durable type of method
53:37to produce the base electricity that's
53:40always demanded such as uh hydroelectric
53:44Dam or in particular a CO coal F Co Coal
53:48Fired plant or nuclear plant is a good
53:51one of these and then they'll use some
53:53plant that has can be ramped up very
53:57quickly uh for the spiky demand such as
54:00a natural gas fire and those ramped up
54:02ones are always more expensive right and
54:05so the fact that something that wants to
54:07be durable is being forced to respond to
54:10these spikes makes it more expensive
54:13although I think due to the new natural
54:15gas uh well it may be changing change
54:20but one they were built they were
54:21definitely more expensive yeah but I
54:23mean all but more more importantly I
54:25think like you just have to build a
54:27giant bunch of giant plants and you
54:29can't like build more plants at the
54:31moment when there's more demand you have
54:33to like you you can put more stuff into
54:35it but because there's these big plants
54:37that have to be built like that's just
54:39going to make it more expensive if there
54:41are Cycles than if there were constant
54:42amounts and you could build the amount
54:44that was perfect for all times similarly
54:46vacations are really really expensive in
54:50places that don't have any other
54:51industry and they're less expensive
54:53relative to like the overall real estate
54:55price in places where uh there is
54:59business Travelers as well right because
55:01then the demand because hotels are lumpy
55:04right and you want to keep sort of
55:06constant demand but if they have to make
55:08all their money to like recover the cost
55:10of the hotel in the vacation season when
55:12they have booking it's going to be very
55:14expensive right so anything that is
55:17durable but that faces cyclic demand is
55:20going to be very expensive relative to
55:22what it would be if you could have
55:24constant demand but the same amount of
55:26demand
55:27right so durables don't like to have
55:30these bumps on the other hand storables
55:32like to have these bumps right so a
55:36storable if you had to like consume that
55:39Peak amount of demand all the time of
55:41oil it would be much more expensive than
55:43if you have sometime people want oil
55:46sometimes people don't want oil because
55:48storables actually like to have these or
55:50you know
55:51vacations would actually probably be
55:54like less enjoyable if you didn't have
55:56some cycle to them because you would be
55:59constantly going on vacation and that
56:01wouldn't be actually all that
56:02interesting right so in fact the optimal
56:05production of storables will usually
56:07involve some sort of a cycle of using it
56:10things can also move in an unpredictable
56:13cycle such as the demand for men's
56:15underwear why is that well demand for
56:17men's underwear tends to follow the
56:19business cycle when a lot of people are
56:21un when a lot of men are unemployed they
56:22tend not to buy new underwear it turns
56:25out uh and they just use that they
56:27scrimp and they use their old underwear
56:28and let it like disintegrate
56:31right and uh um the business cycle is
56:34pretty unpredictable so the demand for
56:36men's underwear is follows a pretty
56:37unpredictable cycle um demand can also
56:41move
56:42erratically uh sort of like with no good
56:45pattern so like a lot of fashion demand
56:47is that way uh demand for gold diamonds
56:51Etc okay now um it's not only the
56:56expected duration of a shock but the
56:59time since the shock occurred that
57:01matters for example there can be lags
57:04after there's a shock and returning to
57:06the equilibrium before the shock imagine
57:08demand goes up temporarily for a while
57:10but then it takes a while to ramp down
57:12now the simplest example would be like
57:13cupcakes there's like all these cupcake
57:15stores built and what's going to
57:17probably happen is as the demand for
57:18cupcakes go down they'll sort of persist
57:20for a while their prices will fall you
57:23know and they'll take a while to
57:24eliminate all those cupcakes stores that
57:26got built but I think my favorite
57:28example happens during Civil Wars or
57:31other violent episodes uh Mike this
57:33thing's
57:36flashing
57:38um so uh drug demand dramatically
57:42increased in me demand to ship drugs
57:45through Mexico dramatically increased
57:47because the US cracked down on what used
57:49to happen which is the Colombians used
57:51to fly uh Planes full of drugs to the US
57:55and then there was a big crack on that
57:56and
58:20that and they've been trained to be very
58:23violent right so what they've done given
58:25that the uh amount of profits they can
58:27make in the drug trade has gone
58:29down is they've gone into other areas
58:33like um kidnapping uh Etc because
58:37there's no longer the profitability here
58:39but they're trained in this violence so
58:41the even though the demand for the
58:43violence in some sense has dissipated
58:45now there's a long process of
58:47readjusting to the equilibrium similarly
58:50countries that have had a civil war
58:52almost always have years of like just
58:54criminality after that Civil War because
58:56it takes a while for those people to
58:58adjust back to society and go to other
58:59things so even though the demand for
59:01violence has gone down the violence will
59:02persist because there's this durability
59:05that causes you know it to be
59:07intertemporal compliments
59:10yeah like the overall durability of
59:13things like violence like if you were to
59:15compare I don't know like Cambodia and
59:17Mexico after you know peace periods
59:20violence tend to you know yeah it it
59:22would be interesting I think it depends
59:23a lot on the educational institutions of
59:25the country right so if you have really
59:27good retraining programs that decreases
59:28the durability of Education if you have
59:30really good military that also decreases
59:32the durability of education so having
59:36educational institutions I think is a
59:38really important way to change the
59:40durability of that so like a lot of you
59:43know Colombia has had this big thing
59:44about like retraining
59:46guerillas uh from the Civil War to try
59:48to avoid that
59:51problem um
59:53okay uh so it takes a long time for this
59:57sort of violent human capital to
1:00:00depreciate but there can also be lags in
1:00:03getting to the post shock equilibrium so
1:00:04there's both ones in coming back from it
1:00:06but also getting to it so for example I
1:00:09think probably Google's market dominance
1:00:11was largest about six years ago not
1:00:14today uh because now they have Facebook
1:00:16and all these other things that have
1:00:18like but they're the actual size of
1:00:21their Workforce is continually growing
1:00:23why is that because it's taken a while
1:00:25for them to hire people I mean they they
1:00:28were only a few years old six years ago
1:00:30right and so it took a while for them to
1:00:32establish an HR division to hire the
1:00:34people for the HR division those people
1:00:36that they hired in the HR division could
1:00:37then hire people and then you know they
1:00:40had to build campuses for the people all
1:00:41these things are highly durable right so
1:00:44Google's still catching up to the big
1:00:46shock to demand that it faced right
1:00:50there going to also be lags in adjusting
1:00:52to or away from cyclicality so for
1:00:55example it used to be that there was
1:00:57like this need for all these migrant
1:00:59workers to come to California now that
1:01:02agriculture has ways that they can
1:01:04sustain it over longer periods of time
1:01:06it's not as seasonal and also the
1:01:08seasonality of the demand is cushioned
1:01:10by all these Foreign imports so they
1:01:11could just have more of a permanent
1:01:13Workforce in California now but they're
1:01:15used to having cycles and so they had
1:01:18all these immigrant workers coming and
1:01:20so just like the process of changing
1:01:22away from having Cycles itself can have
1:01:24a lag right so what I'm trying to show
1:01:27you is that like by putting together
1:01:28different of these temporal aspects that
1:01:30we're learning in different combinations
1:01:31you can explain a lot of
1:01:34phenomena so one really cool example of
1:01:38this uh is the cyclical pattern of
1:01:41demand for cattle of or of supply of
1:01:44cattle so this shows as a function of
1:01:47the number of uh over time what the
1:01:50number of cattle in the United States
1:01:52has been and you see it follows this
1:01:54very regular cycle
1:01:56seems weird it doesn't have anything
1:01:57particularly to do with the business
1:01:58cycle what's going on well think about
1:02:02how cattle work imagine there's like a
1:02:04big UPS surgeon the demand for beef
1:02:07today what will happen well if it's very
1:02:09short lived you'll probably kill More
1:02:12Cows today to serve that demand but if
1:02:14it's going to last for a little bit
1:02:16longer what would you do you'd actually
1:02:19have less beef supplied to the market
1:02:20today why so you can have more cows
1:02:23breed so you can supply more beef to the
1:02:25market tomorrow
1:02:26right and if it's extremely long lived
1:02:30you know whatever so the point is that a
1:02:33shock to demand today can cause ripples
1:02:36for many years because you'll get more
1:02:39in the future and then you'll Slaughter
1:02:40that and then that will reduce the
1:02:42number that you have and etc
1:02:45etc
1:02:47okay so so far beyond our initial
1:02:50discussion I focused on um durable uh in
1:02:56puts but now I want to talk about an
1:02:58extreme counter example which is oil
1:03:00which is like a super super super
1:03:03storable input right because oil can
1:03:06essentially costlessly be stored in the
1:03:08ground but it's very uh cheap to extract
1:03:11it uh except for fracking but I mean for
1:03:13the like Saudi Arabia and so forth it's
1:03:15very cheap to
1:03:16extract if there's no cost of extraction
1:03:19then the price of the oil has to rise at
1:03:22exactly the interest rate and can anyone
1:03:24tell me why that is
1:03:26uh reishi um so if there's no cost of
1:03:30extraction then if you sell the oil
1:03:32today yeah and you know it's you know
1:03:34the price is going to rise later on you
1:03:36want to make sure that what you sell it
1:03:38for today is at least as much as what
1:03:40you would have gotten for when you sell
1:03:41it when you would have sold the exactly
1:03:44and and the difference between today and
1:03:46tomorrow is however much you can earn
1:03:48saving that money
1:03:50right on the other hand if it were
1:03:53cheaper today
1:03:56uh then you would just sell the oil
1:03:59tomorrow and borrow the money that you
1:04:01need today yeah remind me of your name
1:04:03my uh I was just wondering what if there
1:04:06were a cost of extraction like how would
1:04:08that
1:04:09affect so then it has to be that the
1:04:11rent that you get is grows at this
1:04:14interest rate the rent that you get is
1:04:17the amount um that you get on the market
1:04:21minus the cost of
1:04:22extraction so that difference has has to
1:04:25grow at the interest rate okay that's
1:04:27called the the the rent the oil the uh
1:04:31exhaustible
1:04:33rent uh yeah follow that would be
1:04:35assuming that the cost of extraction is
1:04:38just a constant and you can yes a large
1:04:42am well but okay so if it's not a
1:04:45constant then you need that the mar the
1:04:48rent on the marginal unit that you uh
1:04:51extract grows at the interest rate
1:04:57okay so um there if there's a temporary
1:05:03shock
1:05:06uh note that all prices through for the
1:05:10rest of time will move uh
1:05:14proportionately why is that well imagine
1:05:18that there's like suddenly a surge in
1:05:19demand for oil but it only lasts for a
1:05:21few weeks right in order for this
1:05:23equation to still be the case all pric
1:05:26have to rise for all of the rest of the
1:05:28future uh by however much they rise
1:05:30today because otherwise everyone would
1:05:33put all their oil on the market right
1:05:34now right and so that means that if oil
1:05:38Rises for a short period of time the
1:05:40demand for oil Rises there can be almost
1:05:42no increase in price because you can't
1:05:45have like for a very short increase in
1:05:47demand that like oil for the rest of
1:05:49time is going to be more expensive right
1:05:53and so what that means is the oil price
1:05:55hardly moves it all and to accommodate
1:05:57that demand it's almost all an increase
1:06:00in quantity which means extremely
1:06:02extremely elastic Supply in that short
1:06:04term right it's basically like any
1:06:06demand is just completely accommodated
1:06:08by an increase in Supply yeah Philip um
1:06:11in the real world since OPEC commands
1:06:15Market power is that why we see uh large
1:06:19spikes and Cycles like oil hitting 110
1:06:22pretty
1:06:23quickly well so I mean OPEC does have
1:06:27some incentives to do that what they
1:06:29actually want to do is set the marginal
1:06:31revenue uh to grow at the interest rate
1:06:35but
1:06:36the they'll only have an incentive to
1:06:39raise prices in response to a demand
1:06:41shock if it makes demand more inelastic
1:06:43not if it just increases the total
1:06:44quantity of demand and it's not clear
1:06:47that most demand increases make demand
1:06:49more elastic in
1:06:51elastic question is like has the average
1:06:53willingness of people to pay gone up or
1:06:55is it just that there are more people
1:06:57who want to buy it like more total
1:06:58demand I don't know and sometimes there
1:07:01can be more demand and actually people
1:07:02are more
1:07:03elastic you know for example during a
1:07:06recession measure that there's a
1:07:09recession but it's also the summer time
1:07:10well people have more demand for gas but
1:07:12they'll also be cheaper you know they
1:07:14won't want to pay as much and then you
1:07:16might actually lower the price so it's
1:07:18not it's not completely obvious yeah so
1:07:21what oil does go these wild swings
1:07:23occasionally does like like a lot of
1:07:24Commodities what do you that to
1:07:25speculation about potential future
1:07:27shocks I mean that's the reason why oil
1:07:29does go on those wild swings think about
1:07:31it all the prices need to be the same
1:07:34over time so that means any information
1:07:36that you get about any
1:07:38future uh demand shock could cause the
1:07:42price to change for no apparent reason
1:07:45today so that's why oil is so volatile
1:07:48and other things are much more stable is
1:07:50because they're those are more durable
1:07:52it's affected by immediately apparent
1:07:54factors not by the
1:07:56crazy things about the future
1:07:59demand
1:08:01um and so everyone says that's
1:08:03speculation but it's just the law of
1:08:06exhaustible resources and that's
1:08:07incredibly logical and it's socially
1:08:09valuable that that happens imagine that
1:08:11we learn that there's going to be a huge
1:08:12amount of demand for oil in the
1:08:14future if the price of oil didn't
1:08:17suddenly rise today then we would be
1:08:19using way too much oil today and not
1:08:21saving it for the future right it's like
1:08:24if you were to learn that um imagine
1:08:27like you have some booze and like you
1:08:29don't have access to a fake ID and you
1:08:32suddenly learn that like you know
1:08:34there's some uh you know potential
1:08:37romantic partner who you want to like
1:08:39throw a party for uh some time in the
1:08:41future well you're going to stop
1:08:43drinking your booze today right so that
1:08:45you can save it for that time in the
1:08:46future right uh and uh in the same way
1:08:50like the economy should save its oil if
1:08:52we suddenly learn that there's going to
1:08:54be uh a real need for oil in the future
1:08:58right on the other hand I think that
1:09:01this uh shows us so this shows you that
1:09:05demand is much much more elastic in the
1:09:06short term than in the long term for an
1:09:08exhaustible resource that's very
1:09:10storable like
1:09:11this it also has some really important
1:09:13lessons for climate policy so imagine
1:09:16that we just put a uniform tax on oil
1:09:18that's going to last forever that's
1:09:20basically going to do
1:09:22nothing right because the price will
1:09:25just rise all the prices will rise but
1:09:28it's not going to change when we consume
1:09:29the oil we're going to consume the oil
1:09:31at some point right what really matters
1:09:34is the timing of the oil tax so if you
1:09:36say we're going to have a high tax now
1:09:37but then it's going to go down over time
1:09:39that will get us to consume the oil much
1:09:41in the future rather than today yeah go
1:09:43ahead jul in the book it said that uh
1:09:46the like the price at the End of Time
1:09:49depends on uh what you would be
1:09:50replacing oil with so if the tax
1:09:54increase like more development of
1:09:56Renewables which then reduces the price
1:09:58of Renewables cuz the technology gets
1:10:01better then wouldn't
1:10:03have I guess that that would be actually
1:10:05worse so that that that's actually the
1:10:08really bad thing imagine that oil is
1:10:10going to be cheap in the like there's
1:10:13going to be no use for oil in the future
1:10:16then you'll use even more today so
1:10:18actually the devel expecting development
1:10:20of Renewables in the future can actually
1:10:22worsen the climate change problem
1:10:28it's pretty interesting no remind me of
1:10:31your name Dake Dake oh then why are oil
1:10:34why would you explain oil prices rising
1:10:37over time and especially in the past say
1:10:3910 or 20 years I'm not really an expert
1:10:43on the oil Market but I would guess that
1:10:46what's happening is people are expecting
1:10:48instability in the in the Middle East
1:10:50well that wouldn't necessarily do it
1:10:53actually e actually people are expecting
1:10:55the Middle East to get more stable
1:10:57because what could happen is then then
1:10:59the the the cost of extracting it from
1:11:01the Middle East will be lower in the
1:11:02future than it is today and that'll mean
1:11:04people don't want to extract it
1:11:06today I mean it's really it's a
1:11:08complicated problem you see what I mean
1:11:10to even interpret what's going on like
1:11:12you can see why it's hard to be an oil
1:11:14analyst but you really need to think
1:11:15about all these factors oh so if it's
1:11:17cheaper to get oil in the future if it's
1:11:20cheaper to extract the oil in the future
1:11:21then you want to extract it in the
1:11:22future rather than today that makes it
1:11:24more expensive today okay you see what I
1:11:27mean yeah Christen I mean don't you
1:11:28think it could just be the like we
1:11:30talked about the anticipation of future
1:11:31regulations and taxes on o like say or
1:11:35the anticipation of I I actually I
1:11:38genuinely think the anticipation
1:11:41of yeah so the question is if people
1:11:44don't anticipate us developing
1:11:46Renewables so like for example if you
1:11:49anticipate imagine the people thought
1:11:51that in like 5 or 10 years we might get
1:11:54Kyoto but now suddenly people are like
1:11:56oh Kyoto is not going to happen at
1:11:58all like they we're not going to do
1:11:59anything about climate change that could
1:12:01actually cause the price of oil to go up
1:12:04today because now they no longer think
1:12:07that there's going to be all these
1:12:08Renewables that would lead us to want to
1:12:10consume our oil
1:12:15today so I mean yeah so like this is the
1:12:18really cool thing about the economics of
1:12:20this stuff is if you really learn to
1:12:21think about it you can really interpret
1:12:23what's going I mean I haven't thought
1:12:24through it we're sort of just thinking
1:12:25through it on the Fly here right but it
1:12:27gives you this whole set of
1:12:29tools it's not about the mathematics
1:12:31it's about the tools that you're going
1:12:33to get that are going to be able to make
1:12:35you like a really valuable person for a
1:12:37company to hire because they're going to
1:12:39be able to like you're going to be able
1:12:41to say things about this that they
1:12:43wouldn't be able to think of you know
1:12:45what I
1:12:46mean okay so oil and other exhaustible
1:12:50resources are an extreme but very
1:12:52important case and I think there's like
1:12:54a much broader lesson here about
1:12:56economics so like for example in macro
1:12:58you learn that the long-term supply
1:13:01curve is
1:13:02vertical right whereas the short-term
1:13:05supply curve could be more horizontal
1:13:08right but this is exactly the
1:13:10exhaustible resource model on the other
1:13:13hand you learn that everything in micro
1:13:16is more elastic in the long run than in
1:13:17the short run so why should the economy
1:13:20as a whole be more elastic in the short
1:13:23term than in the long term well B based
1:13:25on this idea that there's like a fixed
1:13:27amount of stuff we have and we either
1:13:28consume it today or we consume it
1:13:29tomorrow and we can't increase it is
1:13:32that really realistic imagine that like
1:13:35currently there's no demand and so like
1:13:37all of the people unemployed and
1:13:39therefore their skills start going to
1:13:41crap then there's not going to be as
1:13:43much ability to produce tomorrow because
1:13:46people's skills won't be as good or
1:13:48imagine that like everybody's unemployed
1:13:50and so there's no like people developing
1:13:52new technologies
1:13:55then will that will reduce the
1:13:57production in the future as well yeah
1:13:59Philip but what about all those
1:14:01unemployed people start going to college
1:14:04instead well so then it could have the
1:14:06opposite I mean you see like this this
1:14:09uh this idea in macro is based on like
1:14:13one incredibly incredibly stylized
1:14:15assumption about what like the supply
1:14:17side of the economy looks like and all
1:14:20the micro results are based on exactly
1:14:22the opposite completely stylized
1:14:24assumption of what the economy looks
1:14:25like one's based on complete storability
1:14:27one's based on complete durability and
1:14:31they're all just like oh yeah well
1:14:32that's sort of how it is there's like no
1:14:34real discussion of like why that
1:14:36assumption is being made whether it's
1:14:38realistic given the things that you're
1:14:39talking about Etc right so there's like
1:14:44these two things that you learn are
1:14:45completely inconsistent with one another
1:14:47and yet you learn them both as if
1:14:48they're completely obvious right so like
1:14:52I one of the fun things about preparing
1:14:54this lecture was I was was basically
1:14:55going to try to teach you these two
1:14:56things and I was trying to think how the
1:14:58hell are these consistent with one
1:14:59another and I realized well it depends
1:15:01on whether things are intertemporal
1:15:02compliment or substitutes and you know
1:15:04if you learn to actually think through
1:15:07this stuff rather than just take what
1:15:09your book tells you you know you'll have
1:15:12much more power to really come up with
1:15:15something that makes sense and to
1:15:17critically evaluate the ideas you get
1:15:19almost anytime you see a result in an
1:15:21economics book and it seems like it came
1:15:23from heaven and you sort of don't
1:15:24understand why it's almost always
1:15:25because there's some really strong
1:15:26assumption being made uh that maybe not
1:15:29that realistic so you you almost get you
1:15:32almost never get something for nothing
1:15:35it's almost always coming out of some
1:15:36assumption you're making uh and so you
1:15:39should really view economics as a
1:15:40toolbox for thinking about the world
1:15:42around you rather than a set of like
1:15:44conclusions that you should just
1:15:46impose so

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