[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Internet Connection
THE DEMAND AND SUPPLY IN THE OIL MARKET
The U.S. Energy Information Administration (EIA) has a slide
presentation at www.eia.doe.gov/emeu/25opec/anniversary.html
that illustrates some of the major ways that the energy price
increases during the 1970s affected the types of cars Americans
bought and how they heated their homes.
exchange.” Figure 3.15 presents a demand and a supply curve for water. Individuals
are willing to pay a high price for the water they need to live, as illustrated by point
A on the demand curve. But above some quantity, B, people will pay almost nothing
more for additional water. In most of the inhabited parts of the world, water is readily
available, so it is supplied in plentiful quantities at low prices. Thus, the supply curve
of water intersects the demand curve to the right of B, as in the figure—hence, the
low equilibrium price. (Of course, in the desert the water supply may be very limited
and the price, as a result, very high.)
To an economist, the observations that the price of diamonds is
high and the price of water is low are statements about supply and
demand conditions. They say nothing about whether diamonds are
“more important” or “better” than water. In Adam Smith’s terms,
they are not statements about value in use.
Price is related to the marginal value of an object: that is, the value
of an additional unit of the object. Water has a low price not because the
total value of water is low—it is obviously high, since we could not live
without it—but because the marginal value, what we would be willing
to pay to be able to drink one more glass of water a year, is low.
Just as economists take care to distinguish between the words
“price” and “value,” so they also distinguish the price of an object (what
it sells for) from its cost (the expense of making the object). This is
another crucial distinction in economics. The costs of producing a
good affect the price at which firms are willing to supply that good.
An increase in the costs of production will normally cause prices to
rise. And in the competitive model, in equilibrium, the price of an object
will normally equal its (marginal) cost of production (including the
amount needed to pay a firm’s owner to stay in business rather than
seek some other form of employment). But there are important cases—
as we will see in later chapters—where price does not equal cost.
As we think about the relationship of price and cost, it is interesting
to consider the case of a good in fixed supply, such as land.
Normally, land is something that cannot be produced, so its cost of
production can be considered infinite (though sometimes land can
be produced, as when Chicago filled in part of Lake Michigan to
expand its lake shore). Yet there is still an equilibrium price of land—
where the demand for land is equal to its (fixed) supply.
PRICE OF WATER
Quantity
needed
to live
A
Figure 3.15
Demand
for water
B
Quantity
beyond
which extra
water has
little use
Equilibrium
quantity
QUANTITY OF WATER
SUPPLY AND DEMAND FOR WATER
Supply
of water
Point A shows that people are willing to pay a relatively high
price for the first few units of water. But to the right of B,
people have plenty of water already and are not willing to
pay much for an additional amount. The price of water will
be determined at the point where the supply curve crosses
the demand curve. In most cases, the resulting price is
extremely low.
PRICE, VALUE, AND COST ∂ 71