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Session 1: Partial Equilibria using Matrix Algebra.
The position of equilibrium (eqm) is very important to
economists applied in numerous models.
Equilibrium: a point of rest i.e. all outside forces that alter a
particular variable are constant.
When those outside forces change we get a new equilibrium
(instantaneously or otherwise).
In economics we have endogenous variable(s) determined
by a model that is a function of exogenous variables. Classic
example is Demand = Supply.
D = f(P)
S = f(P)
If the price of another good (exogenous variable) alters, it
may change demand until a new eqm is reached. Eqm price
and quantity are treated as endogenous variables in this
context.
Equilibrium is not necessarily desirable. It is simply a
position obtained. “Goal” equilibria is another issue
altogether explored later (max utility; max profit; min av.
cost). An economy can settle at an eqm position of high
unemployment which is not a good thing.
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A Partial equilibrium model: Demand and Supply
(linear case)
Find values of endogenous variables that satisfy an eqm
condition.
Demand (Qd) and Supply (Qs) : single good case
In general Q = f(P)
More specifically:
Qd = Qs
Qd = a – bP
Qs = - c + dP
We require 3 endogenous variables to be solved: P*, Qd*
and Qs* where Qd* = Qs*
Find P* first
a – bP = - c + dP (easier to rid negative signs)
a + c – bP = dP
a + c = dP + bP
a + c = P(d + b)
a + c = P* → reduced form (endog expressed in
d+b terms of exogenous (d+b≠0) vbles only
So note here that one of the endogenous variables has been
expressed in terms of the parameters (a,b,c,d) and not Q
which itself is another endogenous vble. The parameters in
a sense are behaving as exogenous vbles (slopes and
intercept terms).
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Now for Q* (take Qs or Qd and substitute in)
Q* = a – b(a + c)
b+d
= a(b + d) – b(a + c)
b+d
= ab + ad – ba – bc
b+d
Q* = ad – bc → reduced form (ad > bc for Q* > 0)
b+d
A numerical example
Qs = -32 + 7P
Qd = 128 - 9P
Qs = Qd
128 - 9P = -32 + 7P
160 = 16P
10 = P*
If P* = 10, Qd* = Qs* = 38.
Check general equations
a = 128; b = 9; c = 32, d = 7
a + c = P* = 128 + 32 = 10 ☺
d+b 7+9
ad – bc = Q* = 128*7 – 9*32 = 38 ☻
d+b 7+9
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A 2 good model (beef and pork):
QdB = 82 – 3PB + PP
QsB = -5 + 15PB
QdP = 92 + 2PB - 4PP
QsP = -6 + 32PP
Qs = Qd in each market simultaneously
Complements or substitutes?
Methodology: substitution of variables
82 – 3PB + PP = -5 + 15PB
92 + 2PB – 4PP = -6 + 32PP
18PB – PP = 87 (1)
-2PB + 36PP = 98 (2) 2 equations, 2 unknowns
Solve for PP in (1)
PP = 18PB – 87
Substitute in (2)
-2PB + 36(18PB – 87) = 98
646PB = 3230
PB* = 5
Substitute PB = 5 in (1)
PP = 3
So QdB* = 70 = QsB* and QdP* = 90 = QsP*
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CLASS: Another 2 good model (shirts and jackets):
QdS = 410 – 5PS – 2PJ
QsS = -60 + 3PS
QdJ = 295 – PS – 3PJ
QsJ = -120 + 2PJ
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A 3 good model
Qd1 = 23 – 5P1 + P2 + P3
Qs1 = -8 + 6P1
Qd2 = 15 + P1 – 3P2 + 2P3
Qs2 = -11 + 3P2
Qd3 = 19 + P1 + 2P2 – 4P3
Qs3 = -5 + 3P3
Set all equations to zero once Qdi = Qsi
31 – 11P1 + P2 + P3 = 0 (1)
26 + P1 - 6P2 + 2P3 = 0 (2)
24 + P1 + 2P2 - 7P3 = 0 (3)
3 equations; 3 unknowns
Eliminate one of the variables (e.g. P2)
(1) * 2 = 62 – 22P1 + 2P2 + 2P3 = 0 (4)
then do (4) – (3)
62 – 22P1 + 2P2 + 2P3 = 0 (4)
–
24 + P1 + 2P2 - 7P3 = 0 (3)
=
38 – 23P1 + 9P3 = 0 (5)
Multiply (3) * 3 =
72 + 3P1 + 6P2 - 21P3 = 0 (6)
(2) + (6) =
7
98 + 4P1 - 19P3 = 0 (7)
Now we have 2 equations (7) and (5) that contain P1 and P3
Solve for P1 and P3
38 – 23P1 + 9P3 = 0 (5)
98 + 4P1 - 19P3 = 0 (7)
(5) * 19 = 722 – 437P1 + 171P3 = 0
(7) * 9 = 882 + 36P1 - 171P3 = 0
Add the two new equations:
1604 = 401P1
P 1* = 4
Substitute P1* in (5)
38 – 23*4 + 9P3 = 0
P 3* = 6
Substitute P1* and P3* in (1), (2) or (3) to get P2* = 7.
CLASS: Another 3 good model:
After setting Qdi = Qsi
4P1 + 3P2 + 5P3 = 27 (1)
P1 + 6P2 + 2P3 = 19 (2)
3P1 + P2 + 3P3 = 15 (3)
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A Partial equilibrium model: Demand and Supply
(non-linear case)
Look at a non-linear demand function and linear supply
function using coefficients.
Qd = Qs
Qd = 4 - P2
Qs = 4P - 1
Where Qd = Qs we get a quadratic equation:
P2 + 4P - 5 = 0 quadratic equation (reveals 2 ordered
pairs P1,0 and P2,0) )
[P2 + 4P - 5 = f(P) quadratic function] (reveals infinite
solutions, Pi, f(Pi))
Finding solution values of P where f(P) = 0 gives us the
“roots” of the quadratic equation or our equilibrium values.
Compare fig 3.2 with 3.3.
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Solving a quadratic
Use the quadratic formula:
If ax2 + bx + c = 0 then
x1* and x2* = -b ± (b2 - 4ac)1/2
2a
So from our example, if a = 1, b = 4, c = -5
P1* and P2* = -4 ± (42 - 4*1*-5)1/2
2
= -4 ± (16 + 20)1/2
2
= -4 ± 6
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P1* and P2* = 1 and -5
Since we are only interested in positive values of P, we take
P* = 1 (and Q* = 3) as the solution value.
If we have a higher polynomial such as P3 - P2 - 4P + 4 = 0
then the factoring becomes more difficult but the principle is
the same.
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CLASS: Another non-linear example
Question 1.
Solve equilibrium values for P and Q when:
Qd = 3 - P2
Qs = 6P - 4
Question 2.
Qd = 3P + Q2 + 5Q - 102 = 0 (1)
Qs = P - 2Q2 + 3Q + 71 = 0 (2)
Question 3.
Qd = P + Q2 + 3Q - 20 = 0
Qs = P - 3Q2 + 10Q = 5
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Application in Income Determination
Nice examples of partial equilibria in macro too.
Keynesian model:
Y=C+I+G
C = a + bY
Which are endogenous and exogenous?
Endogenous Exogenous
C, Y I, G, a, b
We need equilibrium values of Y and C (Y* and C*)
expressed in terms of the exogenous variables (the reduced
form) only.
To begin with we can simply substitute C in Y:
Y = a + bY + I + G
(1-b)Y = a + I + G
Y* = a + I + G
1-b
where 1/1-b is the simple Keynesian multiplier.
To find C* we simply substitute in to C:
C* = a +bY*
C* = a + b(a + I + G)
1-b
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multiply both sides by 1-b:
C*(1-b) = a(1-b) + b(a + I + G)
C*(1-b) = a-ab + ba + bI + bG
C*(1-b) = a + bI + bG
C* = a + b(I + G)
(1-b) (assuming b ≠ 1 and in general MPC ≠ 1)
The endogenous variable, C* is expressed in terms of
exogenous variables only.
Another example:
Y=C+I Yd = Y - T
C = 100 + 0.6 Yd T = 50 I = 40
i) Identify exogenous and endogenous variables:
ii) Find equilibrium income with and without tax
i)
Endogenous Exogenous
C, Y,Yd I, T
ii) Without tax
Y=C+I
Y = 100 + 0.6Y + 40
Y* = 350
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With tax
Y=C+I
Y = 100 + 0.6(Y-T) + 40
Y = 140 + 0.6(Y-50)
Y-0.6Y = 110
Y* = 110/0.4 = 275
CLASS
C = 48 + 0.8Y
Y=C+I
I = 98 - 75i
Ms = 250 (money supply)
Mt = 0.3Y (transactions demand for money)
Mz = 52-150i (speculative demand for money)
Find the values of Y and i when both the commodity markets
and money markets are in equilibrium.
