Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Wednesday, June 08, 2005

Short-Run and Long-Run Effects of an Increase in Demand

Here is one of the very best real-world examples I have seen of
  1. the short-run and long-run effects of an increase in demand, and
  2. the inability on the part of journalists to understand these basic relationships.

Suppose it takes some time for the quantity supplied to adjust to new, higher prices. Then an increase in demand will raise prices in the short-run.

However, in the long-run, the higher profits will induce entry into the industry.

One would think entry would drive prices back down to their original point, but that will not happen if some of the inputs are fixed or in short supply.

John Chilton provides a great example in grocery pricing:

Demand is being pushed up by a rapid growth in population and by the growth in the country's income from oil due to the steep increase in world oil prices. An increased demand leads to an increase in retail prices at groceries even if the wholesale prices have not changed. Some groceries are experiencing above normal profits. ...

The profits the groceries experience will attract entrants and supply will grow with time. However, because the rent for retail space has increased, retail prices for groceries will not return to their previous level.

Straight-forward and brilliant.

As I told a bunch of journalists many years ago, "Look for the fixed factors."

Who Links Here