Income changes in the supply-demand model

This discussion could be helpful at the very beginning of the Microeconomics course, to establish concepts of supply and demand model, shifts of the curves and along the curves, the changes in prices and quantities as a result of a change in an exogenous variable as income. It also shows the students how realistic phenomenon and statistical information could be analyzed by using theoretical models of economics. Last, students can understand the dynamic of economics markets, how one result could influence another. This activity could take only about 10-15 minutes, but will give the option to those who are interested in the topic to develop it to other directions as international trade and economic growth. No special equipment is necessary for the discussion and its relatively easy to adapt the activity to other contexts and data.

Expected Student Learning Outcomes

This exercise should enable students to understand the consequences of income changes, the following shift in demand for different types of goods (normal, inferior or luxury good) and the final result of price and quantity changes. Students will be able to analyze an observed phenomenon in the international market and use the theory of demand and supply in order to explain how it happened. Students will be able to differentiate between endogenous changes (movements along the demand curve) and exogenous changes (shifts of the demand curve to the right or to the left).

Information Given to Students

You are a chief economist to the White House; your expertise is international relations and economic growth. In order to strengthen the relationship with China, you prepare a report on their recent economic development in education, real estate, health and energy. It appears from the data that over the last decade, energy prices in China have risen 30%, but energy use per person in China has risen 35%. This information seems weird to you, as you know that along the demand curve there is a negative correlation between price and quantity, and you are looking for possible explanations to see if this phenomenon follows the law of demand.

Your possible explanations are:

A. Chinese government intervention in markets causes results not predicted by supply-demand analysis.

B. This change must be coming from a shifting of the demand curve, rather than a movement along it.

C. Price ceilings on energy were eliminated.

D. Energy in China is an inferior good.

Students should be able to discuss each one of the possible explanations. Eliminate explanations which cannot explain the situation and gather all explanations which can explain the situation together (one explanation is not enough in this case).

The main questions for discussion:

How did you eliminate option D from consideration? [After students explain, ask them to] Provide an example of an inferior good.

Show graphically the shift in curves describing the situation.

What kind of evidence would you look for to determine whether it was income growth or the removal of a price ceiling that accounts for the observed price and quantity changes?

What do you predict will happen to energy prices in China in the future?

What could be the influence of higher energy prices in China on energy prices in the USA?

Review the chapter discussing energy prices (pages 25-32) as part of the report : KEY CHINA ENERGY STATISTICS, 2016, by Lawrence Berkeley, National Laboratory, China Energy Group:

https://china.lbl.gov/publications/key-china-energy-statistics-2016

In addition, make sure to review the definition of normal and inferior goods (based on course text book, as in: http://www.saylor.org/books/):

"The nature of the income effect of a price change depends on whether the good is normal or inferior. The income effect reinforces the substitution effect in the case of normal goods; it works in the opposite direction for inferior goods."