## Saturday, April 9, 2016

### Simulations with supply, demand and prices

One thing I wanted to clarify is that when I said in this post that increasing supply increases prices, it doesn't always increase prices. A great example (or natural experiment) is the case of Magic cards:
The first thing the company had to do was to bring the price of the cards back down, so the average person could buy them again. They did this by dramatically increasing the supply.

The key factor is the speed of the increase. If the increase  is such that demand can catch up (e.g. a slow increase, as for housing), then you get a steadily rising price. Here's an example (here the IT index k = 1.3, so demand D ~ S^1.3 and P ~ S^0.3) of the "general equilibrium" solution:

And now here's the same thing, but adding a faster increase in the supply for a short period:

The brief period of rapid increase in supply causes a dip in the price ("partial equilibrium"), which then returns to the trend increase.

For more details on general and partial equilibrium, you can see the paper.

1. You'll be interested to see that in his most recent piece, Kevin comes to the same essential conclusion: the housing market is currently not in equilibrium, and that if it were to equilibrate, the expected result of increased build out would, in fact, be for prices to rise 30%: http://idiosyncraticwhisk.blogspot.com/2016/04/housing-part-134-deprivation-created.html I admit I still struggle with this result, but the math/logic seem reasonable.

One observation from the debate over the financial crisis/housing bubble and the debate within econ over whether agent biases and microfoundations "matter". While I largely agree with your premise that the biases/behavior of individual agents are not relevant and macro behaviors are emergent, some individuals (e.g. those who make government policy) have an outsize impact, as their individual beliefs/biases result in rules and regulations that bound the state space the broader population can explore. So while the behavioral biases of the aggregate of agents may very rarely matter, the behavioral biases of the much smaller number of agents that get to alter the shape of the phase space ALWAYS matter. This shifts from macroecon more to politics, but it strikes me that making macro policy as if politics don't exist leaves something to be desired. Thoughts?

1. Government regulations, state, local, etc are effectively collusion among agents.
Other factors, inherent in the product(s), that create correlations in micro components are likely suspects, e.g. gasoline production vs jet fuel production vs heating oil.
The price of tortillas and corn alcohol also comes to mind.