Complements and Substitutes in General Equilibrium
Christopher Makler
Stanford University Department of Economics
Econ 50Q: Section 10
Demand Effects
Suppose two goods are complements.
What happens in both markets
if there is a supply shift
in the market for one of the goods?
Specifically, what happens to the equilibrium prices and quantity in both markets, if there is an increase in the cost of producing good 1?
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Equilibrium in One Market
Market for Good 2
Market for Good 1
Equilibrium in Two Markets with Related Demand
Market for Good 2
Market for Good 1
Equilibrium in Two Markets with Related Demand
(a and b are cost shifters)
Which good will have the higher price in equilibrium?
Key insight: remember that firms will produce at the point along the PPF where the MRT is equal to the price ratio. What point along the PPF must be chosen with this utility function?
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What is the equilibrium price ratio?
Key insight: remember that firms will produce at the point along the PPF where the MRT is equal to the price ratio. What point along the PPF must be chosen with this utility function?
pollev.com/chrismakler
What is the equilibrium price ratio?
Key insight: remember that firms will produce at the point along the PPF where the MRT is equal to the price ratio. What point along the PPF must be chosen with this utility function?
Equation of the PPF:
Expression for the MRT:
Bonus question to do at home: suppose that in equilibrium, p1=80 and Y1=24. What must the wage rate be?