(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 622

CHAPTER 16 • General Equilibrium and Economic Efficiency 597

Price
($)

*
SM

6.82
6.75

SM

6.35

*
DM

6.00

DMЈ

Price
($)

SV

3.58
3.50
3.00

D*V
DVЈ

DM

QMЈ QЉM Q*M QM

Number of
movie tickets

(a)

DV

QV QVЈ Q*V

Number
of DVDs

(b)

F IGURE 16.1

TWO INTERDEPENDENT MARKETS: (A) MOVIE TICKETS AND (B) DVD RENTALS
When markets are interdependent, the prices of all products must be simultaneously determined.
* , as shown in (a). The
Here a tax on movie tickets shifts the supply of movies upward from SM to S M
higher price of movie tickets ($6.35 rather than $6.00) initially shifts the demand for DVDs upward
(from DV to DV= ), causing the price of DVDs to rise (from $3.00 to $3.50), as shown in (b). The higher
=

video price feeds back into the movie ticket market, causing demand to shift from DM to D M
and the
price of movies to increase from $6.35 to $6.75. This continues until a general equilibrium is reached,
* and S * in (a), with a movie ticket of $6.82, and the intersection of
as shown at the intersection of D M
M
*
D V and SV in (b), with a DVD price of $3.58.

What about the market for movies? The original demand curve for movies
presumed that the price of DVDs was unchanged at $3.00. But because that
=
in
price is now $3.50, the demand for movies will shift upward, from DM to D M
*
Figure 16.1 (a). The new equilibrium price of movies (at the intersection of S M
=
and D M) is $6.75, instead of $6.35, and the quantity of movie tickets purchased
=
==
has increased from Q M
to Q M
. Thus a partial equilibrium analysis would have
underestimated the effect of the tax on the price of movies. The DVD market is
so closely related to the market for movies that to determine the tax’s full effect,
we need a general equilibrium analysis.

Reaching General Equilibrium
Our analysis is not yet complete. The change in the market price of movies will
generate a feedback effect on the price of DVDs that, in turn, will affect the price

of movies, and so on. In the end, we must determine the equilibrium prices and
quantities of both movies and DVDs simultaneously. The equilibrium movie price
of $6.82 is given in Figure 16.1 (a) by the intersection of the equilibrium supply
* and D * ). The equilibrium DVD price
and demand curves for movie tickets (S M
M
of $3.58 is given in Figure 16.1 (b) by the intersection of the equilibrium supply and demand curves for DVDs (SV and D V* ). These are the correct general
equilibrium prices because the DVD market supply and demand curves have