The example that we just discussed is an illustration of a general technique used by economists for two purposes. First, we use it to explain changes in prices and quantities that we have observed in the past. Second, we use it to predict what will happen to market prices and quantities in the future. The technique is called comparative statics.
Toolkit: Section 16.8 "Comparative Statics"
Comparative statics is a technique that allows us to describe how market equilibrium prices and quantities depend on exogenous events. As such, much of economics consists of exercises in comparative statics. In a comparative statics exercise, you must do the following:
- Begin at an equilibrium point where the quantity supplied equals the quantity demanded.
- Based on a description of an event, determine whether the change in the exogenous factor shifts the market supply curve or the market demand curve.
- Determine the direction of this shift.
- After shifting the curve, find the new equilibrium point.
- Compare the new and old equilibrium points to predict how the exogenous event affects the market.
The most difficult part of a comparative statics exercise is to determine, from a description of the economic problem, whether it is the supply or demand curve (or both) that shifts. Once you conquer the economics of determining which curve is shifting, then it is a matter of mechanically using the framework to find the new equilibrium. A comparison of the old and new equilibrium points allows you to predict what will happen to equilibrium prices and quantities following an exogenous change.
KEY TAKEAWAY
Exogenous variables are determined from outside a framework, while endogenous variables are determined within the framework.
Changes in exogenous variables lead to shifts in market supply and/or market demand curves. These shifts in supply and demand then lead to changes in quantities and prices.
Comparative statics is a technique that describes how changes in exogenous variables influence equilibrium quantities and prices. It is used to answer questions about how markets respond to changes in exogenous variables.
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Checking Your Understanding
Name two exogenous variables that might affect the equilibrium outcome in the market for used cars.
Draw the market for housing when there is a decrease in supply and a decrease in demand. What happens to the price? Why can you not say for sure what happens to the quantity of houses bought and sold?
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