Download Using Supply and Demand

Using Supply and
Demand
Chapter 5
1
The Power of Supply and
Demand
• Changes in supply and demand will change
equilibrium price and quantity.
• A shift in demand that moves the demand
curve to the right causes equilibrium price
and quantity to rise.
• A shift in supply that moves the supply
curve to the left causes equilibrium price
to rise and equilibrium quantity to fall.
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A Shift in Demand
S0
B
$2.50
Excess demand
A
2.25
D0
0
D1
8
9
10
Quantity of cassettes (per week)
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A Shift in Supply
S1
S0
C
$2.50
2.25
B
Excess demand
A
D0
0
8
9
10
Quantity of cassettes (per week)
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Real World Examples of
Supply and Demand
• Supply and demand can shed light on
a variety of real-world events:
– Florida freeze.
– Financial assets and the baby boomers.
– Ten percent excise tax.
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Florida Freeze
• The crop-damaging freeze shifted
the supply curve to the left.
• At the original price, quantity
demanded exceeded quantity
supplied.
• Price rose until the quantity
demanded equaled the quantity
supplied.
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Florida Freeze
S1
S0
P1
P0
Demand
(c)
QS
Qe Q D
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Financial Assets
and the Baby Boomers
• Demographic changes among baby
boomers moved the demand curve for
financial assets to the right.
• At the original price, quantity
demanded exceeded quantity
supplied.
• Price rose until the quantity
demanded equaled the quantity
supplied.
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Financial Assets and the
Baby Boomers
S
P1
P0
D1
D0
(f)
Q0
Q1
QD
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Financial Assets and the
Baby Boomers
• The same phenomenon occurred in
the surging demand for housing
among this group during the 180s.
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Excise Taxes
• Congress imposed a 10 percent
surtax on luxury boats.
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Excise Taxes
• A 10 percent surtax on luxury boats
levied on suppliers shifts the supply
curve to the left.
• After the tax is imposed, the
quantity of boats demanded drops.
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Excise Taxes
S1
S0
P1
P0
D0
QD
Q1
Q0
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A Review
No change in Supply shifts
supply
out
No change
in demand
Demand
shifts out
No change.
Supply shifts
in
Price falls;
Price rises;
Quantity rises. Quantity falls.
Quantity rises;
Price rises;
Quantity falls. Price could be
high or lower.
Price falls;
Price rises;
Quantity falls Quantity could
rise or fall.
Price rises;
Quantity could
rise or fall.
Quantity falls;
Price could
rise or fall.
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Government
Interferences
• Buyers look to government for ways
to hold prices down. Sellers look to
government for ways to hold prices
up.
15
Price Ceilings
• A price ceiling is a governmentimposed limit on how high a price can
be charged.
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Rent Controls
• Rent control is a price ceiling on
rents set by government.
• An example is rent control in Paris
following World War I and World
War II.
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Rent Controls
• The following were the consequences
of rent control in Paris:
– A huge shortage of living quarters.
– New housing construction stopped.
– Existing housing was allowed to
deteriorate.
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Rent Controls
• The following were the consequences
of rent control in Paris:
– For many, the only way to get living
quarters was to offer a huge bribe to
the landlord.
– Many families had to double up with
other family members.
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Rental Price (per month)
Rent Controls
Supply
Shortage
$17.00
2.50
Demand
QS
QD
Quantity of apartments
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Minimum Wage
• A price floor is a governmentimposed limit on how low a price can
be charged.
• The minimum wage is an example of a
price floor.
• A minimum wage is set by
government specifying the lowest
wage a firm can legally pay an
employee.
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Minimum Wage
• The effect of the minimum wage depends
on whether it is higher, lower, or the same
as the market wage rate.
• If it is higher than the market wage then
the minimum wage creates winners and
losers:
– Those who can find work earn a higher
wage.
– Others become unemployed.
– Production costs increase.
– Consumers pay higher prices.
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Minimum Wage
The minimum wage is a price floor. The MW law does not
prohibit paying more for labor…it only prohibits paying less
than the minimum wage. In this example the market wage is
higher than the minimum wage. Consequently, the minimum
wage is not binding here.
Wage (per hour)
Labor
Supply
$7.00
5.50
Labor
Demand
QS
QD
Quantity of apartments
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Minimum Wage
Wage (per hour)
In this example the market wage is lower than the minimum
wage. Consequently, the minimum wage is binding here. More
people want to work than employers are willing to hire at this
wage, consequently we have unemployment.
$7.00
5.50
Labor
Supply
Labor
Demand
QD
QS
Quantity of apartments
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The Limitations Of
Supply And Demand
Analysis
• Other things don't remain constant.
• Sometimes supply and demand are
interconnected.
• Supply/demand analysis is the first step to
analysis, not the complete analysis.
• Deciding whether the effects are
significant to consider requires a
knowledge of the structure of the economy
because all actions have ripple or feedback
effects.
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The Roles of Government
• Provide a stable institutional
framework.
• Promote effective and workable
competition.
• Correct for externalities.
• Ensure economic stability and growth.
• Provide for public goods.
• Adjust for undesired market results.
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Provide a Stable Set of
Institutions and Rules
• Only the government can create a
stable environment and enforce
contracts through its legal system.
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Provide a Stable Set of
Institutions and Rules
• When governments do not provide a
stable environment, as is now
happening in Russia, economic growth
is difficult - usually such economies
are stagnant.
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Promote Effective and
Workable Competition
• Government promotes competition
and protect against monopolies.
– Monopoly power is the ability of
individuals or firms currently in business
to prevent other individuals or firms
from entering the same kind of business
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Promote Effective and
Workable Competition
• Monopoly power gives existing firms
or individuals the power to raise
prices.
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Promote Effective and
Workable Competition
• Many players in the market insist on
open competition except when it
comes to themselves:
– Farmers like competition but still want
price supports.
– Lawyers and architects like competition
but still want licensing to prevent others
from entering the market.
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Correct for Externalities
• Unless they are required to do so,
parties to any exchange are unlikely
to take into account any externality.
32
Correct for Externalities
• An externality is the effect that an
action may have on a third party that
the person who undertook that action
did not take into account.
33
Correct for Externalities
• The externality may be positive in
which case society benefits even
more than the two parties – an
example is education.
34
Correct for Externalities
• The externality may be negative in
which case society as a whole
benefits less than the two parties –
an example is pollution.
35
Correct for Externalities
• When there are externalities,
government has the potential role to
change the rules so that the parties
must take into account the effect of
their actions on others.
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Ensure Economic
Stability and Growth
• Most Americans agree that
government should:
– Prevent large fluctuations in economic
activity.
– Maintain a relatively constant price
level.
– Provide an economic environment
conducive to economic growth.
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Ensure Economic
Stability and Growth
• Most economists support these goals
since they involve macroeconomic
externalities.
• Macroeconomic externalities are
externalities that affect the levels
of unemployment, inflation, and
growth in the economy as a whole.
38
Provide for Public Goods
• Public goods are those whose
consumption by one individual does
not prevent their consumption by
other individuals – an example is a
public park.
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Provide for Public Goods
• In contrast, a private good is one
that, when consumed by one
individual, cannot be consumed by
other individuals – an example is an
apple.
40
Provide for Public Goods
• A free rider is a person who
participates in something without
having to pay for it.
41
Provide for Public Goods
• Since most everyone would enjoy
having public parks without having to
pay for them, government requires
that the public be taxed to pay for
public parks, thereby eliminating free
riders.
42
Adjust for Undesired
Market Results
• In an attempt to make the market
fairer, the government, through
taxes and expenditures,
redistributes income among
households.
– The result is controversy.
43
Adjust for Undesired
Market Results
• For example, in trying to be fair,
which type of tax should the
government use?
44
Adjust for Undesired
Market Results
• A progressive tax, such as the U.S.
income tax is one whose rates
increase as a person's income
increases.
45
Adjust for Undesired
Market Results
• A regressive tax such as a sales tax
is one whose effect decrease as
income rises.
46
Adjust for Undesired
Market Results
• A proportional tax, such as the
Social Security tax, is one whose
rates are constant at all income
levels, regardless of the taxpayer's
total annual income.
47
Adjust for Undesired
Market Results
• Another controversial role for
government involves deciding what is
best for people independently of
their desires.
48
Adjust for Undesired
Market Results
• Should government prohibit demerit
goods and activities?
49
Adjust for Undesired
Market Results
• Demerit goods and activities are
things government believes are bad
for you, although you may like them.
– Addictive drugs are a demerit good;
using addictive drugs is a demerit
activity.
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Adjust for Undesired
Market Results
• Merit goods and activities are
things the government believes are
good for you, although you may not
like– Motorcycle
them.
helmets are a merit good;
using helmets while driving a motorcycle
is a merit activity.
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Market Failures and
Government Failures
• Market failures are situations where the
market does not lead to a desired result.
• The government sometimes intervenes in
markets when market occurs.
• Government intervention, however, may make
matters worse.
• Government failures are situations where the
government intervenes and makes the
situation worse
52
Market Failures and
Government Failures
• Real-world policy makers must choose
the option which is least bad -market failure or government failure
– by weighing the costs and benefits
of each.
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Using Supply and
Demand
End of Chapter 5
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