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Introduction
Chapter 4
Extensions
of Demand
and Supply
Analysis
Shipping companies have found in recent
years that there has been a shortage of
available space at U.S. seaports. What
market condition would give rise to a
persistent shortage?
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Learning Objectives
Learning Objectives
Discuss the essential features
of the price system
Explain the effects of price ceilings
Explain the effects of price floors
Evaluate the effects on the market
price and equilibrium quantity of
changes in demand and supply
Describe various types of governmentimposed quantity restrictions on markets
Understand the rationing function
of prices
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1
Chapter Outline
Chapter Outline
The Policy of Government-Imposed
Price Controls
The Price System
Exchange and Markets
The Policy of Controlling Rents
Changes in Demand and Supply
Price Floors in Agriculture
Price Flexibility and Adjustment Speed
The Rationing Function of Prices
Price Floors in the Labor Market
Quantity Restrictions
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Did You Know That...
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The Price System
A shortage of flu vaccine arose in 2003?
Persistent shortages and surpluses may
be observed in various markets?
The model of supply and demand can
explain many of these instances of a
gap between quantity supplied and
quantity demanded?
Price System (market system)
– An economic system that allocates
resources based on relative prices
determined by supply and demand
– Prices signal what is relatively scarce
and relatively abundant
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Exchange and Markets
Exchange and Markets
Markets
Voluntary Exchange
– Emphasize voluntary exchange
– Acts of trading between individuals
that make both parties to the trade
subjectively better off
– Determine the terms of exchange
– Facilitate exchange
Terms of Exchange
– The prices we pay for the desired items
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Exchange and Markets
Exchange and Markets
The role of middlemen
Transaction Cost
– Middlemen (intermediaries) or brokers
reduce transaction cost by providing
information to buyers and sellers.
– The costs associated with exchange
– Examples
•
•
•
•
•
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Price shopping
Determining quality
Determining reliability
Service availability
Cost of contracting
– Examples
•
•
•
•
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Real estate brokers
Stock brokers
Consignment shops
Car dealerships
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Exchange and Markets
Changes in Demand and Supply
Observation
Changes in supply and demand
create a disequilibrium
– Consumers on the Internet rely on
intelligent shopping agents to act as
middlemen
The market price and quantity
adjust to a new equilibrium
Question
– How has the increase in the number of
web pages affected the potential market
for shopbot services?
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Shifts in Demand and Supply:
Determinate Results
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Shifts in Demand and Supply:
Determinate Results
Increase Demand with Supply Constant
Increase Demand with Supply Constant
S
S
E1
P1
D1
D2
D1
Q1
Figure 4-1
At price P1 quantity
demanded exceeds
quantity supplied—
a shortage exists
E1
P1
Q1
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Figure 4-1
Q2
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Shifts in Demand and Supply:
Determinate Results
Shifts in Demand and Supply:
Determinate Results
Increase Demand with Supply Constant
Decrease Demand with Supply Constant
S
At price P1 quantity
supplied exceeds
quantity demanded—
a surplus exists.
P1
E2
P2
S
E1
Equilibrium price
and quantity
increase to P2 and Q2
E1
P1
D1
Q1
D2
D2
D1
Q2
Q2
Figure 4-1
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Shifts in Demand and Supply:
Determinate Results
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Shifts in Demand and Supply:
Determinate Results
Decrease Demand with Supply Constant
E1
Increase Supply with Demand Constant
S1
S
Equilibrium price
and quantity decrease
to P3 and Q3
P1
P3
Q1
Figure 4-1
E3
E1
P1
D1
D
D3
Q3
Figure 4-1
Q1
Q1
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Figure 4-1
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Shifts in Demand and Supply:
Determinate Results
Shifts in Demand and Supply:
Determinate Results
Increase Supply with Demand Constant
Increase Supply with Demand Constant
At price P1 quantity
supplied exceeds
quantity demanded—
a surplus exists
S1
S2
E1
Equilibrium price
decreases and quantity
increases to P2 and Q2
S1
S2
E1
P1
P1
E2
P2
D
Q1
D
Q3
Q1
Figure 4-1
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Shifts in Demand and Supply:
Determinate Results
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Shifts in Demand and Supply:
Determinate Results
Decrease Supply with Demand Constant
S3
S1
E1
Q2
Figure 4-1
Decrease Supply with Demand Constant
S3
At price P1 quantity
demanded exceeds
quantity supplied—
a shortage exists
E3
S1
P3
E1
P1
P1
D
Q2
Figure 4-1
Equilibrium price
decreases and quantity
increases to P3 and Q3
D
Q1
Q3
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Figure 4-1
Q1
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Changes in Demand and Supply
Summary
Changes in Demand and Supply
Summary
– Increases in demand increase equilibrium
price and quantity.
– Increases in supply decrease equilibrium
price and increase equilibrium quantity.
– Decreases in demand decrease
equilibrium price and quantity.
– Decreases in supply increase equilibrium
price and decrease equilibrium quantity.
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Changes in Demand and Supply
When both demand and supply shift
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Changes in Demand and Supply
When both demand and supply increase
– Simultaneous changes in demand
and supply put conflicting pressure
on price or quantity
– Change in price is indeterminate
– Quantity will increase
When both demand and supply decrease
– The resulting effect depends upon how
much each curve shifts
– Change in price is indeterminate
– Either equilibrium price or quantity
will be indeterminate
– Quantity will decrease
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Changes in Demand and Supply
Price Flexibility
and Adjustment Speed
When supply decreases and demand increases
Flexibility and indirect adjustment
– Price will increase
– Quality
– Change in quantity is indeterminate
– Service
When supply increases and demand decreases
– Rebates
– Price will decrease
– Change in quantity is indeterminate
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Price Flexibility
and Adjustment Speed
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Example:
Why Plywood Prices Have Soared
Adjustment speed
– Market characteristics influence
adjustment speed
– Markets may overshoot in the adjustment
process
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The supply has decreased, due to
some lumber sellers going out of
business and to delays in timber
harvesting as a result of wet weather.
Demand has increased both from the
private sector and from government
purchases for the military.
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Example:
Why Plywood Prices Have Soared
The Rationing Function of Prices
When surpluses and shortages exist,
the price adjusts to clear the market.
This adjustment is the rationing
function of price.
Figure 4-2
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The Rationing Function of Prices
When prices cannot adjust non-price
rationing occurs
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The Rationing Function of Prices
The essential role of rationing
– With scarcity rationing must occur
– Rationing by queues
– Rationing by lotteries
– We must choose the rationing
mechanism: price or non-price
– Rationing by coupons
– Price rationing is the most efficient
• Further trades could not occur without making
somebody worse-off
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The Rationing Function of Prices
Question
The Policy of Government-Imposed
Price Controls
Price Controls
– Government-mandated minimum
or maximum prices
– If price rationing is the most efficient
is it the best way to ration?
Price Ceiling
– A legal maximum price
Price Floor
– A legal minimum price
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The Policy of Government-Imposed
Price Controls
Price ceiling and black markets
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The Policy of Government-Imposed
Price Controls
Non-Price Rationing Devices
– Price ceilings may prevent the equilibrium
price from being achieved if it is above
the ceiling price.
– All methods used to ration scarce goods
that are price-controlled
Black Market
– A market in which price-controlled goods
are sold at an illegally high price
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Example:
Vaccine Shortages
Black Markets
S’
Implicit supply schedule
at P1 < Pe
Government mandates have resulted
in a substantial portion of childhood
vaccines being sold at prices below the
market price.
Price
P2
Pe
As a consequence, pharmaceutical
companies are cutting back on the
production of vaccines.
P1
Shortage
D
Qs
Figure 4-3
Qe
Qd
Quantity per Unit Time Period
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The Policy of Controlling Rents
The Policy of Controlling Rents
The functions of rental prices
Rent controls and construction
– Promote the efficient maintenance
and construction of housing
– Controls discourage construction
• With a 16% vacancy rate and no controls,
Dallas recently built 11,000 new rental units.
• With a 1.6% vacancy rate and controls,
San Francisco recently built 2,000 new
rental units.
– Allocate existing housing
– Ration the use of housing
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The Policy of Controlling Rents
Effects on the existing supply
of housing
The Policy of Controlling Rents
Rationing the current use of housing
– Reduces mobility
• New York’s “housing gridlock”
– Property owners cannot recover costs
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The Policy of Controlling Rents
The Policy of Controlling Rents
Attempts at evading rent controls
Who gains and who loses
from rent controls?
– Forcing tenants to leave
– Losers
– Tenants subletting apartments
• Property owners
• Low-income individuals
– Housing courts
– Benefits
• Upper-income professionals
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Price Floors in Agriculture
Agricultural Price Supports
Excess quantity
supplied
Support Price
– the governmentally established minimum
price farmers are to receive for a
particular agricultural product.
S
Dollars per Unit
Ps
Pe
E
D
Qd Qe
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Price Floors in Agriculture
Questions
– How could the government keep the price
from falling?
Figure 4-4
Qs
Quantity of Peanuts per Time Period
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Policy Example:
Agricultural Subsidies in the European Union
The European Union pays farmers for
using environmentally sound
agricultural practices.
In some cases, the preferred practice
may be not to farm at all.
– Who benefits from agricultural price
supports?
In effect, this is a program of
agricultural price supports.
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Price Floors in the Labor Market
The Effect of Minimum Wages
Minimum Wage
S
– Lowest hourly wage rate that firms
may legally pay their workers
A
Wage Rate per Unit
Wm
B
We
C
Excess quantity
supplied at
wage Wm
E
Reduction
in quantity
of labor
demanded
Increase in
quantity of labor
supplied
D
Qd
Qe
Qs
Quantity of Labor per Time Period
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Quantity Restrictions
Figure 4-5
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Quantity Restrictions
Government Prohibitions or Licensing
Requirements
Prohibitions on the ownership
or trading of a good
– Some commodities cannot be purchased at all
legally; others require a license.
– Human organs
– Drugs
Import Quota
– Hospital beds
– Supply restriction that prohibits
the importation of more than a specified quantity
of a particular good in a one-year period
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Policy Example:
U.S. Textile Quotas Abound
Issues and Applications:
Traffic Jams in U.S. Seaports
There are legal restrictions on the
amount of textiles and the number of
apparel products that can be imported
into the U.S. each year.
These numbers are specific to the
country of origin.
Demand for dock space has increased due
to the increased volume of cruise travel.
Fees charged for the use of such space are
government regulated. Regulators have
been slow to respond.
A shortage has arisen because the price
remains below the market-clearing level.
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Summary Discussion
of Learning Objectives
Issues and Applications:
Traffic Jams in U.S. Seaports
Essential features of the price system
– A price system (market system) allows
prices to respond to changes in supply
and demand for different commodities.
– The terms of exchange—prices—are
communicated in markets that tend
to minimize transactions costs.
Figure 4-7
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Summary Discussion
of Learning Objectives
Summary Discussion
of Learning Objectives
How changes in demand and supply
affect market price and equilibrium
quantity
How changes in demand and supply
affect market price and equilibrium
quantity
– Increases in demand increase equilibrium price
and quantity. Decreases in demand decrease
equilibrium price and quantity.
– Increases in supply decrease market price
and increase equilibrium quantity. Decreases
in supply increase market price and decrease
equilibrium quantity.
– When both demand and supply shift
at the same time, the result is
indeterminate.
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Summary Discussion
of Learning Objectives
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Summary Discussion
of Learning Objectives
The rationing function of prices
The effects of price floors
– In a market system, prices ration
scarce goods and services.
The effect of price ceilings
– A price ceiling set below the market
(equilibrium) price results in a shortage.
– The resulting shortage can lead to nonprice rationing devices and black markets.
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– If the price floor is set above
the market price, a surplus results.
– A price floor can take the form
of a government-imposed price support
or minimum wage.
– Quantity restrictions can take the form
of import quotas.
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Summary Discussion
of Learning Objectives
End of
Chapter 4
Government-imposed restrictions
on market quantities
Extensions
of Demand
and Supply
Analysis
– Bans on sale or ownership
– Licensing restrictions
– Import quotas
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