Download The Demand Schedule and Demand Curve

CHAPTER 4
DEMAND, SUPPLY, AND MARKETS
In this chapter, you will find:
Chapter Outline with PowerPoint Script
Chapter Summary
Teaching Points (as on Prep Card)
Answers to the End-of-Book Questions and Problems for Chapter 4
Supplemental Cases, Exercises, and Problems
INTRODUCTION
Chapter 4 introduces the concepts of demand and supply as well as the analysis of competitive markets. Other
major topics in this chapter include equilibrium, shifts in demand and supply, and disequilibrium. Diagrams
and graphs play a central role in this chapter, and most students will find it helpful if your presentations and
discussions of the material use a similar treatment. A thorough understanding of demand and supply analysis is
critical to the study of economics so this chapter may be the most important in the textbook.
LEARNING OUTCOMES
1 Explain how the law of demand affects market activity
Demand is a relationship between the price of a product and the quantity consumers are willing and able to buy per
period, other things constant. According to the law of demand, quantity demanded varies negatively, or inversely,
with the price. A demand curve slopes downward because a price decrease makes consumers (a) more willing to
substitute this good for other goods and (b) more able to buy the good because the lower price increases real income.
2 Explain how the law of supply affects market activity
Supply is a relationship between the price of a good and the quantity producers are willing and able to sell per
period, other things constant. According to the law of supply, price and quantity supplied are usually positively, or
directly, related, so the supply curve typically slopes upward. The supply curve slopes upward because higher prices
make producers (a) more willing to supply this good rather than supply other goods that use the same resources and
(b) more able to cover the higher marginal cost associated with greater output rates.
3 Describe how the interaction between supply and demand create markets
Demand and supply come together in the market for the good. A market provides information about the price,
quantity, and quality of the good. In doing so, a market reduces the transaction costs of exchange—the costs of time
and information required for buyers and sellers to make a deal. The interaction of demand and supply guides
resources and products to their highest-valued use.
4 Describe how markets reach equilibrium
Impersonal market forces reconcile the personal and independent plans of buyers and sellers. Market equilibrium,
once established, will continue unless there is a change in a determinant that shapes demand or supply.
5 Explain how markets react during periods of disequilibrium.
Disequilibrium is usually temporary while markets seek equilibrium, but sometimes disequilibrium lasts a while,
such as when government regulates the price.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 4
Demand, Supply, and Markets
50
CHAPTER OUTLINE WITH POWERPOINT SCRIPT
USE POWERPOINT SLIDE 2 FOR THE FOLLOWING SECTION
Demand: Refers to the demand curve, the relation between the price of a good and the quantity demanded
when other factors remain unchanged. Demand indicates the quantity consumers are both willing and able to
buy at each possible price during a given time period, other things constant.
USE POWERPOINT SLIDES 3-6 FOR THE FOLLOWING SECTION
The Law of Demand
 The Law of Demand states the quantity of a good demanded varies inversely with its price, other things
constant. More is demanded when the price decreases. Less is demanded when the price increases.
Demand, Wants, and Needs – are not the same
The Substitution Effect of a Price Change: Caused by a change in the relative price of a good. If the price of
one good falls relative to the prices of other goods, consumers tend to substitute the lower-priced good for the
other goods.
The Income Effect of a Price Change: Caused by a change in a consumer's real income. If the price of a good
falls, other things constant, the consumer’s purchasing power (real income) rises, increasing her or his ability
to purchase all goods.
USE POWERPOINT SLIDES 7-11 FOR THE FOLLOWING SECTION
The Demand Schedule and Demand Curve
 Demand Schedule: Lists possible prices, along with the quantity demanded at each price.
 Demand Curve: A plot of the demand schedule. It slopes downward, reflecting the law of demand.
 Quantity demanded: One point on the demand curve that shows the quantity demanded at a particular
price.
 Movement along the demand curve: Reflects a change in quantity demanded caused by a change in
price.
 Individual versus Market Demand
USE POWERPOINT SLIDE 12 FOR THE FOLLOWING SECTION
Shifts of the Demand Curve
The demand curve isolates the relation between the price of a good and quantity demanded, assuming other
factors remain constant. Other variables that may affect demand include the money income of consumers,
prices of other goods, consumer expectations, number of consumers, and consumer tastes. Changes in these
factors lead to shifts in the demand curve.
USE POWERPOINT SLIDES 13-14 FOR THE FOLLOWING SECTION
Changes in Consumer Income
 Demand for normal goods increases as money income increases.
 Demand for inferior goods decreases as money income increases.
 Increase in demand: A shift to the right of the demand curve; consumers are willing and able to buy more
units at each price and to pay more per unit at each quantity.
 Decrease in demand: A shift to the left of the demand curve; consumers are willing and able to buy fewer
units at each price and to pay less per unit at each quantity.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 4
Demand, Supply, and Markets
51
USE POWERPOINT SLIDE 15 FOR THE FOLLOWING SECTION
Changes in the Prices of Other Goods
 Substitutes: Goods that are related in such a way that an increase in the price of one increases demand for
the other, shifting that demand curve rightward (example: apples and pears).
 Complements: Goods that are related in such a way that an increase in the price of one decreases demand
for the other, shifting that demand curve leftward (example: hot dogs and hot dog rolls).
USE POWERPOINT SLIDE 16 FOR THE FOLLOWING SECTION
Changes in Consumer Expectations
 Consumers expecting increased future income may increase their current demand for a good.
 Consumers expecting a future price increase may increase their current demand for the good.
USE POWERPOINT SLIDES 17-19 FOR THE FOLLOWING SECTION
Changes in the Number or Composition of Consumers: Market demand is the sum of individual demands.
If the number of consumers in the market changes, the demand curve will shift.
Changes in Consumer Tastes:
 Tastes: A change in consumer likes and dislikes for a particular good would shift that good’s demand
curve.
USE POWERPOINT SLIDE 20 FOR THE FOLLOWING SECTION
Supply: Refers to the supply curve, the relation between the price of a good and the quantity supplied when
other factors remain unchanged. Supply indicates how much producers are willing and able to offer for sale per
period at each possible price, other things constant.
USE POWERPOINT SLIDES 21-23 FOR THE FOLLOWING SECTION
 Law of supply: The quantity supplied is usually directly related to its price, other things constant. The
lower the price, the smaller the quantity supplied and the higher the price, the higher the quantity supplied.
As the price of a good increases, producers become more willing and able to supply the good. The higher
price provides producers with a profit incentive to shift some resources from lower-valued uses to the
higher-valued use. A higher price makes producers more willing and able to increase quantity supplied of
a good.
The Supply Schedule and Supply Curve
 Supply Schedule: Lists possible prices, along with the quantity supplied at each price.
 Supply Curve: A plot of the supply schedule. It slopes upward, reflecting the law of supply.
USE POWERPOINT SLIDES 24-26 FOR THE FOLLOWING SECTION
 Quantity supplied: One point on the supply curve that shows the quantity supplied at a particular price.
 Movement along the supply curve: Reflects a change in quantity supplied caused by a change in price.
 Individual versus Market Supply
USE POWERPOINT SLIDE 27 FOR THE FOLLOWING SECTION
Shifts of the Supply Curve
The supply curve isolates the relation between price and quantity supplied, assuming other factors are held
constant. Other variables that may affect supply include the state of technology, the prices of relevant
resources, the prices of alternative goods, producer expectations, and the number of producers in the market.
Changes in these factors lead to shifts in the supply curve.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 4
Demand, Supply, and Markets
52
USE POWERPOINT SLIDES 28-29 FOR THE FOLLOWING SECTION
Changes in Technology: If a better technology is discovered, production costs will fall. Quantity supplied at
each price will increase, and the supply curve will shift to the right.
 Increase in Supply: A shift of the supply curve to the right
 Decrease in supply: A shift of the supply curve to the left
USE POWERPOINT SLIDE 30 FOR THE FOLLOWING SECTION
Changes in the Prices of Relevant Resources
 Those resources employed in the production of the good.
 If the price of a relevant (important) resource decreases, costs of production fall and the supply curve
shifts to the right.
 If the price of a relevant (important) resource increases, costs of production increase and the supply curve
shifts to the left.
USE POWERPOINT SLIDE 31 FOR THE FOLLOWING SECTION
Changes in the Prices of Alternative Goods
 Alternative goods: Those that use some of the same resources as are employed to produce the good under
consideration.
 A rise in the price of an alternative good will cause the supply of the good in question to decrease, or shift
to the left because some producers will opt to produce the alternative good.
USE POWERPOINT SLIDE 32 FOR THE FOLLOWING SECTION
Changes in Producer Expectations: If a producer expects the future price of a good to be higher than today's
price, he may decrease or increase the current supply, depending on the good under consideration.
USE POWERPOINT SLIDES 33-34 FOR THE FOLLOWING SECTION
Changes in the Number of Producers: If the number of producers increases, supply will increase, or shift to
the right.
USE POWERPOINT SLIDE 35 FOR THE FOLLOWING SECTION
Demand and Supply Create a Market
Market: Arrangements made by individuals to buy and sell goods and services.
 Reduces the transaction costs of exchange.
 Coordinates the independent intentions of buyers and sellers through Adam Smith's "invisible hand."
USE POWERPOINT SLIDES 36-40 FOR THE FOLLOWING SECTION
Market Equilibrium
 Surplus: Excess quantity supplied; puts downward pressure on the price.
 Shortage: Excess quantity demanded; puts upward pressure on the price.
 Equilibrium: Occurs when the quantity consumers are willing and able to buy equals the quantity
producers are willing and able to sell. There is no pressure to change price or quantity.
 Impersonal market forces synchronize the personal and independent decisions of many individual buyers
and sellers to achieve equilibrium price and quantity.
USE POWERPOINT SLIDES 41-43 FOR THE FOLLOWING SECTION
Changes in Equilibrium Price and Quantity
Factors that Shift the Demand Curve
 Given an upward-sloping supply curve, a rightward shift of the demand curve increases both equilibrium
price and quantity. Given an upward-sloping supply curve, a leftward shift of the demand curve decreases
both equilibrium price and quantity.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 4
Demand, Supply, and Markets
53
USE POWERPOINT SLIDES 44-46 FOR THE FOLLOWING SECTION
Factors that shifts the Supply Curve
 Given a downward-sloping demand curve, a leftward shift of the supply curve decreases equilibrium
quantity but increases equilibrium price. Given a downward-sloping demand curve, a rightward shift of
the supply curve increases equilibrium quantity but decreases equilibrium price.
USE POWERPOINT SLIDES 47-50 FOR THE FOLLOWING SECTION
Simultaneous Shifts of Demand and Supply Curves
 If both curves shift, the results are less obvious but can be approximated by drawing the demand and
supply diagram, shifting the curves appropriately, and interpreting the new equilibrium point.
USE POWERPOINT SLIDE 51 FOR THE FOLLOWING SECTION
The Market for Professional Basketball
USE POWERPOINT SLIDE 52 FOR THE FOLLOWING SECTION
Disequilibrium Prices: Represent a temporary phase while the market seeks equilibrium.
USE POWERPOINT SLIDES 53-55 FOR THE FOLLOWING SECTION
Price Floor: A minimum selling price above the equilibrium price. To have an impact, the price floor must be
set above the equilibrium price.
Price Ceiling: A maximum selling price for goods and services set by public officials. To have an impact, the
price ceiling must be set below the equilibrium price.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 4
Demand, Supply, and Markets
54
CHAPTER SUMMARY
Demand is a relationship between the price of a product and the quantity consumers are willing and able to buy
per period, other things constant. According to the law of demand, quantity demanded varies negatively, or
inversely, with the price, so the demand curve slopes downward.
A demand curve slopes downward for two reasons. A price decrease makes consumers (a) more willing to
substitute this good for other goods and (b) more able to buy the good because the lower price increases real
income.
Assumed to remain constant along a demand curve are (a) money income, (b) prices of other goods, (c)
consumer expectations, (d) the number or composition of consumers in the market, and (e) consumer tastes. A
change in any of these will shift, or change, the demand curve.
Supply is a relationship between the price of a good and the quantity producers are willing and able to sell per
period, other things constant. According to the law of supply, price and quantity supplied are usually positive,
or directly, related, so the supply curve typically slopes upward.
The supply curve slopes upward because higher prices make producers (a) more willing to supply this good
rather than supply other goods that use the same resources and (b) more able to cover the higher marginal cost
associated with greater output rates.
Assumed to remain constant along a supply curve are (a) the state of technology, (b) the prices of resources
used to produce the good, (c) the prices of other goods that could be produced with these resources, (d)
supplier expectations, and (e) the number of producers in this market. A change in any of these will shift, or
change, the supply curve.
Demand and supply come together in the market for the good. A market provides information about the price,
quantity, and quality of the good. In doing so, a market reduces the transaction costs of exchange—the costs of
time and information required for buyers and sellers to make a deal. The interaction of demand and supply
guides resources and products to their highest-valued use.
Impersonal market forces reconcile the personal and independent plans of buyers and sellers. Market
equilibrium, once established, will continue unless there is a change in a determinant that shapes demand or
supply. Disequilibrium is usually temporary while markets seek equilibrium, but sometimes disequilibrium
lasts a while, such as when government regulates the price.
A price floor is the minimum legal price below which a particular good or service cannot be sold. The federal
government imposes price floors on some agricultural products to help farmers achieve a higher and more
stable income than would be possible with freer markets. If the floor price is set above the market clearing
price, quantity supplied exceeds quantity demanded. Policy makers must figure out some way to prevent this
surplus from pushing the price down.
A price ceiling is a maximum legal price above which a particular good or service cannot be sold.
Governments sometimes impose price ceilings to reduce the price of some consumer goods such as rental
housing. If the ceiling price is below the market clearing price, quantity demanded exceeds the quantity
supplied, creating a shortage. Because the price system is not allowed to clear the market, other mechanisms
arise to ration the product among demanders.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 4
Demand, Supply, and Markets
55
TEACHING POINTS
1.
Students are usually confused by the distinction between demand and quantity demanded. Such
confusion can be reduced by continually reminding students that demand is a curve that depicts the
relationship between price and quantity demanded assuming that all other factors (which may affect
demand) are held constant. Quantity demanded is a point on the curve that shows the quantity demanded
at a given price. Quantity demanded will increase as the price falls. An increase in demand, by
definition, is a shift of the demand curve. Another way to emphasize the distinction is to emphasize that
because we graph the current quantity demanded (holding all other factors constant) against price:
 A change in price leads to a movement along the demand curve.
 ONLY changes in factors other than price can lead to a change or shift in demand (curve) since
once we allow these factors to change, the original curve is no longer valid (because it assumed all
other factors were held constant).
2.
You may wish to begin the discussion of demand and supply by creating both curves through an example
in class (i.e., ask students how many cookies they would like to buy next class at different prices. Then
ask what they would be willing to supply at various prices). Briefly discuss the equilibrium process,
making sure that students understand the importance of market forces. This will provide a context for the
textbook’s development of demand, then supply, and then market equilibrium.
3.
The income and substitution effects can be presented as the direct consequence of the ceteris paribus
assumption. Holding other prices constant while changing the price of the good whose demand curve is
being constructed results in a change in its opportunity cost because its relative price has changed.
Holding money income constant while changing the price of the good results in a change in the
purchasing power or real income of the person whose demand curve is being constructed.
4.
You should use examples to discuss how the demand for a particular good changes when the price of a
substitute or a complement changes. Students may have trouble with this concept, but if concrete
examples are used it becomes clear (i.e., if Pepsi is on sale, those who normally purchase Coca Cola may
switch).
5.
Students frequently become mixed up in distinguishing between movements along and shifts in the
demand and supply curves. It is best to use MANY examples to illustrate the difference. Numerical
examples are helpful to some students since they see clearly price changes as well as changes in the
equilibrium price and quantity. Work through the comparative statics adjustment of quantity and price
very carefully. You may wish to emphasize the fact that shifts in supply move you “along the demand
curve,” and vice versa, leading to predictable changes in equilibrium price and quantity in both instances.
You may also wish to talk specifically about the quantities of goods purchased at nonequilibrium prices.
This will be useful in discussing efficiency later in the course.
6.
You may want to get into the normative aspects of equilibrium price changes to answer the question “Is
the equilibrium price a desirable price?” This will lead to a discussion of who gains and who loses from
such price changes as well as keying in on the importance of the ability (as well as the willingness) to
pay underlying the demand curve.
7.
By the end of the chapter, students may still have difficulty understanding how markets are able to
identify the equilibrium price. Charles Holt, in a 1996 article published in the Journal of Economic
Perspectives, shows how instructors can use playing cards to illustrate the interaction of demand and
supply in competitive markets. This method can also be used to illustrate how price ceilings, price floors,
and shifts in demand and supply influence equilibrium price and quantity. The method is very easy to use
in the classroom and should generate much interest among students.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 4
Demand, Supply, and Markets
56
ANSWERS TO END-OF-BOOK QUESTIONS AND PROBLEMS
1.1 (Shifting Demand) Using demand and supply curves, show the effect of each of the following on the
market for cigarettes:
a. A cure for lung cancer is found.
b. The price of cigars increases.
c. Wages increase substantially in states that grow tobacco.
d. A fertilizer that increases the yield per acre of tobacco is discovered.
e. There is a sharp increase in the price of matches, lighters, and lighter fluid.
f. More states pass laws restricting smoking in restaurants and public places.
a.
b.
c.
d.
e.
f.
This should shift the demand curve for cigarettes to the right.
This should shift the demand curve for cigarettes to the right.
This should shift the supply curve of cigarettes to the left
This should shift the supply curve of cigarettes to the right.
This should shift the demand curve for cigarettes to the left.
This should shift the demand curve of cigarettes to the left.
1.2 (Substitutes and Complements) For each of the following pairs of goods, determine whether the goods
are substitutes, complements, or unrelated:
a. Peanut butter and jelly
b. Private and public transportation
c. Coke and Pepsi
d. Alarm clocks and automobiles
e. Golf clubs and golf balls
a.
b.
c.
d.
e.
Complements
Substitutes
Substitutes
Unrelated
Complements
2.1 (Supply) What is the law of supply? Give an example of how you have observed the law of supply at
work. What is the relationship between the law of supply and the supply curve?
The law of supply states that the quantity supplied of a good is usually directly related to its price, other
things constant. At work a student might observe a greater effort by his or her company to supply
products that have been experiencing a rising price. Producers try their best to produce as much as
possible when a product is in great demand and, thus, its price is increasing. Along an upward sloping
supply curve the variables, price and quantity, are directly related. As the price of a good increases, a
producer becomes more willing to supply the good. The higher price provides the producer with a
profit incentive to shift some resources from lower-valued uses to the higher-valued use.
3.1 (Demand and Supply) How do you think each of the following affected the world price of oil? (Use
demand and supply analysis.)
a. Tax credits were offered for expenditures on home insulation.
b. The Alaskan oil pipeline was completed.
c. The ceiling on the price of oil was removed.
d. Oil was discovered in the North Sea.
e. Sport utility vehicles and minivans became popular.
f. The use of nuclear power declined.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 4
a.
b.
c.
d.
e.
f.
Demand, Supply, and Markets
57
Such credits decreased the demand for oil and lowered the world price.
This increased the supply of oil and lowered the world price.
The answer depends on whether the control price had been set below equilibrium.
This increased the supply of oil and lowered the world price.
This increased the demand for oil and raised the world price.
This increased the demand for oil and raised the world price.
3.2 (Demand and Supply) What happens to the equilibrium price and quantity of ice cream in response to
each of the following? Explain your answers.
a. The price of dairy cow fodder increases.
b. The price of beef decreases.
c. Concerns rise about the fat content of ice cream. Simultaneously, the price of sugar (used to
produce ice cream) increases.
a. The supply curve shifts left, equilibrium price rises, equilibrium quantity falls.
b. Assuming cattle can be substituted between dairy and livestock uses, dairy use becomes more
attractive and the supply curve shifts right, equilibrium price falls, and equilibrium quantity rises.
c. Fat concerns shift demand left, equilibrium price falls, and equilibrium quantity falls. Increase in
price of sugar leads to leftward supply shift, equilibrium price rises, equilibrium quantity falls. In
the end, equilibrium quantity will fall but impact on price is unclear.
4.1 (Equilibrium) “If a price is not an equilibrium price, there is a tendency for it to move to its equilibrium
level. Regardless of whether the price is too high or too low to begin with, the adjustment process will
increase the quantity of the good purchased.” Explain, using a demand and supply diagram.
At PH (a price above equilibrium price P), quantity supplied exceeds quantity demanded by (QSH – QDH).
The amount actually purchased is QDH, which is less than the amount purchased when the price is P.
At PL (a price below P), quantity demanded exceeds quantity supplied by (QDL – QSL). The amount
actually purchased is QSL, which is less than the amount purchased when the price is P.
4.2 (Equilibrium) Assume the market for corn is depicted as in the table that appears below.
a. Complete the table below.
b. What market pressure occurs when quantity demanded exceeds quantity supplied? Explain.
c. What market pressure occurs when quantity supplied exceeds quantity demanded? Explain.
d. What is the equilibrium price?
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Chapter 4
e.
f.
Demand, Supply, and Markets
58
What could change the equilibrium price?
At each price in the first column of the table below, how much is sold?
Price per
Bushel
$1.80
2.00
2.20
2.40
2.60
2.80
Quantity Demanded
(millions of bushels)
320
300
270
230
200
180
Quantity Supplied
(millions of bushels)
200
230
270
300
330
350
Surplus/
Shortage
Will Price
Rise or Fall?
a.
Price per
Quantity Demanded
Quantity Supplied
Surplus/
Will Price
Bushel
(millions of bushels)
(millions of bushels)
Shortage
Rise or Fall?
$1.80
320
200
120 shortage
Rise
2.00
300
230
70 shortage
Rise
2.20
270
270
Equilibrium
No move
2.40
230
300
70 surplus
Fall
2.60
200
330
130 surplus
Fall
2.80
180
350
170 surplus
Fall
b. When quantity demanded exceeds quantity supplied, this creates a shortage in the market. A shortage
c.
d.
e.
f.
exerts upward pressure on price.
When quantity supplied exceeds quantity demanded, this creates a surplus in the market. A surplus
exerts downward pressure on price.
Equilibrium price is $2.20.
If any determinant of either demand or supply changes, the respective curves would shift and equilibrium
price would change.
At $1.80, 200 bushels of corn are sold; at $2.00, 230 bushels are sold. These amounts are sold because
at prices below equilibrium, the amount sold is equal to the quantity supplied. At $2.20, 270 bushels are
bought and sold because this is equilibrium. At $2.40, 230 bushels are sold; at $2.60, 200 bushels are
sold; and at $2.80, 180 bushels of corn are sold. These amounts are sold because at prices above
equilibrium, the amount sold is equal to the quantity demanded.
4.3 (Market Equilibrium) Determine whether each of the following statements is true, false, or uncertain.
Then briefly explain each answer.
a. In equilibrium, all sellers can find buyers.
b. In equilibrium, there is no pressure on the market to produce or to consume more than is being sold.
c. At prices above equilibrium, the quantity exchanged exceeds the quantity demanded.
d. At prices below equilibrium, the quantity exchanged is equal to the quantity supplied.
a. True; otherwise there would be a surplus.
b. True; in each period the same equilibrium quantity will be produced and sold.
c. False; the quantity exchanged is exactly equal to the quantity demanded, even though the
quantity supplied at prices above equilibrium will exceed the quantity demanded.
d. True; the quantity supplied equals the quantity exchanged, even though the quantity demanded at
prices below equilibrium will exceed the quantity supplied
4.4 (Changes in Equilibrium) What are the effects on the equilibrium price and quantity of steel if the wages
of steelworkers rise and, simultaneously, the price of aluminum rises?
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 4
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59
As wages rise, the supply curve shifts leftward, increasing equilibrium price and reducing equilibrium
quantity. The increase in the price of aluminum (a substitute for steel) should lead to an increase in the
demand for steel. The rightward shift in demand will push equilibrium price and quantity up. The net
impact is an increase in price but the net impact on equilibrium quantity is unclear and depends on the
relative sizes of the changes in demand and supply.
5.1 (Price Floor) There is considerable interest in whether the minimum wage rate contributes to teenage
unemployment. Draw a demand and supply diagram for the unskilled labor market, and discuss the
effects of a minimum wage. Who is helped and who is hurt by the minimum wage?
The following diagram shows the demand and supply for unskilled workers. At equilibrium, the wage is
W1 and quantity Q1 is employed. Suppose that minimum wage W2 is imposed by the government. The
effect will be to reduce employment from Q1 to Q2. Those whose wages were initially below the new
minimum and who keep their jobs will get pay raises to W2. Others will be hurt by imposition of the
minimum wage, since they will lose their jobs. However, those who keep their jobs will be better off.
SUPPLEMENTAL CASES, EXERCISES, AND PROBLEMS
Case Studies
These cases are available to students online at www.cengagebrain.com.
The Market for Professional Basketball
Toward the end of the 1970s, the NBA seemed on the brink of collapse. Attendance had sunk to little more
than half the capacity. Some teams were nearly bankrupt. Championship games didn’t even merit prime-time
television coverage. But in the 1980s, three superstars turned things around. Michael Jordan, Larry Bird, and
Magic Johnson added millions of fans and breathed new life into the sagging league. Successive generations of
stars, including Dwayne Wade, Kevin Durant, and LeBron James, continue to fuel interest.
Since 1980 the league has expanded from 22 to 30 teams and attendance has more than doubled. More
importantly, league revenue from broadcast rights jumped nearly 50-fold from $19 million per year in the
1978–1982 contract to $930 million per year in the current contract, which runs to 2016. Popularity also
increased around the world as international players, such as Dirk Nowitzki of Germany and Yao Ming of
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 4
Demand, Supply, and Markets
60
China, joined the league (basketball is now the most widely played team sport in China). NBA rosters now
include more than 80 international players. The NBA formed marketing alliances with global companies such
as Coca-Cola and McDonald’s, and league playoffs are now televised in more than 200 countries in 45
languages to a potential market of 3 billion people.
What’s the key resource in the production of NBA games? Talented players. Exhibit 10 shows the market
for NBA players, with demand and supply in 1980 as D1980 and S1980. The intersection of these two curves
generated an average pay in 1980 of $170,000, or $0.17 million, for the 300 or so players then in the league.
Since 1980, the talent pool expanded somewhat, so the supply curve in 2010 was more like S2010 (almost by
definition, the supply of the top few hundred players in the world is limited). But demand exploded from D1980
to D2010. With supply relatively fixed, the greater demand boosted average pay to $6.0 million by 2010 for the
450 or so players in the league. Such pay attracts younger and younger players. Stars who entered the NBA
right out of high school include Kobe Bryant, Kevin Garnett, and LeBron James. (After nine players
entered the NBA draft right out of high school in 2005, the league, to stem the flow, required draft candidates
to be at least 19 years old and out of high school at least one year. So talented players started turning pro after
their first year of college; in 2008, for example, 12 college freshman were drafted including five of the top
seven picks.)
But rare talent alone does not command high pay. Top rodeo riders, top bowlers, and top women basketball
players also possess rare talent, but the demand for their talent is not sufficient to support pay anywhere near
NBA levels. NBA players earn on average nearly 100 times more than WNBA players. For example, Diana
Taurasi, a great University of Connecticut player, earned only $40,800 her first WNBA season. Some sports
aren’t even popular enough to support professional leagues.
NBA players are now the highest-paid team athletes in the world—earning at least double that of
professionals in baseball, football, and hockey. Both demand and supply determine average pay. But the NBA
is not without its problems. In 2010 NBA players received 57 percent of all team revenue. Some team owners
say they have been losing money, so they want to cut the share of revenue going to players. To cut costs, some
teams, such as the Detroit Pistons, have traded their highest paid players.
Sources: Howard Beck, “Falk Says NBA and Players Headed for Trouble,” New York Times, 13 February
2010; Jonathan Abrams, “NBA’s Shrinking Salary Cap Could Shake Up 2010 Free Agency,” New York Times,
8 July 2010; and U.S. Census Bureau, Statistical Abstract of the United States: 2010 at
http://www.census.gov/compendia/statab/.
Rent Ceilings in New York City
New York City rent controls began after World War II, when greater demand for rental housing threatened to
push rents higher. To keep rents from rising to their equilibrium level, city officials imposed rent ceilings.
Since the quantity demanded at the ceiling rent exceeded the quantity supplied, a housing shortage resulted, as
was sketched out in panel (b) of Exhibit 11. Thus, the perverse response to a tight housing market was a policy
that reduced the supply of housing over time. The city-wide vacancy rate was recently just 3 percent.
Prior to rent controls, builders in New York City completed about 30,000 housing units a year and 90,000
units in the peak year. After rent controls, new construction dropped sharply. To stimulate supply, the city
periodically promised rent-ceiling exemptions for new construction. But three times the city broke that promise
after the housing was built. So builders remain understandably wary. During the peak year of the last decade
only about 10,000 new housing units were built.
The excess demand for housing in the rent-controlled sector spilled into the free-market sector, increasing
demand there. This greater demand raised rents in the free-market sector, making a rent-controlled apartment
that much more attractive. New York City rent regulations now cover about 70 percent of the 2.1 million rental
apartments in the city.
Tenants in rent-controlled apartments are entitled to stay until they die, and with a little planning, they can
pass the apartment to their heirs. Rent control forces tenants into housing choices they would not otherwise
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Chapter 4
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make. After the kids have grown and one spouse has died, the last parent standing usually remains in an
apartment too big for one person but too much of a bargain to give up. An heir will often stay for the same
reason. Some people keep rent-controlled apartments as weekend retreats for decades after they have moved
from New York. All this wastes valuable resources and worsens the city’s housing shortage.
Since there is excess quantity demanded for rent-controlled apartments, landlords have less incentive to
maintain apartments in good shape. A survey found that about 30 percent of rent-controlled housing in the
United States was deteriorating versus only 8 percent of free-market housing. Similar results have been found
for England and France. Sometimes the rent is so low that owners simply abandon their property. During one
decade, owners abandoned a third of a million units in New York City. So rent controls reduce both the quality
and the quantity of housing available.
You would think that rent control benefits the poor most, but it hasn’t worked out that way. Henry
Pollakowski, an MIT housing economist, concludes that tenants in low- and moderate-income areas get little
or no benefit from rent control. But some rich people living in a rent-controlled apartment in the nicest part of
town get a substantial windfall. Someone renting in upscale sections of Manhattan might pay only $1,000 a
month for a three-bedroom apartment that would rent for $12,000 a month on the open market. According to a
recent study, more than 87,000 New York City households with incomes exceeding $100,000 a year benefited
from rent control by paying below-market rents.
Once a tenant leaves a rent-controlled apartment, landlords can raise the rent on the next tenant and under
some circumstances can escape rent controls entirely. With so much at stake, landlords under rent control have
a strong incentive to oust a tenant. Some landlords have been known to pay $5,000 bounties to doormen who
report tenants violating their lease (for example, the apartment is not the tenant’s primary residence or the
tenant is illegally subletting). Landlords also hire private detectives to identify lease violators. And landlords
use professional “facilitators” to negotiate with tenants about moving out. Many tenants end up getting paid
hundreds of thousands of dollars for agreeing to move. Some have been paid more than $1 million. Facilitators
can often find tenants a better apartment in the free-market sector along with enough cash to cover the higher
rent for, say, 10 years. Since the rental market is in disequilibrium, other markets, such as the market for
buying out tenants, kick in.
Sources: Edward Glaeser and Erzo Luttmer, “The Misallocation of Housing Under Rent Control,” American
Economic Review, 93 (September 1993): 1027–1046; Henry Pollakowski, “Who Really Benefits from New
York City’s Rent Regulation System?” Civic Report 34 (March 2003) at http://manhattaninstitute.org/pdf/cr_34.pdf. Janny Scott, “Illegal Sublets Put Private Eyes on the Cast,” New York Times, 27
January 2007; and Eileen Norcross, “Rent Control Is the Real New York Scandal,” Wall Street Journal,
September 13, 2008. The New York City Rent Guideline Board’s Web site is at
http://www.housingnyc.com/html/resources/dhcr/dhcr1.html.
Experiential Exercises
1. Divide the class into groups of students and have them determine their market demand for gasoline. Make
up a chart listing a variety of prices per gallon of gasoline—in an ideal world, $1.00, $1.25, $1.50, $1.75,
$2.00, $2.25. Ask each student how many gallons per week they would purchase at each possible price.
Then:
a. Have them plot their demand curves. Check to see whether each student’s responses are consistent with
the law of demand.
b. Have students derive the “market” demand curve by adding the quantities demanded by all students at
each possible price.
c. Ask them what they think will happen to that market demand curve after the class graduates and their
incomes rise?
2. The minimum wage is a price floor in a market for labor. The government sets a minimum price per hour of
labor in certain markets, and no employer is permitted to pay a wage lower than that. Send students to the
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Chapter 4
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Department of Labor’s minimum wage Web page to learn more about the mechanics of the program:
http://www.dol.gov/dol/topic/wages/minimumwage.htm. Then have them use a demand and supply
diagram to illustrate the effect of imposing an above-equilibrium minimum wage on a particular labor
market. Ask them what happens to quantity demanded and quantity supplied as a result of the minimum
wage?
3. After reading this chapter, students should have a basic understanding of how demand and supply determine
market price and quantity. Ask them to find an article in the “first section” of today’s Wall Street Journal
and interpret the article, using a demand and supply diagram. Have students explain at least one case in
which a curve shifts, what caused the shift, and how it affected price and quantity.
4. (Global Economic Watch) Go to the Global Economic Crisis Resource Center. Select Global Issues in
Context. In the Basic Search box at the top of the page, enter the phrase "Law of Supply, Demand." On the
Results page, go to the Global Viewpoints section. Click on the link for the November 21, 1984, article
"Law of Supply, Demand Applies to Everyone." Did the article describe a surplus of supply or a shortage of
supply?
The article described a surplus of supply driving down the equilibrium price.
5. (Global Economic Watch) Go to the Global Economic Crisis Resource Center. Select Global Issues in
Context. Go to the menu at the top of the page and click on the tab for Browse Issues and Topics. Choose
Business and Economy. Click on the link for Oil Prices. Find an article from the last 12 months. Compare
and contrast the information about oil prices in the article from Problem 23 and in the current article. Use
demand, supply, and equilibrium in your analysis.
The 1984 article described a surplus of supply driving down the equilibrium price. Student answers will
vary with the current situation, but may, for example, describe an increase in demand in developing
countries leading to a shortage of supply and a higher equilibrium price.
Additional Questions and Problems
(From student Web site at www.cengagebrain.com)
1.
(Law of Demand) What is the law of demand? Give two examples of how you have observed the law of
demand at work in the “real world.” How is the law of demand related to the demand curve?
The law of demand states that the quantity of a product demanded during a given time period varies
inversely with its price, other things constant. Real-world examples of the law of demand at work could
include students buying less gasoline when the price per gallon rises or buying fewer take-out pizzas
when the price of pizza rises.
Along a downward-sloping demand curve, the variables, price and quantity, are inversely related. As
the price of the good rises, the quantity demanded decreases. As the price of the good falls, the quantity
demanded increases.
2.
(Changes in Demand) What variables influence the demand for a normal good? Explain why a reduction
in the price of a normal good does not increase the demand for that good.
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Chapter 4
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63
The demand for a normal good is determined by consumer income, changes in prices of other goods,
consumer expectations, the composition of consumers and consumer tastes. As these variables change,
the demand for normal goods will change. Changes in consumer income influence the position of the
demand curve. Income and the demand curve for a normal good are directly or positively related. If
consumer income increases, the demand curve for a normal good shifts to the right. If consumer income
decreases, the demand curve for the normal good shifts to the left.
A reduction in the price of a normal good causes a movement along the demand curve, an increase in
quantity demanded, not an increase in demand.
3.
(Substitution and Income Effects) Distinguish between the substitution effect and income effect of a price
change. If a good’s price increases, does each effect have a positive or a negative impact on the quantity
demanded?
The substitution effect refers to the change in a good’s price relative to the prices of alternative goods. A
price increase makes the good more expensive, so customers are more likely to buy a substitute. The
income effect refers to the change in the purchasing power of the consumer’s income. A price increase
reduces purchasing power. The substitution effect always creates a negative impact on the quantity
demanded; the income effect has a positive impact for normal goods and a negative impact for inferior
goods.
4.
(Demand) Explain the effect of an increase in consumer income on demand for a good.
Increased income leads to greater demand for normal goods and lower demand for inferior goods.
5.
(Income Effects) When moving along the demand curve, income must be assumed constant. Yet one
factor that can cause a change in the quantity demanded is the “income effect.” Reconcile these
seemingly contradictory facts.
This question highlights the difference between nominal (money) income, which is constant as you move
along a demand curve, and real income, which changes whenever the nominal income or price changes.
Because the price falls as you move down the demand curve while nominal income is held constant, real
income increases, leading to an increase in the quantity demanded (i.e., the income effect).
6.
(Demand) If chocolate is found to have positive health benefits, would this lead to a shift in the demand
curve or a movement along the demand curve?
This would lead to an increase in demand, a rightward shift in the demand curve, because changing
consumer tastes increase demand for chocolate at every price because of the health benefits associated
with consumption.
7.
(Changes in Supply) What kinds of changes in underlying conditions can cause the supply curve to shift?
Give some examples and explain the direction in which the curve shifts.
Changes in the determinants of supply other than the price of the good in question can cause the supply
curve to shift. These determinants of supply include technology, the prices of relevant goods (inputs to
production), the prices of alternative goods (those goods that use some of the same resources as are
used to produce the good in question), producer expectations; and the number of producers.
Supply will decrease, that is, the supply curve will shift to the left, if one of these occurs:
 A more expensive technology has to be used due to safety regulations.
 The price of a relevant resource increases, raising the costs of production.
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Chapter 4
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64
 The price of an alternative good—one that can be produced using the same resources as the good in
question—increases.
 The future price of the product is expected to be higher.
 The number of producers decreases.
Supply will increase, that is, the supply curve will shift to the right, if one of these occurs:
 A more efficient technology is discovered, reducing production costs.
 The price of a relevant resource decreases, lowering the costs of production.
 The price of an alternative good decreases
 The future price of the product is expected to be lower.
 The number of producers increases.
Gasoline is a relevant resource in the production of many goods. A rise in the price of this important
resource increases the costs of production and causes the supply of many products to decrease, shifting
their supply curves to the left.
8.
(Supply) If a severe frost destroys some of Florida’s citrus crop, would this lead to a shift of the supply
curve or a movement along the supply curve?
This would lead to a leftward shift in the supply curve because output has declined and producers are
now willing and able to supply less citrus at every price.
9.
(Markets) How do markets coordinate the independent decisions of buyers and sellers?
Markets provide information about the price, quantity, and quality of products for sale—information
that a potential buyer needs to make a decision. Markets also reduce transaction costs because buyers
need less time to gather information and make a purchase. The interaction of the buyers and sellers is
coordinated in a way that guides resources and products to their highest valued uses.
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Chapter 4
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10. (Equilibrium) Consider the following graph in which demand and supply are initially D and S1,
respectively. What are the equilibrium price and quantity? If demand increases to D ', what are the new
equilibrium price and quantity? What happens if the government does not allow the price to change
when demand increases?
P
S1
$12
10
•
•
•
D’
D
100
175
250
400
Q
The initial equilibrium price and quantity are $10 and 175 units, respectively. After demand increases,
the equilibrium price and quantity are $12 and 250 units, respectively. If the government does not allow
the price to rise, then the quantity demanded rises to 400 units while the quantity supplied remains at
175 units, creating a shortage of 225 units.
ANSWERS TO ONLINE CASE STUDIES
1.
(CaseStudy: The Market for Professional Basketball) In what sense can we speak of a market for
professional basketball? Who are the demanders and who are the suppliers? What are some examples of
how changes in supply or demand conditions have affected this market?
The market involves all individuals who “demand” professional basketball by attending games in person
or by watching games on television. It also involves all firms and individuals who supply the service by
playing on, coaching, or administering pro basketball teams.
The appearance of superstar basketball players in the 1980’s improved the quality of games and
stimulated an increase in demand. That increased the price—either the price of game tickets or the
amount the NBA charged television networks for the rights to televise games. The players’ strike during
the 1998—99 season reduced the supply of basketball games. That certainly reduced the price and
quantity of basketball (to zero)
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Chapter 4
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12. (CaseStudy: Rent Ceilings in New York City) Suppose the demand and supply curves for rental housing
units have the typical shapes and that the rental housing market is in equilibrium. Then, government
establishes a rent ceiling below the equilibrium level.
a. What happens to the quantity of housing available?
b. What happens to the quality of housing and why?
c. Who benefits from rent control?
d. Who loses from rent control?
e. How do landlords of rent-controlled apartments try to get tenants to leave?
a. The quantity of housing available falls because, at the rent-controlled price, less rental housing is
supplied.
b. The quality of housing deteriorates because, if rent is controlled, landlords have less incentive to keep
apartments in good shape.
c. Anyone renting at the rent-control price is better off.
d. People who would have rented an apartment at the uncontrolled price but are not able to get one at
the rent-control price (after all, fewer units are available) are worse off, as are the suppliers of
rental housing units.
e. Landlords of rent-controlled apartments may pay a “bounty” to doormen or hire private detectives
to identify lease violators. Landlords may also use professional “facilitators” to negotiate with
tenants about moving out.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.