Download Supply and Demand: Applications and Extensions

Economic Examples
1. Cyclone Larry in Australia
• Destroyed 80% of the banana crop.
• Prices went from $1.00 to $2.00 per pound
• Supply or Demand problem??
S2
Price
Banana
Market
S1
$2.00
$1.00
DR
Quantity
Q2 Q 1
Sales of SUVs in the U.S.
Average price fell 10%
SUVs
P
Supply or Demand problem?
S0
Increasing gas costs causes
the demand curve to shift
left
Price for SUVs fell
from
P0 to P1 where
Q demanded = Q supplied
P0
P1
D0
D1
Q1
Q0
Q
Coffee Beans
• fell from $2.00/pound in 1997 to $.50 in 2002
Supply or Demand problem?
New growing
techniques and the
entry of new growers
shifted the supply
Price
curve.
S2
Coffee Bean
Market
S1
$2.00
$0.50
Dc
Q1
Q2
Quantity
2. Increase in the Demand for
Loanable Funds
Interest
rate
Lending
• At the interest rate r the
quantity of loanable
funds demanded by
borrowers into equals
quantity supplied by
lenders.
• An increase in demand
will move D1 to D2
the interest rises to r2 and
increasing borrowing to Q2
• Higher interest rates
encourage additional
savings, making it
possible to fund
more borrowing.
S
r2
r1
Borrowing
D1
Q1 Q2
D2
Quantity of
loanable funds
The Price of Foreign Currency
• Foreign exchange market is where currency of
one country is traded for another.
• The exchange rate is measured as the dollar
price of foreign currency.
• Changes in exchange rates will alter the
prices of internationally traded
goods/services and assets
• A lower dollar price of foreign currency will
have two effects:
• It will lower the price of foreign goods to
U.S. residents and raise imports.
• It will raise the price of U.S. goods to
foreigners and lower exports.
Examples of exchange rates
Country currency
In US$
Per US$
US$ vs. YTD
change (%)
Mexico peso
0.0738
13.5520
- 1.3
China yuan
0.1463
6.8348
0.2
United Kingdom pound
1.4828
0.6744
- 1.6
Poland zloty
0.3032
3.2982
11.1
Israel shekel
0.2400
4.1667
10.3
Kuwait dinar
3.4376
0.2909
5.3
Increase in the Demand for Foreign
Exchange
• Beginning equilibrium
exchange rate:
(10 cents = 1quetzal).
• An increase in American
demand for Guatemalan
coffee will also increase
the demand for quetzals
• Equilibrium occurs where
the new demand for
quetzals D2 just equals
the supply S – at $.20 per
quetzal with Q2 > Q1
quetzals clearing the
market.
U.S. sales to
Guatemala
Exchange rate
($ per quetzal)
S
0.20
0.10
D2
U.S. purchases
from Guatemala
D1
Q1
Q2
Quantity of
quetzal exchange
Government
Intervention
in the
Market
1. Price Ceilings
• Price ceiling is a legally established
maximum price that sellers may charge.
• It stops the price from rising to the
equilibrium level.
• Example: rent control
• The direct effect of a price ceiling is
a shortage: quantity demanded
exceeds quantity supplied.
The Impact of a Price Ceiling
Price
(rent)
• In the rental housing
market the price (rent) P0
would bring the quantity
of rental units demanded
into balance with the
quantity supplied.
• A price ceiling like P1sets a
price below equilibrium …
quantity demanded QD …
exceeds quantity supplied QS
…
resulting in a shortage.
S
Rental housing
market
P0
Price
ceiling
P1
Shortage
D
QS
QD
Quantity of
housing units
Effects of Rent Control
• The future supply of housing will decline.
• The quality of housing will deteriorate.
• Non-price methods of rationing will
increase in importance.
• Long-term renters will benefit at the
expense of newcomers.
2. Price Floors
• Price floor is a legally established minimum
price that buyers must pay.
• It stops the price from dropping down to
equilibrium level.
• Example: minimum wage
• The direct effect of a price floor above the
equilibrium price is a surplus: quantity
supplied exceeds quantity demanded.
The Impact of a Price Floor
Price
• A price floor like P1 sets a
price above market equilibrium
P1
causing quantity supplied QD …
S
Surplus
Price
floor
to exceed quantity demanded QS
P0
…
resulting in a surplus.
•Non-price factors will become
more important than prices in
determining where scarce
goods go.
D
QD
QS
Quantity
Minimum Wage Effects
• Direct effect:
• Reduces employment of low-skilled labor.
• Indirect effects:
• Reduction in non-wage component of
compensation.
• Less on-the-job training.
• May encourage students to drop out of
school
• A higher minimum wage does little to help
the poor.
Employment and the Minimum Wage
• If a price (wage) of $4.00
could bring equilibrium.
Price
(wage)
Excess
supply
• A minimum wage (price floor) $ 5.15
of $5.15 would increase the
earnings of those who stayed
employed (E1), but would reduce
the employment of others.
$ 4.00
S
Minimum
wage level
• Those who lose their job (E0
to E1) would be pushed into
either unemployment or some
other less preferred form of
employment.
D
E1
E0
Quantity
(employment)
Excise Taxes
• Government impacts markets through taxation
• An excise tax is a tax that is levied on a
specific good
• A tariff is an excise tax on an imported good
• The result of taxes and tariffs is an increase in
equilibrium prices and reduce equilibrium
quantities
5-16
The Effect of an Excise Tax
P
Government imposes a
$10,000 luxury tax on the
suppliers of boats
Luxury Boats
S1
S0
Tax = $10,000
$70,000
The supply curve shifts up by
the amount of the tax
$65,000
$60,000
D0
420
510
Q
The price of boats rises
by less than the tax to
$70,000
Quantity Restrictions
• Government regulates markets with licenses,
which limit entry into a market
• Many professions require licenses, such as doctors,
financial planners, cosmetologists, electricians, or
taxi cab drivers
• The results of limited number of licenses in a
market are increases in wages and an increases in
the price of obtaining the license
5-18
The Effect of a Quantity Restriction
NYC Taxi Drivers
P(wage)
Successful lobbying by taxi cab
drivers in NYC resulted in quantity
restrictions (medallions)
QR
D1
$1
5
D0
12,0
00
When the demand for taxi
services increased, because the
number of taxi licenses was
limited, wages increased
Q(of drivers)
Application: The Effect of a Quantity
Restriction
NYC Taxis Medallions
P
QR
The demand for taxi
medallions also increased
because wages were
increasing. But because the
number of taxi licenses was
limited, the price of a
medallion also increased
$400,00
0
D1
Initial Fee
D0
12,0
00
Q(of medallions)
Third-Party-Payer Markets
• In third-party-payer markets, the person who
receives the good differs from the person paying
for thea good
• Under
third-party-payer system, the person who
chooses how much to purchase doesn’t pay the entire cost
• Equilibrium quantity and total spending can be much
higher in third-party-payer markets
• Goods from a third-party-payer system will be rationed
through social and political means
5-21
Third-Party-Payer Markets
P
With a co-payment of $5,
consumers demand 18 units
Health Care
Sellers require $45 per
unit for that quantity
S0
$4
5
Total expenditures for
18 units of health care
$2
5
$5
…are greater than when…
D0
10
18
Q
The consumer pays
the entire cost