Download Principles of Economics, Case and Fair,9e

PART I INTRODUCTION TO ECONOMICS
4
Demand and Supply
Applications
Prepared by:
Fernando & Yvonn Quijano
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
Principles of Macroeconomics 9e by Case, Fair and Oster
PART I INTRODUCTION TO ECONOMICS
CHAPTER 4 Demand and Supply Applications
Demand and Supply
Applications
© 2009 Pearson Education, Inc. Publishing as Prentice Hall
4
CHAPTER OUTLINE
The Price System: Rationing and
Allocating Resources
Price Rationing
Constraints on the Market and
Alternative Rationing Mechanisms
Prices and the Allocation of Resources
Price Floors
Supply and Demand Analysis:
An Oil Import Fee
Supply and Demand
and Market Efficiency
Consumer Surplus
Producer Surplus
Competitive Markets Maximize the
Sum of Producer and Consumer
Surplus
Potential Causes of Deadweight
Loss from Under- and Overproduction
Looking Ahead
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The Price System: Rationing and Allocating Resources
CHAPTER 4 Demand and Supply Applications
Price rationing: The process by which the price system allocates
goods and services to consumers when there is a shortage.
Suppose in 2008 that 15,000
square miles of lobstering
waters off the coast of Maine are
closed. The supply curve shifts
to the left. Before the waters are
closed, the lobster market is in
equilibrium at the price of $11.50
and a quantity of 81 million
pounds. The decreased supply
of lobster leads to higher prices,
and a new equilibrium is
reached at $16.10 and 60 million
pounds.
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The Price System: Rationing and Allocating Resources
CHAPTER 4 Demand and Supply Applications
Price Rationing: The Market for a Rare Panting
There is some price that will
clear any market, even if
supply is strictly limited. In an
auction for a unique painting,
the price (bid) will rise to
eliminate excess demand until
there is only one bidder willing
to purchase the single
available painting.
The adjustment of price is the rationing mechanism in free markets. Price
rationing means that whenever there is a shortage exists, the price of the
good will rise until equilibrium is reached.
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The Price System: Rationing and Allocating Resources
CHAPTER 4 Demand and Supply Applications
On occasion, both governments and private firms decide to use
some mechanism other than the market system to ration an
good in shortage.
Regardless of the rationale, two things are clear:
1. Attempts to bypass price rationing in the market and use
alternative rationing devices are more costly than they seem.
2. Often, such attempts distribute costs and benefits among
households in unintended ways.
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The Price System: Rationing and Allocating Resources
Price Ceiling: When a maximum legal price is charged for a good.
CHAPTER 4 Demand and Supply Applications
Oil, Gasoline, and OPEC
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In 1974, a ceiling price of $0.57
cents per gallon of gasoline was
imposed. The equilibrium price was
$1.50 per gallon.
At $0.57 per gallon, there was a
shortage in the market.
Because the price system was not
allowed to function, a governmental
rationing system was used to
distributed the available supply of
gasoline.
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The Price System: Rationing and Allocating Resources
Alternative Rationing Mechanisms
CHAPTER 4 Demand and Supply Applications
Queuing: Waiting in line as a means of distributing goods and
services
Favored Customers: Those who receive special treatment
from dealers during situations of excess demand
Ration Coupons: Tickets or coupons that entitle individuals
to purchase a certain amount of a given product per month
Black Market: A market in which illegal trading takes place
at market-determined prices
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The Price System: Rationing and Allocating Resources
CHAPTER 4 Demand and Supply Applications
Concert by a Popular Musician
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The face value of a ticket to the Justin
Timberlake concert on September 16,
2007, at the Staples Center in Los
Angeles was $50. The Staples Center
holds 20,000. The supply curve is
vertical at 20,000.
At $50, the quantity supplied is below
the quantity demanded. The diagram
shows that the equilibrium price was
$300.
On E-Bay, some tickets were sold at
$16,000 each.
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The Price System: Rationing and Allocating Resources
CHAPTER 4 Demand and Supply Applications
No matter how good the intentions of private organizations and
governments, it is very difficult to prevent the price system from
operating and to stop willingness to pay from asserting itself.
Every time an alternative is tried, the price system seems to sneak
in the back door. With favored customers and black markets, the
final distribution may be even more unfair than that which would
result from simple price rationing.
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The Price System: Rationing and Allocating Resources
CHAPTER 4 Demand and Supply Applications
Price changes resulting from shifts of demand in output markets
cause profits to rise or fall.
Profits attract capital and enable firms to pay higher wages. Higher
wages attract labor and encourage workers to acquire skills.
At the core of the system, supply, demand, and prices in input and
output markets determine the allocation of resources and the ultimate
combinations of things produced.
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CHAPTER 4 Demand and Supply Applications
The Price System: Rationing and Allocating Resources
The Price Mechanism at
Work for Shakespeare
Every summer, New York City puts on free performances of Shakespeare in
the Park. The true cost of a ticket is $0 plus the opportunity cost of the time
spent in line.
Some high school/college students pick up tickets by waiting in line. They
then turn around and sell tickets to more affluent Shakespeare lovers.
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The Price System: Rationing and Allocating Resources
CHAPTER 4 Demand and Supply Applications
Price Floor: When a minimum legal price is charged for a good.
The Minimum Wage: When the government sets the
market wage above the equilibrium wage.
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Supply and Demand Analysis: An Oil Import Fee
CHAPTER 4 Demand and Supply Applications
The U.S. Market for Crude Oil, 1989
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Supply and Demand and Market Efficiency
CHAPTER 4 Demand and Supply Applications
Consumer Surplus: The difference between the
maximum amount a person is willing to pay for a
good and its current market price.
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CHAPTER 4 Demand and Supply Applications
Supply and Demand and Market Efficiency
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Supply and Demand and Market Efficiency
CHAPTER 4 Demand and Supply Applications
Producer Surplus: The difference between the
market price and the cost of production for the firm.
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CHAPTER 4 Demand and Supply Applications
Supply and Demand and Market Efficiency
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Supply and Demand and Market Efficiency
CHAPTER 4 Demand and Supply Applications
Competitive Markets maximize the sum of PS and CS
Total producer and consumer surplus is greatest where supply and demand curves
intersect at equilibrium.
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Supply and Demand and Market Efficiency
CHAPTER 4 Demand and Supply Applications
Dead-weight Loss: The net loss of producer and
consumer surplus from underproduction or
overproduction.
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CHAPTER 4 Demand and Supply Applications
Supply and Demand and Market Efficiency
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Supply and Demand and Market Efficiency
Potential Causes of Deadweight Loss From Under- and
Overproduction
CHAPTER 4 Demand and Supply Applications
When supply and demand interact freely, competitive markets produce
what people want at least cost, that is, they are efficient.
There are a number of naturally occurring sources of market failure:
• Monopoly power gives firms the incentive to underproduce and
overprice
•Taxes and subsidies may distort consumer choices
• External costs such as pollution and congestion may lead to over- or
underproduction of some goods
• Price floors and price ceilings may have the same effects.
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