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SAYRE | MORRIS Seventh Edition CHAPTER 3 Demand and Supply: an Elaboration © 2012 McGraw-Hill Ryerson Limited 3-1 CHAPTER 3 Demand and Supply: an Elaboration Learning Objectives: 1. Explain the effects on equilibrium price and quantity of simultaneous changes in supply and demand 2. Explain why markets do not always work well 3. Understand why price ceilings cause shortages © 2012 McGraw-Hill Ryerson Limited 3-2 CHAPTER 3 Demand and Supply: an Elaboration Learning Objectives: 4. Understand why price floors cause surpluses 5. Ask some interesting “what if ” questions concerning the shape of demand and supply curves © 2012 McGraw-Hill Ryerson Limited 3-3 Determinants of Supply and Demand Determinants of Demand Determinants of Supply Consumer preferences Prices of productive resources Consumer incomes Business taxes Prices of related products Technology Expectations of future prices, incomes, or availability Population: its size, income distribution, and age Distribution Prices of substitutes in production LO1 Future expectations of suppliers Number of suppliers © 2012 McGraw-Hill Ryerson Limited 3-4 Simultaneous Changes in Supply and Demand LO1 • Increase in both demand and supply leads to an increase in equilibrium quantity; price may rise or fall © 2012 McGraw-Hill Ryerson Limited 3-5 LO1 Self-Test Explain what effect the changes will have on equilibrium price and quantity in the following markets: Market Change a)Day-care services More mothers with small children are returning to the labour force; at the same time, government decides to introduce subsidies for day-care operators. b) Marijuana Government severely increases the penalties for both buying and selling marijuana. c) Compact A new processing method significantly reduces the costs of discs producing CDs; at the same time, more consumers download music directly onto their computers. d)Organic vegetables Vegetarianism increases as a result of medical reports extolling its health benefits; at the same time, tighter regulations on the definition of organically grown products are introduced. © 2012 McGraw-Hill Ryerson Limited 3-6 LO1 Self-Test Explain what effect the changes will have on equilibrium price and quantity in the following markets: Market Change a)Day-care services Both demand and supply increase so quantity traded increases but price is indeterminate. b) Marijuana Both demand and supply decrease so price is indeterminate while quantity traded decreases. c) Compact discs Supply increases while demand decreases so price decreases while quantity traded is indeterminate. d)Organic vegetables Demand increases and supply decreases so that price increases while quantity traded is indeterminate. © 2012 McGraw-Hill Ryerson Limited 3-7 LO2 How Well Do Markets Work? Problems with markets: 1. Markets do not always adjust as quickly as we would like 2. Markets do not always produce equitable results 3. Competitive markets may not exist for some goods or services © 2012 McGraw-Hill Ryerson Limited 3-8 LO3 Price Controls Price Controls government regulations to set either a maximum or minimum price for a product Price Ceiling a government regulation stipulating the maximum price that can be charged for a product Price Floor a government regulation stipulating the minimum price that can be charged for a product © 2012 McGraw-Hill Ryerson Limited 3-9 LO3 Price Ceiling • • • Used when present market price for a particular product is considered too high for many buyers The product is felt to be a necessity Example: rent control © 2012 McGraw-Hill Ryerson Limited 3-10 LO3 Price Ceiling • Price ceilings cause shortages © 2012 McGraw-Hill Ryerson Limited 3-11 LO3 Allocating Shortages • • • • The market (supply and demand) First come, first served Producers’ preferences Rationing © 2012 McGraw-Hill Ryerson Limited 3-12 LO3 Self-Test a) Suppose the government introduces a price ceiling that is 20 cents different from the present equilibrium price. Would the result be a surplus or a shortage? Of what quantity? b) If an illegal market were to develop, what would be the maximum illegal market price? © 2012 McGraw-Hill Ryerson Limited 3-13 LO3 Self-Test a) Suppose the government introduces a price ceiling that is 20 cents different from the present equilibrium price. Would the result be a surplus or a shortage? Of what quantity? Price = 0.90; Shortage of 12 b) If an illegal market were to develop, what would be the maximum illegal market price? $1.20 © 2012 McGraw-Hill Ryerson Limited 3-14 LO4 Price Floor • • Used when present market price for a particular product is considered too low for producers Often used in agricultural markets © 2012 McGraw-Hill Ryerson Limited 3-15 LO4 Price Floor • Price floors cause surpluses © 2012 McGraw-Hill Ryerson Limited 3-16 LO4 Price Floor • Minimum wage laws can cause unemployment © 2012 McGraw-Hill Ryerson Limited 3-17 LO4 Dealing with Surpluses • • • • • Store it Convert it Sell it abroad at a reduced price (dump) Donate it Destroy it © 2012 McGraw-Hill Ryerson Limited 3-18 LO3 Quota • A quota, or restricting output, can raise price without causing a surplus © 2012 McGraw-Hill Ryerson Limited 3-19 LO3 Self-Test a) In equilibrium, what is the total revenue received by producers? b) Suppose that government imposes a price floor of $4 per kilo. What quantity will be demanded? What quantity will farmers produce? What quantity will government buy? c) How much will it cost to buy the surplus? © 2012 McGraw-Hill Ryerson Limited 3-20 LO3 Self-Test a) In equilibrium, what is the total revenue received by producers? TR = Q x P = 5 x 3.50 = $17.50 b) Suppose that government imposes a price floor of $4 per kilo. What quantity will be demanded? What quantity will farmers produce? What quantity will government buy? Qd=4, Qs=6, buy 2 c) How much will it cost to buy the surplus? 2 x $4 = $8 © 2012 McGraw-Hill Ryerson Limited 3-21 LO5 Vertical Demand Curve • A vertical demand curve suggests that price does not matter • Same quantity is demanded no matter what the price • Some goods seen as necessities (eg, insulin) may have a perfectly inelastic (vertical) range • Eventually, quantity demanded decreases as income is insufficient to pay for the good © 2012 McGraw-Hill Ryerson Limited 3-22 LO5 Upward Sloping Demand Curve • Upward sloping demand curves may be true for some individuals over a limited range of prices © 2012 McGraw-Hill Ryerson Limited 3-23 LO5 The Demand for Water • The effect of a change in supply depends very much on the shape of the demand curve © 2012 McGraw-Hill Ryerson Limited 3-24 CHAPTER 3 SUMMARY Key Concepts to Remember: • • • • • The effects on equilibrium price and quantity of simultaneous changes in supply and demand Why markets don’t always work well Why price ceilings create shortages Why price floors create surpluses Why demand curves might be vertical or upward sloping © 2012 McGraw-Hill Ryerson Limited 3-25