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1.0 Demand and Supply Analysis CHAPTER 3 Real World Examples • FLU SHOTS • • OIL CARTELS • • Illustrates a market shortage Illustrates how supply shifts change transportation costs THE MINIMUM WAGE • Illustrates a price floor Tips for Navigation in the Video Lecture: The table of contents in the left frame : has links to each slide. The slide with the LECTURE OUTLINE lists the main topic s. These topics begin with a whole number (e.g. “2.0” ). The bottom frame : has options to print each slide and to display closed captioning of the audio. The image of the house appears on every slide in the upper left and operates as a hyper link to the slide “LECTURE OUTLINE” Begin © Prof. Harmon 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 1 End 1.1 Flu Shots Each November there never seems to be enough supply. Like HealthCare it’s a shortage problem Republicans and Democrats debate whether there should be government production. We will use Supply and Demand to show a graph of this shortage situation and whether a price floor is a solution Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 2 End 1.2 Oil Cartels Rising oil prices effect the prices of almost everything, and have caused major unemployment problems in the US. Two examples: Transportation costs, US firms have moved furniture making plants abroad close to the raw natural resources of timber forests to reduce shipping costs. US car manufactures are now downsizing to “green” cars and Detroit is shedding jobs. Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 3 End 1.3 Minimum Wage In the market for unskilled labor the minimum wage is a policy solution to the outcome of wages below “living” wage levels. It is controversial because the wage floor (i.e. raising the wage above the equilibrium level) disrupts the market and pits Democrats v Republicans. We will explore the pros and cons of this 4 Return to First Slide Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End Lecture Outline 1. First Slide of Presentation 2. Demand A downward sloping curve 3. Supply A upward sloping curve 4. Market Equilibrium The process of elimination of surplus and shortages, Econ Lab 5. Government Intervention Price ceilings and floors, Econ Lab You can continue to the next slide “Definition of Demand Curve”, or select a topic and click the hyperlink. Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 5 End 2. DEMAND Topics Covered: 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.7 Definition Downward Sloping Individual & Market Demand Move v Shift Move Shift Shift Factors Summary Move v Shift Demand is covered in slides 6 to 27, you can click on the subtopics, or simply right mouse click to advance. Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 6 End 2.1 Demand Demand indicates how much of a good consumers are both willing and able to buy at each possible price during a given time period, other things constant Emphasis on individual being both willing and able to buy is critical to demand Consumer demand and needs are not the same thing Need focuses on the willingness and again ignores the ability to purchase Need may be a reason society consider income transfers Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 7 End 2.2.a Downward Sloping The law says that: The higher the price, the smaller the quantity demanded The lower the price, the larger the quantity demanded Specifically, why is more demanded when the price is lower? The Substitution Effect The Income Effect Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 8 End 2.2.b Substitution Effect Substitution Effect When the price of a good falls, its new price. which is now cheaper relative to the price of similar goods, makes consumers more willing to purchase this good Alternatively, when the price of a good increases, its new price, which is now more expensive relative to the price of similar goods, makes consumers less willing to purchase this good Remember it is the change in the relative price – the price of one good compared to the prices of other goods 9 – that causes the substitution effect Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.2.c Income Effect Money income is simply the number of dollars received per period of time Real income is person’s income measured in terms of the goods and services it can buy purchasing power When the price of a good decreases, a person’s real income increases increased ability to buy a good increase in quantity demanded When the price of a good increases real income declines reduces the ability to buy a good decline in quantity demanded 10 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.3.a Demand Schedule & Demand Curve for Pizza (a) Demand Schedule (b) Demand Curve Quantity Demanded per Week (millions) a) $15 b) 12 c) 9 d) 6 e) 3 $18 8 14 20 26 32 $15 The price is for a 12 inch regular pizza and the time period is 1 week. The demand schedule lists possible prices, along with the quantity demanded at each price. Price per Pizza Price per Pizza The demand curve at the right shows each price / quantity combination listed in the demand schedule as a point on the demand curve. Begin 2 Demand 3 Supply a $12 b $9 c $6 d $3 e $0 8 14 20 26 32 Millions of Pizzas per week 4 Market Equilibrium 5 Government Intervention 11 End 2.3.b Individual & Market Demand Individual demand refers to the demand of an individual consumer Market demand is the sum of the individual demands of all consumers in the market Important: the convention is that “demand “ is meant to refer to market demand 12 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.4 MOVE V SHIFT Change in Quantity Demanded Compared to Change in Demand Change in Quantity Demanded Refers to a move along the demand curve Shifts of the Demand Curve (change in demand) Refers to moving the entire demand curve You can click select a topic above, or click here to skip ahead to the summary of this13 section. Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.5.a Change in Quantity Demanded: MOVE Demand for pizza is not a specific quantity, but rather the entire relation between price and quantity demanded, and is represented by the entire demand curve a Price per quart $15.00 An individual point on the demand curve shows the quantity demanded at a particular price For example, at a price of $12, the quantity demanded is 14 million pizzas per week A change in price, other things constant, causes a movement along a demand curve b 12.00 c 9.00 d 6.00 e 3.00 D 0 The movement from say, b to c, is a change in quantity demanded and is shown as a movement along the demand curve and can only be caused by a change in price 8 14 20 26 32 Millions of pizzas per week Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 14 End 2.5.b Black Friday: The Super Bowl of Shopping Black Friday, it is the day when thousands of people across America spend hours in line – even camping out -- to get their hands on sharply discounted products, often in the wee hours of the morning. Retailers hope Black Friday sales (and the expanded openings on "Grey Thursday") aren't the equivalent of a Hollywood film that has a strong first weekend and then tanks the next. During the sale quantity demanded increases After the sale quantity demanded declines Discuss whether this is move along or shift of the demand curve. After Rush, Retailers Try New Shopping Lures By C. TAN, 11/26, 2007 15 Return to Move V Shift Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.6 Change in Demand: SHIFT The Demand curve shifts when factors other than price, change. Economists also refer to shifts in demand as a “change in demand” Demand can either increase, or decrease as shown in the next 2 slides Return to Move V Shift 16 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End The original demand curve is given as D, and assumes a certain level of money income. Suppose market demand increases from D to D‘ consumers now are willing to buy more pizza at each price. Price 2.6.a Shifts (changes) in Market Demand: INCREASE $15 b 12 f An increase in demand rightward shift in the demand curve consumers are willing and able to buy more pizza (by 6 units)at each price. 9 For example, at a price of $12, the amount of pizza demanded increases from 14 to 20 million per week as shown by the movement from b on demand curve D to point f on demand curve D'. 6 3 –A change in one of the determinants of demand other than price causes a shift of a demand curve changing demand D' D 0 8 14 20 26 Millions of pizzas per week 32 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 17 End The original demand curve is given as D, and assumes a certain level of money income. Suppose market demand decreases from D‘ to D now consumers are less willing to buy pizza at each price. Price 2.6.b Shifts (changes) in Market Demand: DECREASE $15 b 12 f A decrease in demand leftward shift in the demand curve consumers are less willing to buy pizza (by 6 units)at each price. 9 For example, at a price of 6 –A change in one of the $12, the amount of pizza determinants of demand demanded decreases from 20 3 other than price causes a to 14 million per week as shift of a demand curve shown by the movement point changing demand from f on demand curve D‘ 0 to b on demand curve D . Return to Shift 8 14 20 D' D 26 Millions of pizzas per week 32 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 18 End 2.7 Demand Curve Shift Factors Examples are: 1. Money income of consumers • Normal Goods Inferior Goods 2. Prices of related goods: • 2a Substitutes, 2b Complements 3. Consumer expectations 4. Number and composition of consumers in the market 5. Consumer tastes Click here to Skip ahead to summary of Moves v Shifts Return to Shift 19 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.7.1. Changes in Consumer Income Goods can be classified into two broad categories depending on how the Return to demand for the good responds to Shift Factors changes in money income Normal goods: the demand increases when income increases, and decreases when income decreases Inferior goods: the demand decreases when income increases, and increases when income decreases • As income increases, consumers tend to switch from consuming these goods to consuming normal goods McDonald's has been benefitting from the tendency of cash-strapped consumers to "trade down" from more pricey eating-out options in the U.S. WSJ 8/8/2008 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 20 End 2.7.2.a Changes in the Prices of Related Goods The prices of other goods are another of the factors assumed constant along a given demand Return to curve Shift Factors Two general relationships Two goods are substitutes if an increase in the price of one shifts the demand for the other rightward • and, conversely, if a decrease in the price of one shifts the demand for the other good leftward Two goods are complements if an increase in the price of one shifts the demand for the other leftward, • and conversely, a decrease in the price of one shifts the demand for the other rightward 21 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.7.2.b.Example of Substitutes • Who’s burgers are better?) What about homemade? Return to Shift Factors 22 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.7.2.c Example of Complements • The current run up in the price of gasoline has decreased the demand for the SUV gas guzzlers) Return to Shift Factors Begin “rising prices at the pump are starting to make some Americans think twice before buying a gas-23 sucking behemoth. Sales of big SUVs took a beating in April” (Business Week May 2004) 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.7.3. Changes in Consumer Expectations A change in consumer expectations with respect to future prices and future incomes is another of the factors which shifts demand: Changes in income expectations If individuals expect income to increase in the future, current demand increases and vice versa Changes in price expectations Return to Shift If individuals expect prices to increase in the future, current Factors demand increases. • For example if consumers expect interest rates to rise (as they did on: May 25, 2004) then demand for housing increases Conversely, it decreases if future prices are expected to decrease 24 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.7.4. Number or Composition of Consumers Because the market demand curve is the sum of the individual demand curves, a change in the number of consumers changes demand: An increase in the number of consumers increase in market demand A decrease in the number of consumers decrease in market demand Return to Shift Demographic changes in the population that Factors consumes pizza , for example, will change the demand for pizza McDonald's has been benefitting from new menu items, expanded hours and the tendency of cash-strapped consumers to "trade down" from more pricey eating out options in the U.S. And overseas, it is benefiting from expansion and organic growth in key markets like Australia, China and Japan while getting the currency benefits of the sagging U.S. dollar Click for News Article Begin 2 Demand 3 Supply WSJ 7/23/08 4 Market Equilibrium 5 Government Intervention 25 End 2.7.5 Consumer Tastes Sarah Palin's Glasses a Hit They're all all the rage and you can thank Sarah Palin for that. The VP nominee's eyeglasses are flying off the shelves all over the country. Yakima's Cascade Eye Center receives several phone calls a week, requesting them. The maker of the glasses is Kazuo Kawasaki and the frame is titanium. Currently the glasses are on backorder right now. Return to Shift Factors 26 Source Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 2.8 Summary: shifts v move along Remember the distinction between a movement along a given demand curve and a shift of the demand curve A change in one of the A change in price, other things Return to determinants of demand other than price causes a constant, causes a movement Shift along a demand curve Factors shift of a demand curve changing quantity demanded changing demand 27 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3. SUPPLY Topics Covered: 3.1 3.2 3.3 3.4 3.5 3.6 3.7 Definition Upward Sloping Individual & Market Supply Move Shift Shift Factors Summary Move v Shift Supply is covered in slides 28 to 43, you can click on the subtopics, or simply right mouse click to 28 advance. Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.1 Definition of Supply Supply indicates how much of a good producers are willing and able to offer for sale per period at each possible price, other things constant Law of supply states that the quantity supplied is usually directly related to its price, other things constant The lower the price, the smaller the quantity supplied Conversely, the higher the price, the greater the quantity supplied Reasons for Upward Slope Increased Rewards Increased Costs Return to Supply 29 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.2.a Upward Sloping bec. Higher Rewards Two reasons producers tend to offer more for sale when the price rises First, as the price increases, other things constant, a producer becomes more willing to supply the good Prices act as signals to existing and potential suppliers about the rewards for producing various goods higher prices attract resources from lower-valued uses 30 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.2.b Upward Sloping bec. Higher Costs Second, higher prices reflect the producer’s greater cost to supply the good The law of increasing opportunity costs the marginal cost of production increases as output increases Since producers face a higher marginal cost of production, they must receive a higher price for that output in order to be able to increase the quantity supplied 31 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.2.c Supply Schedule and Supply Curve for Pizzas Supply Schedule Price per Pizza Quantity Supplied per Week (millions) $15 12 9 6 3 28 24 20 16 12 S Price $15 12 9 6 Both the supply curve and the supply schedule show the quantities of pizza supplied per week at various prices by all 3 the pizza makers in the market. Price and quantity supplied are directly, 0 or positively related. Producers offer more for sale at higher prices than at lower prices the supply curve slopes upward. Begin 2 Demand 3 Supply 12 16 20 24 28 Millions of pizzas per week Return to Supply 4 Market Equilibrium 5 Government Intervention 32 End 3.3 Individual Supply and Market Supply Individual supply refers to the supply of an individual producer Market supply is the sum of individual supplies of all producers in the market Unless otherwise noted, we will be referring to market supply 33 Return to Supply Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.4 Change in Quantity Supplied: MOVE Supply of pizza is not a specific quantity, but rather the entire relation between price and quantity supplied, and is represented by the entire supply curve Price $15 A change in price, other things constant, causes a movement along a supply curve For example, at a price of $9, the quantity supplied is 20 million pizzas per week C 9 B 6 A 3 The movement from say, c to d, is a change in quantity supplied and is shown as a movement along the supply curve and can only be caused by a change in price E D 12 An individual point on the supply curve shows the quantity supplied at a particular price S 0 12 16 20 24 28 Millions of pizzas per week Return to Supply Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 34 End 3.5.a Shifts of the Supply Curve The Supply curve shifts when factors other than price, change. Economists also refer to shifts in supply as a “change in supply” Click here for “Increase in Supply” Click here for “Decrease in Supply” Click here to continue ahead to “Shift Factors” Return to Supply 35 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.5.b An Increase in the Supply of Pizza $15.00 Price per quart Suppose we begin with the initial supply curve as S. A new high-tech oven bakes pizza in half the time, and the impact of this is that the supply curve shifts from S to S'. The result of the increase in supply is that more is supplied at each possible price. E.g., when the price is $12, the amount supplied increases from 24 million to 28 million pizzas, as shown by the movement from point g to point h. Remember: as with demand, a rightward shift of supply represents an increase in supply S S' g 12.00 h 9.00 6.00 3.00 0 12 16 20 24 28 Millions of pizzas per week Return to Shift Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 36 End 3.5.b Decrease in the Supply of Pizza 2 Demand 3 Supply $15.00 Price per quart Suppose we begin with the initial supply curve as S. A new safety precaution doubles the baking time for a pizza, and the impact of this is that the supply curve shifts to S from S'. The result of the decrease in supply is that less is supplied at each possible price. E.g., when the price is $12, the amount supplied decreases from 28 million to 24 million pizzas, as shown by the movement from point h to Begin point g. Remember: as with demand, a leftward shift of supply represents a decrease in supply S S' g 12.00 h 9.00 6.00 3.00 0 12 16 20 24 28 Millions of pizzas per week Return to Shift 4 Market Equilibrium 5 Government Intervention 37 End 3.6 Supply Curve Shift Factors Examples of shift factors are: 1. State of technology 2. Prices of relevant resources 3. Producer expectations 4. Number of producers in the market Click the topic to view the corresponding slide, or Click here to Skip ahead to summary of 38 Moves v Shifts Return to Shift Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.6.1. Changes in Technology If a more efficient technology is discovered, production costs fall suppliers will be more willing and more able to supply the good rightward shift of the supply curve Return to shift factors Example: Wal-Mart Stores Inc., is eliminating paper payroll checks in the U.S., transferring workers' earnings to a debit card if they decline direct deposit to a bank. A move that it said will save paper and money. It estimates the move will save 257,572 pounds of paper a year. The shift will reduce its payroll costs. (WSJ 9/3/09) 39 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.6.2. Changes in the Prices of Relevant Resources Relevant resources are those employed in the production of the good in question For example, pizza • if the price of mozzarella cheese falls, the cost of pizza production declines supply increases shifts to the right • Conversely, if the price of some relevant resource increases supply decreases shifts to the left Other examples: Farmers are expected to plant less corn this year (2008) and that could mean higher bills at the Return to shift grocery store. Hershey again raised wholesale prices (2008) , pushing domestic prices up nearly 10%, to offset rising costs for raw materials,40fuel and transportation. factors Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.6.3 Changes in Producer Expectations Changes in producer expectations about the future can change current supply • If pizza suppliers expect higher prices in the future, they may begin to expand today current supply shifts rightward • Conversely, when a good can be easily stored, expecting future prices to be higher may reduce current supply • More generally, any change expected to affect future profitability could shift the supply curve Example: Champagne producers agreed to pick 32% fewer grapes this year, leaving Return billions of grapes to rot on the ground,to shift factors in a move to counter fizzling bubbly sales around the world amid the economic downturn. WSJ 9/3/09 41 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.6.4. Changes in the Number of Producers Since market supply sums the amounts supplied at each price by all producers, the market supply depends on the number of producers in the market • If that number increases, supply increases shifts to the right • If the number of producers decreases, supply will decrease shift to the left 42 Return to shift factors Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 3.7 Summary: shifts v move along Remember the distinction between a movement along a given demand curve and a shift of the supply curve A change in price, other things constant, causes a movement along a supply curve changing quantity supplied A change in one of the determinants of supply other than price causes a shift of a supply curve changing supply Return to 3. SUPPLY 43 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4. MARKET EQUILIBRIUM 4.1 The Free Market Dynamic Surplus, Shortage, Stable outcome 4.2 Solo Shifts Shifting one curve holding the other constant, examining the effects on price and quantity 4.3 Simultaneous Shifts Shifting both curves holding the other constant, examining the effects on price and quantity 44 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4.1.a Markets A market sorts out the conflicting price perspectives of individual participants – buyers and sellers Market represents all the arrangements used to buy and sell a particular good or service Markets reduce the transaction costs of exchange – the costs of time and information required for exchange The coordination that occurs through markets occurs because of Adam Smith’s invisible hand Surplus, Shortage 45 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4.1.b Surplus Suppose the initial price is $12 producers supply 24 million pizzas per week as shown by the supply curve while consumers demand only 14 million excess quantity supplied (or surplus) of 10 million pizzas per week $15.00 Surplus 12.00 c 9.00 6.00 3.00 D 0 The “invisible hand” goes to work quickly as the suppliers’ desire to eliminate the surplus puts downward pressure on the price, as symbolized by the arrow Begin pointing down in the graph 2 Demand S Price 3 Supply 16 20 24 Millions of pizzas per week As the price falls, producers reduce their quantity supplied and consumers increase their quantity demanded and the market moves towards equilibrium at point c 4 Market Equilibrium 5 Government Intervention 46 End 4.1.c Shortage Price Alternatively, suppose the price is initially $6 per pizza. At this price $15.00 consumers demand 26 12.00 million pizzas but producers supply only 9.00 16 million an excess quantity demanded (or a 6.00 shortage) of 10 million pizzas per week. 3.00 S c Shortage D The “invisible hand” 0 quickly works as producers 16 20 26 notice that the quantity Millions of pizzas per week supplied has sold out and those customers still As prices increase, producers increase their quantity demanding pizzas are supplied and consumers reduce their quantity demanded grumbling pressures for until the equilibrium price of $9 at point c is reached Beginprices as shown by higher 47 End the arrow2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 4.1.d The Invisible Hand at Work A surplus creates downward pressure on the price and a shortage creates upward pressure At a specific price, so long as quantity supplied and quantity demanded differ, prices will tend to change Note that a shortage or a surplus must always be defined at a particular price 48 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4.1.e Stable Outcome When the quantity that consumers are willing and able to pay equals the quantity that producers are willing and able to sell, the market reaches equilibrium the independent plans of both buyers and sellers exactly match market forces exert no pressure to change price or quantity In a diagram this occurs at the point where the supply and demand curves intersect. In other words at the middle of the “X” 49 Return to 4. EQUILIBRIUM Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4.2.a Solo Shifts Once a market reaches equilibrium, that price and quantity will prevail until one of the determinants of demand or supply changes A change in any one of these determinants will usually change equilibrium price and quantity in a predictable way We will now look at solo shifts, that is shifting one curve and leaving the other constant: • Demand Shift • Supply Shift Return to 4. EQUILIBRIUM 50 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4.2.b Solo Shift in Demand The initial equilibrium price is given by D and S $9 and 20 million pizzas per week. Price S Now suppose that one of the determinants of demand changes in a $12 way that increases demand demand 9 shifts from D to D'. After demand increases to D', the amount demanded at the initial price of $9 is 30 million pizzas which exceeds the amount supplied of 20 million pizzas shortage upward pressure on price. Begin 2 Demand D' D 0 20 24 30 Millions of pizzas per week As the price increases, the quantity demanded decreases along the new demand curve, D', and the quantity supplied increases along the existing supply curve S until the two quantities are again equal to each other at a price of $12 and a quantity of 24 million pizzas per week. 3 Supply 4 Market Equilibrium 5 Government Intervention 51 End 4.2.c Summary Thus, given an upward-sloping demand curve, an increase in demand a rightward shift of the demand curve increases both the equilibrium price and quantity Alternatively, a decrease in demand a leftward shift of the demand curve reduces both the equilibrium price and quantity 52 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4.2.d Solo Shift in Supply Again, suppose that we begin with S and D as the initial supply and demand curves the amount demanded at the initial price of $9.00 is 20 million pizzas. Suppose supply now increases as shown by the shift from S to S'. After supply increases, the amount supplied at the initial price of $9 increases from 20 to 30 million pizzas per week a surplus downward pressure on the price the quantity supplied declines along the new supply curve and the quantity demanded increases along the existing demand curve until the new equilibrium is reached at $6 and the quantity is 26 million pizzas per week Begin 2 Demand 3 Supply S S' $9 6 20 26 30 Millions of Pizzas per Week 4 Market Equilibrium 5 Government Intervention D 53 End 4.2.e Summary An increase in supply a rightward shift of the supply curve reduces the equilibrium price but increases equilibrium quantity On the other hand, a decrease in supply a leftward shift of the supply curve increases equilibrium price but decreases equilibrium quantity 54 Return to Solo Shifts Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4.3.a Simultaneous Shifts As long as only one curve shifts, we can say for sure what will happen to equilibrium price and quantity If both curves shift, however, the outcome is less obvious The possibilities are shown in the next Exhibit 55 Return to 4. EQUILIBRIUM Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4.3.b Effects of Changes in Both Supply and Demand Change in Demand Change in Supply Demand increases Supply increases Supply decreases Equilibrium price change is indeterminate. Demand decreases Equilibrium price falls. Equilibrium quantity increases. Equilibrium quantity change is indeterminate. Equilibrium price rises. Equilibrium price change is indeterminate. Equilibrium quantity change is indeterminate. Equilibrium quantity decreases. Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 56 End 4.3.c Summary: Shift in same direction If demand and supply shift in the same directions, we can say what will happen to equilibrium quantity It will increase if demand increases and supply increases It will decrease if demand decreases and supply decreases Without reference to the size of the shifts, we cannot say what will 57 happen to equilibrium price Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4.3.d Summary: Shift in opposite directions If demand and supply shift in opposite directions, we can say what will happen to equilibrium price It will increase if demand increases and supply decreases It will decrease if demand decreases and supply increases Without reference to the size of the shifts, we cannot say what will 58 happen to equilibrium quantity Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 4.3.e Illustration of Increase in Both Supply and Demand: Indeterminate Effect on Price, Increase in Quantity a) Assume: Shift in demand dominates The initial supply and demand curves are shown as D and S p and Q are the initial price and quantity. Suppose that supply and demand both increase shift to the right. For a determinate effect on Price, further suppose that demand shifts more than supply as shown by D' and S'. In this instance, price and quantity both increase to p' and Q'. S S' p' p D' D 0 Q Q' Units per period Conversely, if both demand and supply were to decrease – for example, from D‘ S‘ to D / S, the equilibrium quantity would decrease and the effect on price would be indeterminate, unless a further assumption is made about which shift dominates. Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 59 End 4.3.f Illustration of Increase in Both Supply and Demand: Indeterminate Effect on Price , Increase in Quantity Assume: Shift in supply dominates Price S Again, suppose both supply and demand increase but in this case, supply shifts by more than demand price decreases from p to p"and quantity increases. S" p Alternatively, if both supply and demand decrease with the shift in supply dominating price will increase and quantity will decrease. p" D" D 0 Q Q" Begin 2 Demand 3 Supply 4 Market Equilibrium Units per period 5 Government Intervention 60 End 4.3.g Flash Module: Illustrate Simultaneous Shifts D&S Shift: Opposite: P Det. Q Indet. Same: P Indet. Q Det. Back Return to 4. EQUILIBRIUM Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 61 End 5. GOVERNMENT INTERVENTION From time to time, in Capitalist Economies, the People determine that market outcomes are unfair. Two famous examples in our economy are: The market price received by the American Farmer for his/her product is too low. • To compensate the Government intervenes and sets a price floor (a minimum price) on agricultural produce. Following WW II, the returning GI faced a situation of a shortage of rental units in urban areas and unaffordable prices. • To alleviate the situation the Government intervened and set a price ceiling (a maximum price) for rental units in large cities. In the next 4 slides we analyze the government budget obligation entailed by these commitments. 5.1 Price Floor 5.2 Price Ceiling 5.3 Summary 5.4 Flash Module 62 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 5.1 Effects of a Price Floor The federal government often regulates the prices of agricultural commodities in an attempt to ensure farmers a higher and more stable income than they would otherwise earn. Reduction in Private Market Sales Price times Increase in Quantity Supplied S To achieve higher prices, the federal government sets a price floor a minimum selling price that is above the equilibrium price Surplus $2.50 Suppose it places a $2.50 per gallon price floor for milk. At this price, farmers supply 24 million gallons per week, but consumers demand only 14 million gallons a surplus of 10 million gallons $1.90 This surplus milk will spoil if it sets on store shelves. As a result of this price support program, the government spends billions of dollars buying and storing surplus agricultural products. (Cost = Green and Blue rectangles) Begin 2 Demand 3 Supply 4 Market Equilibrium Private Market Sales D 0 14 19 24 Millions of gallons per month 5 Government Intervention 63 End 5.2 Effects of a Price Ceiling Prices can be kept below the equilibrium levels by establishing a price ceiling, or a maximum selling price, which is below the equilibrium price A common example is rent control in large cities following WW II. Suppose $200 the market-clearing rent is $200 per month with 50,000 rented apartments. Now suppose the government sets a maximum rent of $100. At this ceiling price, 60,000 rental units are demanded, but only 40,000 are supplied (a shortage). Begin 3 Supply S Rent times Increase in Quantity Demanded $100 To resolve the shortage the Government can construct public housing or subsidizing private construction. (Cost = Green and Blue rectangles). Also it can impose guidelines for 0 the “fair” allocation of the apartments on the private market (Yellow rectangle). 2 Demand Decrease in Rent Roll from Private Market 4 Market Equilibrium Rent Roll from Private Market Shortage D 40 50 60 Thousands of rental units per month 5 Government Intervention 64 End 5.3 Summary: Floors & Ceilings To have an impact, a price floor must be set above the equilibrium price and a price ceiling must be set below the equilibrium price The intent of the price ceiling is to make the item more affordable to consumers, the intent of the price floor is to make the item more profitable for producers. However, the effect of price floors and ceilings is to distort markets in that they create a surplus and a shortage, respectively In these situations, the Government can assume a budget obligation to purchase the resulting surplus or produce enough to eliminate the resulting shortage. 65 Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End 5.4 Flash Module: Illustrate Price Controls D&S Shift: Opposite: P Indet. Q Det. Same: P Det. Q Indet. Back Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 66 End END OF PRESENTATION Clic a pic for review Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 67 End Begin 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention 2 Demand 3 Supply 4 Market Equilibrium 5 Government Intervention End Begin 68 End