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Exploring Economics
by Robert L. Sexton
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Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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Chapter 4
Supply and Demand
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.1 Markets


A market is the process of buyers and
sellers exchanging goods services.
Supermarkets, the Toronto Stock
Exchange, drug stores, roadside
stands, garage sales, Internet stores
are all markets.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.1 Markets


Every market is different. Some markets
are local but numerous(such as housing
or the market for cement), others are
global (such as automobiles or gold).
The important point about a market is
not what it looks like, but what it does–it
facilitates trade.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.1 Markets


Buyers, as a group, determine the
demand side of the market, whether it is
consumers purchasing goods or firms
purchasing inputs.
Sellers, as a group, determine the
supply side of the market, whether it is
firms selling their goods or resource
owners selling their inputs.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.2 Demand


According to the law of demand, the
quantity of a good or service demanded
varies inversely with its price, ceteris
paribus.
More directly, other things equal, when
the price of a good or service falls, the
quantity demanded increases.
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4.2 Demand



The law of demand puts the concept of
basic human “needs” to rest as an
analytical tool.
Needs are those things that you must
have at any price. That is, there are no
substitutes.
But there are usually plenty of
substitutes available for any good, some
better than others.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.2 Demand


The primary reason for the inverse
relationship between price and quantity
demanded is the substitution effect.
At higher prices, buyers have an
incentive to substitute other goods for
the good that now has a higher relative
price.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.2 Demand

An individual demand schedule
reveals the different amounts of a
particular good a person would be
willing and able to buy at various
possible prices in a particular time
interval, other things equal.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 1: Elizabeth's Demand
Schedule for Apples
Price (per
kilogram)
$5
Quantity Demanded
(kilograms per year)
5
4
10
3
15
2
20
1
25
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.2 Demand


An individual demand curve for a
particular good illustrates the same
information as the individual demand
schedule.
It reveals the relationship between the
price and the quantity demanded,
showing that when the price is higher,
the quantity demanded is lower.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 2: Elizabeth's Demand
Curve for Apples
Price of Apples (per
kilogram)
$5
4
Elizabeth’s
demand
curve
3
2
1
0
5
10 15 20 25 30
Quantity of Apples Demanded (kilograms per year)
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.2 Demand



Economists usually speak of the
demand curve in terms of large groups
of people.
The horizontal summing of the demand
curves of many individuals is called the
market demand curve for a product.
It reflects the fact that the total quantity
purchased in the market at a price is the
sum of the quantities purchased by
each demander.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 3: Creating a Market
Demand Curve
The
market demand curve shows the
amounts that all the buyers in the market
would be willing to buy at various prices.
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Exhibit 4: A Market Demand Curve
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4.2 Demand


The money (or absolute or nominal)
price of a good is the price you would
pay for it in dollars and cents,
expressed in dollars of current
purchasing power.
While money prices have fallen over
time for some goods and services, they
have risen over time for most.
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4.2 Demand


The relative price of a good is the
price of one good relative(compared) to
other goods.
In a world where virtually all prices are
changing, relative prices are crucial to
economic decisions.
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4.2 Demand


The money price of a good can be
higher than in the past, and yet have a
lower relative price than in the past.
For example, gasoline prices are higher
than in the past in money terms, yet
they are cheaper relative to other goods
and service than they have been in the
past.
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4.3 Shifts in the Demand Curve


Consumers are influenced by the prices
of goods when they make their
purchasing decisions.
At lower prices, people prefer to buy
more of a good than at higher prices,
holding other factors constant, primarily
because many goods are substitutes for
one another.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.3 Shifts in the Demand Curve


A change in a good's price leads to a
change in quantity demanded,
illustrated by moving along a given
demand curve.
But price is not the only thing that
affects the the quantity of a good people
buy. The other factors that influence the
demand curve are called determinants
of demand and they shift the entire
demand curve—a change in demand.
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4.3 Shifts in the Demand Curve

Some of the possible demand shifters
are:
the prices of related goods
 the incomes of demanders
 the number of demanders
 the tastes of demanders
 the expectations of demanders

Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.3 Shifts in the Demand Curve


An increase in demand is represented
by a rightward shift in the demand
curve.
A decrease in demand is represented
by a leftward shift in the demand
curve.
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.
Price
Exhibit 1: Demand Shifts
Decrease Increase
in
in
Demand
Demand
D2
0
Quantity
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
D0
D1
4.3 Shifts in the Demand Curve

A major variable that shifts the demand
curve is the prices of related goods.

Two goods are called substitutes if an
increase in the price of one causes a an
increase in the demand for the other good.
The opposite also applies: Two goods are
called substitutes if a decrease in the
price of one causes a decrease in the
demand for the other good.

Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.3 Shifts in the Demand Curve
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4.3 Shifts in the Demand Curve


Because personal tastes differ, what are
substitutes for one person may not be so for
another person.
For most people good substitutes might
include: movie tickets and video rentals;
jackets and sweaters; 7-up and Sprite and
peas and carrots.
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SUBSTITUTE GOODS
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4.3 Shifts in the Demand Curve


Two goods are complements if an
increase in the price of one good
causes a decrease in the demand for
the other good.
The opposite is also true: Two goods
are complements if a decrease in the
price of one good causes an increase in
the demand for the other good.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.3 Shifts in the Demand Curve
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4.3 Shifts in the Demand Curve



Complements are goods that “go
together.”
They are often consumed or used
simultaneously.
For examples, skis and bindings; hot
dogs and mustard; motorcycles and
motorcycle helmets; DVD’s and DVD
players.
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COMPLEMENTARY GOODS
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4.3 Shifts in the Demand Curve


Generally the consumption of goods
and services is positively related to the
income available to consumers.
As individuals receive more income,
they tend to increase their purchases of
most goods and services.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.3 Shifts in the Demand Curve




Other things equal, an increase in
income usually leads to an increase in
demand for goods (rightward shift).
A decrease in income usually leads to a
decrease in the demand for goods
(leftward shift).
Such goods are called normal
goods.
For example, CDs, and movie tickets.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.3 Shifts in the Demand Curve
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.3 Shifts in the Demand Curve



Some goods exist for which rising (or
falling) income leads to reduced (or
increased) demand.
These are called inferior goods. The
term inferior does not refer to the quality
of the good but it merely shows that
when income changes demand
changes in the opposite
direction(inversely).
For example, thrift shop clothes, storebrand products, and bus rides.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.3 Shifts in the Demand Curve
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NORMAL AND INFERIOR GOODS
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4.3 Shifts in the Demand Curve


The demand for a good or service will
vary with the size of the potential
consumer population—the number of
buyers.
An increase in the potential consumer
population will increase (shift right) the
demand for a good or service.
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4.3 Shifts in the Demand Curve


Changes in fashions, fads, advertising,
etc. can change tastes or preferences.
An increase in tastes or preferences for
a good or service will increase (shift
right) the demand for a good or service.
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4.3 Shifts in the Demand Curve


While changes in preferences lead to
shifts in demand, much of the predictive
power of economic theory stems from
the assumption that tastes are relatively
stable over a substantial period of time.
We cannot precisely and accurately
measure taste changes.
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4.3 Shifts in the Demand Curve


Sometimes the demand for a good or
service in a given time period will
dramatically increase or decrease
because consumers expect the good to
change in price or availability at some
future date.
An increase in the expected future price
of a good or a decrease in its expected
future availability will increase (shift
right) the current demand for it.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.3 Shifts in the Demand Curve


A decrease in the expected future price
of a good or an increase in its expected
future availability will decrease (shift
left) the current demand for it.
However, what is important in terms of
demand is what people expected to
happen, rather than what actually
happened.
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4.3 Shifts in the Demand Curve


Changes in demand versus changes in
quantity demanded revisited:
If the price of a good changes, we say
this leads to a change in quantity
demanded.

If one of the other factors (determinants
of demand) influencing consumer
behaviour changes, we say there is a
change in demand.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 2: Possible Demand Shifters
Price
Price of complement falls or price of substitute rises
D0
0
Quantity
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.
D1
Exhibit 2: Possible Demand Shifters
Price
Income increases (normal good)
D0
0
Quantity
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.
D1
Exhibit 2: Possible Demand Shifters
Price
Income increases (inferior good)
D1
0
Quantity
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.
D0
Exhibit 2: Possible Demand Shifters
Price
Increase in the number of buyers in the market
D0
0
Quantity
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.
D1
Exhibit 2: Possible Demand Shifters
Price
Tastes change in favor of the good
D0
0
Quantity
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.
D1
Exhibit 2: Possible Demand Shifters
Price
Future price increase expected
D0
0
Quantity
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.
D1
Exhibit 3: Changes in Demand versus Changes
in Quantity Demanded
Price of CDs
A
A
C
Change in demand
C
$10
A
B
Change in
quantity demanded
B
$5
D0
0
QA QB
D1
QC
Quantity of CDs
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.4 Supply


The law of supply states that, other
things equal, the quantity supplied will
vary directly with the price of the good.
According to the law of supply,
the higher the price of the good, the
greater the quantity supplied,
 and the lower the price of the good, the
smaller the quantity supplied.

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4.4 Supply
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4.4 Supply


The quantity supplied is positively related
to the price, because firms supplying
goods and services want to increase their
profits, and the higher the price per unit,
the greater the profitability generated by
supplying more of that good or service.
Also, if costs are rising for producers as
they produce more units, they must
receive a higher price to compensate
producers for their higher costs.
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4.4 Supply

An individual supply schedule reveals
the different amounts of a product that a
producer is willing and able to supply at
various prices in a particular time
interval, other things equal.

An individual supply curve
illustrates that information graphically.
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Exhibit 1: An Individual Supply Curve
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4.4 Supply


The market supply curve for a
product is the horizontal summation of
the supply curves for individual firms.
It shows the amount of goods and
services suppliers are willing and able
to supply at various prices.
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Exhibit 2: A Market Supply Curve
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4.4 Supply



Changes in the price of a good lead to
changes in quantity supplied, which
are shown as movements along a given
supply curve.
Changes in supply occur for other
reasons than changes in the price of the
product itself.
A change in any other factor that can
affect supplier behaviour results in a
shift of the entire supply curve.
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4.4 Supply

These other factors include:









supplier input prices
the prices of related products
expectations
number of suppliers
technology
regulations
taxes
subsidies
weather
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4.4 Supply


An increase in supply shifts the supply
curve to the right.
A decrease in supply shifts the supply
curve to the left.
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Exhibit 3: Supply Shifts
Price
S2
0
S0
Decrease Increase
in
in
Supply
Supply
Quantity
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
S1
4.4 Supply


Higher input prices increase the cost of
production causing the supply curve to
shift to the left at each and every price.
Lower input prices decrease the cost of
production causing the supply curve to
shift to the right at each and every price.
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4.4 Supply


The supply of a good can be influenced
by the prices of related products.
Firms producing a product can
sometimes use their resources to
produce alternative products.
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4.4 Supply



Suppose a farmer’s land can be used to
grow either barley or wheat.
If the farmer is currently growing barley
and the price of barley falls then this
provides an incentive for the farmer to
shift acreage out of barley and into
wheat.
Thus a decrease in the price of barley
will increase the supply of wheat.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 4: Substitutes in Production
S
P0
P1
0
Q1
Q0
Quantity of Barley Supplied
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.
b. Market for Wheat
Price of Wheat
Price of Barley
a. Market for Barley
S0
S1
0
Quantity of Wheat Supplied
4.4 Supply




If producers expect a higher price in the
future, they will supply less now.
They would prefer to wait and sell when
their goods will be more valuable.
If producers currently expect that the
price will be lower later they will supply
more now.
Otherwise, if they wait to sell, then their
goods will be worth less.
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.
4.4 Supply



The market supply curve is the
horizontal summation of the individual
supply curves.
So an increase in the number of
suppliers will increase market supply.
A decrease in the number of suppliers
will decrease market supply.
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.
4.4 Supply


Technological progress can lower the
cost of production and increase supply.
Supply may also change because of
changes in the legal and regulatory
environment in which firms operate
(e.g., safety and pollution regulations,
minimum wages, taxes, etc.) If such
changes increase costs, they will
decrease supply. If they decrease costs,
they will increase supply.
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.
4.4 Supply



An increase in costly government
regulations, taxes or adverse production
conditions will increase the cost of
production, decreasing supply.
Subsidies, the opposite of a tax can
lower the cost of production and shift
the supply curve to the right.
In addition, weather can affect the
supply of certain commodities.
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4.4 Supply


If the price of a good changes, it leads
to a change in its quantity supplied, but
not its supply.
If one of the other factors influences
sellers' behaviour, it leads to a change
in supply.
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.
Exhibit 5: Possible Supply Shifters
S0
Quantity
Supplier’s input price
(wages) increases
S1
Price
0
S0
0
Quantity
Supplier’s input price
(fuel) falls
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.
S1
Price
S0
Price
S1
0
Quantity
Price of related
products fall
Exhibit 5: Possible Supply Shifters
S1
Quantity
Producer expects
now that the price will
be lower later
S1
Price
0
S0
0
Quantity
Number of suppliers
increases
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
S0
Price
S1
Price
S0
0
Quantity
Taxes rise
Exhibit 5: Possible Supply Shifters
S1
0
S1
S0
Price
Price
S0
Quantity
Technological
advance occurs
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
0
Quantity
Bad weather
Exhibit 6: Change in Supply versus
Change in Quantity Supplied
Price of Wheat
S0
B
P1
P0
0
C
S1
A
B
Change in
quantity supplied
B
C
Change in
supply
A
QA
QB
QC
Quantity of Wheat
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.5 Market Equilibrium Price and Quantity

The price at the intersection of the
market demand curve and the market
supply curve is called the equilibrium
price.

The quantity at the intersection of the
market demand curve is called the
equilibrium quantity.
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.
4.5 Market Equilibrium Price and Quantity



At the equilibrium market price, the
amount that buyers are willing and able to
buy is exactly equal to the amount that sellers
are willing and able to produce.
If the price is set above or below the
equilibrium price, there will be shortages or
surpluses.
However, the actions of many buyers and
sellers will move the price back to the
equilibrium level.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
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4.5 Market Equilibrium Price and Quantity


What is wrong with the table in the next
slide?
If the quantity demanded is greater than
the quantity supplied is that a surplus or
a shortage?
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 1: A Hypothetical Market Supply and
Demand Schedule for Apples
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.
Exhibit 1: A Hypothetical Market Supply and
Demand Schedule for Apples
$6
Supply
Price of Apples
(per kilogram)
5
4
Surplus
QS>QD
3
2
Shortage
QD>QS
1
Demand
0
2
4 6
8 10 12 14
Quantity Demanded and Supplied of Apples
(thousands of kilograms/year)
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.5 Market Equilibrium Price and Quantity


At the equilibrium price, the quantity
demanded equals the quantity
supplied—the amount that buyers are
willing and able to buy is exactly equal
to the amount that sellers are willing
and able to produce.
If the market price is at any other price,
their will be a shortage or a surplus.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.5 Market Equilibrium Price and Quantity




At a price greater than the equilibrium
price, a surplus, or excess quantity
supplied, would exist.
Sellers would be willing to sell more
than demanders would be willing to buy.
Frustrated suppliers would cut their
price and cut back on production, and
consumers would buy more.
This would eliminate the unsold surplus
and return the market to equilibrium.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.5 Market Equilibrium Price and Quantity




At a price less than the equilibrium price, a
shortage, or excess quantity demanded,
would exist.
Buyers would be willing to buy more than
sellers would be willing to sell.
Frustrated buyers would compete for the
existing supply, causing the price to rise, and
producers to increase the quantity supplied.
This would decrease the quantity demanded,
eliminate the shortage, and return the market to
equilibrium.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 2: Shortages
Price of Chicken
Supply
PE
PBE
Shortage
Demand
0
QS
QD
Quantity of Chicken
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.
4.6 Changes in Equilibrium
Price and Quantity



Demand curves shift when any of the
other factors that affect buyers' behaviour
change (but not the price of the good
itself).
Supply curves shift when any of the other
factors that affect sellers' behaviour
change (but not the price of the good
itself).
These changes (shifts) in the demand and
supply curves will lead to changes in the
equilibrium price and equilibrium quantity.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.6 Changes in Equilibrium
Price and Quantity


An increase in demand results in a greater
equilibrium price and a greater equilibrium
quantity.
Conversely, a decrease in demand results
in a lower equilibrium price and a lower
equilibrium quantity.
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.
Exhibit 1: Higher Gasoline Prices
in the Summer
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.
Application: A Change in Demand
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.
Application: A Change in Demand


Notice that in both Exhibit 1 and the
Whistler application that the seasonal
increases in demand led to a shortage
at the original(out of season) price.
When a shortage exists the price will
rise until the new equilibrium is reached.
In this case, at the intersection of the inseason demand curve and the the
supply curve.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.6 Changes in Equilibrium
Price and Quantity


A decrease in supply results in a higher
equilibrium price and a lower equilibrium
quantity.
Conversely, an increase in supply
results in a lower equilibrium price and a
higher equilibrium quantity.
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.
Exhibit 2: The Market for Strawberries
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.6 Changes in Equilibrium
Price and Quantity


The supply of strawberries is larger
during in-season than out-of-season.
At the higher winter price for
strawberries there would be a surplus of
strawberries in-season. This surplus
forces the in-season price down to P1.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.6 Changes in Equilibrium
Price and Quantity


Very often, supply and demand will both
shift in the same time period.
That is, supply and demand will shift
simultaneously.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.6 Changes in Equilibrium
Price and Quantity


When supply and demand move at the
same time, we can predict the change
in one variable (price or quantity), but
we are unable to predict the direction of
effect on the other variable.
This change in the second variable,
then, is said to be indeterminate,
because it cannot be determined
without additional information about the
relative changes in supply and demand.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.6 Changes in Equilibrium
Price and Quantity


We can predict what will happen to
equilibrium prices and equilibrium
quantities in situations where both
supply and demand change.
We can predict this by breaking them
down into their individual effects, then
putting together the price and quantity
effects that each of the shifts would
have separately.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.6 Changes in Equilibrium
Price and Quantity



An increase in supply decreases the
equilibrium price and increases the
equilibrium quantity.
A decrease in demand decreases both
the equilibrium price and quantity.
Taken together, they will decrease the
equilibrium price, but result in an
indeterminate change in the equilibrium
quantity.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.6 Changes in Equilibrium
Price and Quantity



The change in quantity will depend on
the relative changes in supply and
demand.
If the decrease in demand is greater
than the increase in supply, the
equilibrium quantity will decrease.
If the increase in supply is greater than
the decrease in demand, the equilibrium
quantity will increase.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 3: Shifts in Supply and Demand
a. A Little Increase in Supply and a Big Decrease in Demand
S0
E0
S1
Price
P0
E1
P1
D1
0
Q1 Q 0
Quantity
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
D0
Exhibit 3: Shifts in Supply and Demand
b. A Big Increase in Supply and a Little Decrease in Demand
S0
Price
P0
P1
S1
E0
E1
D0
D1
0
Q0
Q1
Quantity
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.6 Changes in Equilibrium
Price and Quantity



An increase in demand increases the
equilibrium price and equilibrium
quantity.
An increase in supply decreases the
equilibrium price and increases the
equilibrium quantity.
Together, they increase the equilibrium
quantity.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.6 Changes in Equilibrium
Price and Quantity


The change in equilibrium price
depends on the relative sizes of the
demand and supply shifts.
If supply shifted more than demand, the
equilibrium price would drop.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 4: An Increase in the Demand
and Supply of VCRs
Price of VCRs
S0
S1
E0
P0
E1
P1
D0 D1
0
Q0
Q1
Quantity of VCRs
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 5: Shifts in Both Supply and Demand
S0
S1
E0
P0
E1
P1
D
0
Q0
Q1
Quantity of LongDistance Calls
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Price of Long-Distance Calls
Price of Long-Distance Calls
a. Increase in Supply
b. Simultaneous Increase
in Supply and Demand
S0
S1
E0
E1
P0
D0
0
Q0
D1
Q1
Quantity of LongDistance Calls
4.6 Changes in Equilibrium
Price and Quantity

The eight possible changes in demand
and/or supply are presented, along with
the resulting changes in equilibrium
price and equilibrium quantity.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 6: The Effect
of Changing Demand and/or Supply
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Exhibit 7: The Combinations of Supply
and Demand Shifts
D unchanged, S
D, S unchanged
S0
S0
Price
E1
P1
P0
E0
D1
D, S unchanged
P0
E0
P1
E1
D0
0
Q0
D
S0
Q1
Quantity
(1)
Price
Price
S1
P0
P1
E1
D0
0
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Q1
Q0
Quantity
(2)
Q0
Q1
Quantity
(3)
E0
D1
0
Exhibit 7: The Combinations of Supply
and Demand Shifts
D unchanged, S
D, S
E1
S0
S0
P1
P0
Price
Price
S1
S1
E0
E1
P0
E0
D1
D0
D
0
Q1
Q0
Quantity
(4)
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
0
Q0
Q1
Quantity
(5)
Exhibit 7: The Combinations of Supply
and Demand Shifts
D, S
D, S
S1
S0
Price
S1
E1
E0
P0
D1
0
Q1
D0
S1
Q0
Quantity
(6)
E1
S0
E0
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Q0?
Quantity
(7)
E1
0
Q0?
Quantity
(8)
D0
0
P0
D1
P1
P0
E0
P1
D, S
Price
Price
S0
D1
D0
4.7 Price Controls



While non-equilibrium prices occur
naturally in the private sector, reflecting
uncertainty, they seldom last for long.
Governments, however, may impose
non-equilibrium prices for significant
time periods.
Price controls involve the use of the
power of the government to establish
prices different from the equilibrium
prices that would otherwise prevail.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls



The motivations for price controls vary
with the market under consideration.
A price ceiling, or a legal maximum
price, is often set for goods deemed
important to low income households,
like housing.
A price floor, or a legal minimum price,
may be set on wages because wages
are the primary source of income for
most people.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls



Price ceiling example: rent control.
Under rent control the price (or rent) of
an apartment is held below market
rental rates, over the tenure of an
occupant.
When an occupant moves out, the
owner can sometimes, but not always,
raise the rent to a near-market level for
the next occupant.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Price of Apartments (Rent)
Exhibit 1: Rent Control
Supply
P*
PRC
Shortage
0
QS
Rent Control
Price
Demand
Q*
QD
Quantity
of Apartments
Copyright © 2007, Nelson, a division of Thomson
Canada Ltd.
.
4.7 Price Controls

Some results of rent controls:

Because living in rent controlled
apartments is a good deal, one which
would be lost by moving, tenants are very
reluctant to move and give up their
governmentally granted right to a belowmarket rent apartment.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls

Some results of rent controls:
Because the rents received by landlords
are constrained at below market levels, the
rate of return on housing investments falls
compared to that on other forms of real
estate not subject to rent controls, reducing
the incentives to construct new rental
housing.
 Where rent controls are truly effective,
there is generally little new construction
going on and a shortage of apartments that
grows
over time.
Copyright © 2007,persists
Nelson, a division ofand
Thomson Canada
Ltd.

.
4.7 Price Controls

Some results of rent controls:


Since landlords are limited in what rent
they can charge, there is little incentive to
improve or upgrade rental apartments in
order to get more rent.
In fact, there is some incentive to avoid
routine maintenance, thereby lowering the
cost of apartment ownership to a figure
approximating the controlled rental price.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls

Some results of rent controls:

With rent controls, there are likely to be
many families wanting to rent an apartment
because the rent is at a below-equilibrium
price. Some of these tenants are seen as
desirable by the landlord and some
undesirable.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls


Price floor example: the minimum wage.
The federal government has, by
legislation, made it illegal to pay most
workers an amount below a legislated
minimum wage (price for labour
services).
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls

Some results of the minimum wage:


Because it would produce willing workers
who will be unable to find jobs, an increase
in the minimum wage would create
additional unemployment for low skill
workers.
The unemployment impact of the minimum
wage falls mainly on the least experienced,
least skilled persons, often teenagers,
holding the lowest paying jobs.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls

Some results of the minimum wage:


They lose their jobs or are unable to get
them in the first place, and suffer a decline
in earnings, not a gain.
Those who continue to hold jobs with the
same hours and working conditions after
the minimum wage is increased gain
substantially, and therefore are supporters
of efforts to increase the minimum.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls



The analysis does not “prove” minimum
wages are “bad.”
There is an empirical question of how
much unemployment is caused by
minimum wages.
Some might believe that the cost of
unemployment resulting from a
minimum wage is a reasonable price to
pay for assuring that those with jobs get
a decent wage.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls


But they do impose a cost
It falls not only on unskilled workers and
employers, but also on consumers of
products that were made more costly by
the minimum wage.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
Wage (price of labour)
Exhibit 2: The Unemployment Effects
of a Minimum Wage
SLABOUR
Unemployed
(labour surplus)
WMIN
WE
DLABOUR
0
QD
QE
QS
Copyright © 2007, Nelson, a division of Thomson CanadaQuantity
Ltd.
of Labour
.
4.7 Price Controls

In the market for skilled and
experienced workers the minimum
wage is not binding because workers
are earning wages that far exceed the
minimum wage
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.
4.7 Price Controls
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls
There is no impact of a price floor on the market for skilled and experienced
workers. In this market the price floor (minimum wage) is not binding
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.
4.7 Price Controls

When markets are altered for policy
reasons, it is wise to remember that the
actual results of actions are not always
as intended, as seen in the cases of
rent control and the minimum wage.

We must always look for unintended
consequences, the secondary
effects of an action that may occur
along with the intended effects.
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.
4.7 Price Controls

The unintended effects may sometimes
completely undermine the intended
effects.
Copyright © 2007, Nelson, a division of Thomson Canada Ltd.
.