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Chapter 5: Using Supply and Demand
Chapter 5: Using Supply and Demand
Questions and Exercises
1.
If price and quantity both rise, the simplest cause would be a shift of the demand
curve to the right.
2.
If price fell and quantity remained constant, a possible cause would be a shift out
to the right of the supply curve and a shift of the demand curve in to the left.
Another possibility would be a shift of the demand curve in to the left with a
vertical supply curve.
3.
Computer pricing of roads could end bottlenecks and rush hour congestion by
price rationing. Currently at zero price, at certain times, the quantity demanded
greatly exceeds the quantity supplied, resulting in congestion. Raising prices,
during those times, could eliminate excess demand and reduce the congestion.
This technological change will spread out congestions over wider geographic
areas and over the day, as individuals with more flexibility with respect to route
and timing will choose to demand less of the current high demand route at rush
hour.
4.
a. This would represent a shift in demand to the left
assuming the decline in Cookie Monster’s popularity
represents a decline in the popularity of cookies. The
price and quantity of cookies would likely fall as
shown in the accompanying graph.
b. This is represented by a shift in demand for bread
(high in carbohydrates) to the left. Equilibrium price
and quantity falls as the graph shows. (Note: this is
the same graph as for part a.)
5. a. Both the shift in demand to the right and the shift of
supply to the left lead to a higher equilibrium price of
oil, in this case over $40 a barrel. The effect on
equilibrium quantity is indeterminate. While the shift
in demand to the right would lead to a rise in
equilibrium quantity, the shift in supply to the left
would reduce it. Whether equilibrium quantity rises
or falls depends on the relative size of the shifts. The
accompanying graph shows no effect on equilibrium
quantity and a significant increase in price.
Colander’s Economics, 8e. McGraw Hill © 2010
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Chapter 5: Using Supply and Demand
b. The increase in the oil quota shifted supply to the right,
reducing the price of oil from $40 a barrel to $38 a barrel in
the short term. Equilibrium quantity increased.
6. a. This represents a shift of the supply curve to the left because the offended decide
not to supply organs, increasing the legal price significantly and perhaps reducing
the equilibrium quantity to a quantity that is below the amount currently provided
at zero cost. This is shown in graph (a) below.
b. How responsive quantity supplied is to price affects the slope of the supply curve.
If quantity supplied is very responsive to price, the equilibrium price might be
quite low and legalizing organ sales would have significant benefits to society. In
fact, the authors of the study estimate the equilibrium price of kidneys to be less
than $1000. In graph (b) below, S1 is much more responsive to price than S0.
(a)
7.
(b)
Political turmoil in South Africa likely led both
foreign and domestic investors to question the
economic stability of the country. Foreign investors
reduced their demand for South African investments,
and therefore their demand for the rand. This shifted
the demand for the rand to the left. Domestic
investors did likewise, shifting their investments to
those outside South Africa, shifting the supply of rand
to the right. The combination led to a lower price for
the rand in terms of other currencies.
Colander’s Economics, 8e. McGraw Hill © 2010
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Chapter 5: Using Supply and Demand
8.
Import disruptions shifted the supply curve for rice to the
left. Equilibrium price rose and quantity fell as the
accompanying graph shows.
9.
See the accompanying graph. A price ceiling of PC below
equilibrium price will cause a shortage shown by the
difference between QD and QS.
10.
As you can see in the accompanying graph, the rent
controls create a situation in which demanders are willing
to pay much more than the controlled price and much
more than the equilibrium price. These payments are
sometimes known as key money. In this graph, landlords
are willing to supply QS at the current controlled rent, PC.
Consumers are willing to pay up to PB for the quantity
QS. Key money can be an amount up to the difference
between PB and PC.
11.
See the accompanying graph. A price floor of PF
above equilibrium price will cause a surplus shown
by the difference between QS and QD.
12.
A minimum wage is a price floor as in question 11. A
Pmin, above the equilibrium wage will result in the
quantity of laborers looking for work to increase to
QS and the quantity of employers looking to hire to
decrease to QD. The difference between the two is a
measure of the number of unemployed.
Colander’s Economics, 8e. McGraw Hill © 2010
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Chapter 5: Using Supply and Demand
13.
A $4 per unit tax on suppliers shifts the supply curve
up by $4 shown as a shift in the supply curve from S0
to S1. Equilibrium price will rise by $4 only if the
demand curve is perfectly vertical. In the case of a
vertical demand curve, quantity would not change.
Otherwise, equilibrium price rises by less than $4 and
equilibrium quantity falls as shown in the
accompanying graph. In this example, the price
increases by less than $4 and quantity declines.
14.
A quota places a quantity restriction on imports.
Consumers are willing to pay a higher price for the
lower quantity (QQ) than the equilibrium price
without a quota. Therefore, quotas lead to higher
import prices as shown in the accompanying graph.
15.
The demand for rolling machines went up enormously because loose tobacco
became a cheaper substitute for the taxed cigarettes and rolling machines are a
complement of loose tobacco; some companies more than quadrupled their sales
of loose tobacco and rolling machines.
16.
Public post-secondary education is an example of a third-party payer market
because it is heavily subsidized by state government and in most cases, a student’s
parents. Those consuming the good, students, do not pay the entire cost of the
education they receive. This likely leads to greater expenditures on postsecondary education than if students had to pay the entire cost of their education.
17.
Governments likely support third-party-payer markets for a variety of reasons. It
could be that they believe the market does not distribute the good equitably
(poorer people have less access to the good); there are positive externalities
associated with the good (for example, public education); or that some other
market failure exists.
18. a. Equilibrium price is $6 and equilibrium quantity is 300.
b. In a third-party payer system where the consumer pays $2, quantity demanded
will be 900. Suppliers require payment of $14 to supply that quantity.
c. Total spending in a is $1,800. Total spending in b is $12,600.
Colander’s Economics, 8e. McGraw Hill © 2010
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Chapter 5: Using Supply and Demand
Issues to Ponder
1. a. Airways have value because they produce revenue and there are only a limited
number of airways in the industry.
b. Television networks have incentives to produce high definition television only to
the extent that they would receive more revenue for using extra bandwidth.
2. a. The supply curve is vertical at 10,000 tickets. We know there is an excess demand
at $130 because there is a secondary market for scalped tickets at a higher price.
The graph below on the left shows excess demand of Qd – 10,000.
b. The people represented by Qd-10,000 will make offers to scalpers for any amount
above $130 up to the equilibrium price (if there had been a market) of $2,000.
The graph below on the right shows the range of $200 to $2,000.
c. If scalping became legalized, more people would be willing to sell their tickets
because there is no risk of being arrested and fined. The shift of the supply curve
for resold tickets to the right will reduce the secondary-market price of Final-Four
tickets.
3. a. A weakly enforced anti-scalping law would add an
additional cost to those selling scalped tickets and
push up the resale cost of tickets to include the
expected cost of being caught, which would be fairly
small given weak enforcement. In the accompanying
graph, this shifts the supply curve from S0 to S1,
Colander’s Economics, 8e. McGraw Hill © 2010
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Chapter 5: Using Supply and Demand
raising equilibrium slightly price from P0 to P1. (Note: This assumes that only
selling, not buying, is illegal.)
b. A strongly enforced anti-scalping law (against suppliers) would push up prices far
more as the cost of supply rose and the supply curve shifted to the left. If
enforcement were sufficiently strong, a two-tier price system would emerge with
a low legal price at P0 and another very high price, P2.
4. a. Boards often exist to benefit the consumer, but also to benefit those who currently
produce. Often those who are currently certified attempt to limit the number of
new certifications so as to limit the supply and thus boost the price they receive.
b. Possible changes include eliminating the board of certification, limiting its
regulation to only those skills that it addresses directly, or requiring continual
recertification so that skills of those already certified reflect the current demand
for skills in that market.
c. A political difficulty with implementing these changes is that a relatively small
group of those currently certified will be hurt and will lobby hard for the status
quo. Those currently certified may have more “clout” with the board if the board
is comprised of certified hairdressers. The benefits of the changes are also large,
but they are spread out over large groups of consumers, with each consumer
benefiting very little. Therefore, it will be easier for the small group, whose
benefit per individual is large, to organize.
5. a. The Oregon Health Plan includes a prioritized list of medical services that
determine whether a service is covered. The list is based on comparative benefit
to those covered. Those services that have the highest net benefit are ranked
highest. Those with a lower net benefit are not covered.
b. Economists should not oppose the Oregon Plan because it involves rationing. The
market involves rationing through the price mechanism. Economists might oppose
the Oregon Plan because in general they support the market as the least-cost
method of providing goods and services. Economists are open to the argument
that the market may not distribute goods and services in the way that society
wants, which may require government intervention.
c. In the market, the interaction of demand and supply determines the equilibrium
price and quantity that is bought and sold. Those who are able to pay the
equilibrium price are the ones who receive the health care. The Oregon Plan uses
its benefit-ranking system rather than price as the rationing mechanism.
6. a. Frequent-flyer programs allow companies to lower their effective prices without
lowering their reported prices. Companies also use them to get business travelers
to choose their airline. Such programs are an example of a third-party-payer
system: The business traveler gets the benefit (frequent-flyer miles), while their
business pays for the current flight.
b. Other examples include points that hotels give to travelers and bonus checks
based on charges that Discover gives those who use its credit card.
c. Firms likely do not monitor these programs because it would be too costly to do
so.
Colander’s Economics, 8e. McGraw Hill © 2010
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Chapter 5: Using Supply and Demand
7. a. An import quota will increase the price of
imported sugar. The accompanying graph
shows how a higher imported sugar price
increases the price that domestic producers
can charge and increase the quantity they can
supply to the market. For example, at world
price P0, domestic consumers demand the
quantity E-B from importers and quantity B
from domestic producers. After a quota
represented by quantity D minus C is
imposed, the import price is P1. Domestic
consumers demand the quantity D-C from
importers and quantity C from domestic
producers.
b. The government could have imposed a tariff on imported sugar. This would also
have raised the price of imported sugar.
c. A minimum required import level of 1.25 million will limit the ability of the
United States to support domestic sugar prices. The increase in quantity supplied
will put downward pressure on sugar prices.
8. a. As shown in the accompanying graph, the
controlled price (PC) is below equilibrium. At this
price the quantity of apartments demanded (QD)
exceeds the quantity of apartments supplied (QS).
Since there are more apartments demanded than
supplied at this price, apartments are hard to find.
b. Since at the existing quantity supplied, Qs,
demanders would be willing to pay Pb, there is a
strong incentive to make side payments to existing
tenants to acquire the apartment. At Pb, more
tenants are willing to supply their apartments than
at Pc, so a side payment can induce a tenant to give up their apartments. This is
one form of rationing. When market price rationing does not take place, some
other form of rationing must take its place.
c. Eliminating rent controls would most likely allow the market price of apartments
to increase and eliminate side payments. The quantity supplied will rise until it
equals the quantity demanded at the market price. The price, quantity combination
is (Pe, Qe) in the graph. However, if there are few additional apartments available
to be rented (the supply curve is almost vertical), then price will increase
dramatically and quantity supplied will only rise slightly.
d. The political appeal of rent control is that it benefits those who currently rent
apartments. Apartment renters who live in rent-controlled apartments are more
likely to vote, and this is why it is maintained. There are other possible reasons as
well.
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Chapter 5: Using Supply and Demand
9. a. The government subsidy of mohair provided an enormous incentive for those who
were allowed to sell mohair to sell large quantities at lower price than otherwise.
The elimination of this subsidy shifted the supply curve to the left (shown below
as a shift from Ssubsidy to S no subsidy, increasing the market price for mohair from P0
to P1 and decreasing the quantity demanded and supplied from Q0 to Q1.
b. This program was likely kept in existence because not many people knew about it
(mohair is a relatively small market), and ranchers had no incentive to broadcast
the subsidy.
c. A law that requires that suppliers receive $3.60 more than the market price is the
same as a tax, but the revenue goes to the supplier. The demand curve would shift
to the left (down) to include this tax. The quantity demanded would fall
dramatically. Consumers would not support this law because they would have to
pay an enormously high price. Suppliers would support this law only if they were
guaranteed that they could sell at that high price.
10.
Excess supply in U.S. agricultural markets is caused by the government’s policy
of agricultural price supports, or price floors on agricultural products. Political
forces prevent the invisible hand from working.
11.
It would likely increase the number since it reduces the cost of having a car that
you drive very little.
12. a. Japan prescribes many more drugs than the U.S. because Japanese doctors have a
financial incentive to do so.
b. It would lead to many more drugs being produced, even if they were not really
innovative, as happened when Japan tried this.
c. Drug reps would likely provide free samples and other gifts to doctors and have
lunches for them where they tout the advantages of their drugs.
13. a. They would likely fall. In fact, they fell by 13 percent.
b. They also would likely fall. In fact, they fell by 22 percent.
c. The graphs below show the effect of increasing co-payments. The graph on the
left has a co-payment of $15. Consumers demand Q1 and the shaded region
Colander’s Economics, 8e. McGraw Hill © 2010
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Chapter 5: Using Supply and Demand
shows the medical claim costs. In the accompanying graph on the right,
consumers must pay the first $1,500 of medical costs, demonstrated by the lowershaded region. (For simplicity, we assume that consumers end up purchasing 50
units at a cost of $30 per unit.) As you can see, however, the medical cost to the
firm (upper shaded area) is much smaller. In addition, the units of medical
services demanded are lower, illustrating the second question – hospital
admissions declined.
Colander’s Economics, 8e. McGraw Hill © 2010
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Chapter 5: Using Supply and Demand
Appendix A
1. a. The tables are shown below:
Price
(Dollars
per
gallon)
0
1
2
3
4
5
6
b.
Quantity
Demanded
(Gallons
per year)
Quantity
supplied
(Gallons
per year
600
500
400
300
200
100
0
-150
0
150
300
450
600
750
See the accompanying graph. Equilibrium price is 3 and equilibrium quantity is
300.
c.
P=3; Q=300
2. a. The following are the demand and supply tables after the hormone is introduced:
Quantity
Quantity
Price
Demanded Supplied
The hormone (a technological advance) shifts the supply curve to the right by 125,000 gallons, The de
(dollars per (gallons per (gallons
gallon)
year)
per
year)
0.00
600
-25
1.00
500
125
2.00
400
275
2.50
350
350
3.00
300
425
4.00
200
575
5.00
100
725
6.00
0
875
b. The original supply curve is S0. The growth hormone shifts the supply curve to
S1 (to the right by 125). Equilibrium price falls to $2.50 a gallon, and equilibrium
quantity rises to 350 million gallons (point B).
c. The demand curve remains the same at QD = 600 - 100P. The supply curve
becomes QS = -25 + 150P. To solve the two equations, set them equal to one
another: 600 - 100P = -25 + 150P and solve for P. Doing so, we get P = 2.5.
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Chapter 5: Using Supply and Demand
Substituting this value for P into either the demand or supply equation gives us
equilibrium quantity of 350.
d. Quantity supplied would be 425 (-25 + 150 X 3) and quantity demanded would be
300 (600 - 100 X 3). There would be excess supply of 125. The price floor is
shown in the accompanying graph.
3. a. The demand curve is QD = 10-P; the supply curve is QS = 2P -5. To solve for
equilibrium price and quantity, set the two equations equal and solve for P.
Substitute P into either to find equilibrium quantity. The solution is P = $5, Q = 5.
b. The new demand curve is QD = 13-P. To solve for equilibrium price and quantity,
set the two equations equal and solve for P. Substitute P into either to find
equilibrium quantity. The solution is P = $6, Q = 7.
c. The new supply curve is QS = 2P-8. To solve for equilibrium price and quantity,
set the two equations equal and solve for P. Substitute P into either to find
equilibrium quantity. The solution is P = $7, Q = 6.
4. a. A demand curve follows the formula QD = a - bP, where a is the quantity-axis
intercept and b is the slope of the curve. A shift in demand is reflected in a change
in a. An increase in demand increases a and a decrease in demand reduces a.
b. A supply curve follows the formula, QS = a + bP, where a is the quantity-axis
intercept and b is the slope of the curve. A shift in supply is reflected in a change
in a. An increase in supply increases a and a decrease in supply decreases a.
c. A movement in supply or demand is reflected in the effect of a change in P on
either QS or QD. The equations themselves do not change.
5. a. P = 4; Q = 6
b. Since the government set price is above the equilibrium price, it is a price floor.
Thus it would create a surplus. Solving the equations, we see the surplus would be
2 million bushels.
6. a. The new supply equation is QS = -150 + 150(P - 1) where P is the equilibrium
price, or QS = -300 + 150P.
b. P = 3.60; Q = 240.
c. Farmers receive $2.60 per gallon, while demanders pay $3.60 per gallon.
7. a. The new demand equation is QD = 600 -100(P+1) where P is the price suppliers
receive, or QD = 500-100P.
b. P = 3.60; Q = 240.
c. Farmers receive $2.60 per gallon. It doesn’t matter who pays the tax, the market
outcome is the same.
8. a. The new supply equation is QS = -150 + 150(P + 1) where P is the equilibrium
price, or QS = 150P.
b. P = 2.40; Q = 360.
c. Farmers receive $3.40 per gallon.
Colander’s Economics, 8e. McGraw Hill © 2010
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Chapter 5: Using Supply and Demand
9.
a.
b.
c.
d.
Equilibrium price is $2.
P = $3 is above equilibrium price, so it is a price floor. There is a surplus of 8.
P = $1.50 is below equilibrium price, so it is a price ceiling. There is a shortage of
4.
P = $2.25 is above equilibrium price, so it is a price floor. There is a surplus of 2.
P = $2.50 is above equilibrium price, so it is a price floor. There is a surplus of 4.
Colander’s Economics, 8e. McGraw Hill © 2010
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