Download Chapter 3 - McGraw Hill Higher Education

CHAPTER 3
SUPPLY AND DEMAND
WHAT IS THIS CHAPTER ALL ABOUT?
This chapter introduces market behavior and the intricacies of the market mechanism. It is
helpful to continue to answer the basic questions of WHAT, HOW, and FOR WHOM and to
briefly outline how the market system answers them.
The chapter focuses on the allocative and distributive functions of the price system. The section
on disequilibrium pricing -- price ceilings and floors -- provides an opportunity to illustrate the
upside and downside of interference with market pricing mechanisms.
The opening illustration of a kidney sale on eBay demonstrates the power and potential
problems of markets.
This introduction sets the general direction of this chapter, which is to look at how the market
system answers the following questions:
1.
What determines the price of a good or a service?
2.
How does the price of a product affect its production and
consumption?
3.
Why do prices and production levels often change?
NEW TO THIS EDITION




New headline on campus drinking
New headline on demand shifts for natural gas
One new question for discussion
One new problem
Chapter 3 – Supply and Demand – Page 46
LECTURE LAUNCHERS
Where should you start?
Supply and Demand analysis is the foundation of much of the analysis the student will perform
during the semester. Therefore, it is important that students get a good start with this material.
1.
Begin your discussion by identifying market participants are, that is the suppliers and
the demanders.
Students sometimes confuse the colloquial use of the term “market” as in a supermarket
with its use by economics.
2.
Follow this discussion with the concept factor and product markets.
Showing the students how the market participants interact in the circular flow helps
illustrate the interaction of markets.
3.
A very good example of supply and demand is the market for web-design used in the text
beginning on page 59.
If you’re new to teaching, you might stick with this example. It is well done and is used
throughout the entire chapter. Using this example allows the students to follow in the
text as you demonstrate different concepts.
4.
Ask about the students’ interests. You might, for example, extend the study of markets to
professional sports teams asking questions such as:
a. How much do playoff game tickets cost?
b. What is the face value on the game tickets?
c. Does a black market or scalpers’ market exist for these tickets? If so, why can
they sell the tickets for more than the face value? This example will help lead
to a discussion about equilibrium prices, surpluses and shortages. Playoff
game tickets are often priced below the equilibrium price creating a
shortage in the market. The scalpers’ market allows market forces to
establish a market equilibrium.
COMMON STUDENT ERRORS
Many students make these common errors. This same list is included in the student study
guide. The first statement in each “common error” below is incorrect. Each incorrect statement
is followed by a corrected version and an explanation.
1.
If a large number of people petition the government in order to get something, then
there is a large demand for that item. WRONG!
There is a demand for a product only if people are willing and able to buy the product.
RIGHT!
People often say they want something, but there is no “demand” for it unless they are
able to pay for it. Economists use the word “demand” in a way that is quite different
from normal usage. People who want (desire; have preferences, a taste, or liking for) a
Chapter 3 – Supply and Demand – Page 47
commodity are seen as going to a market to purchase the commodity with money or
through bartering. As economists use the word, a “demand” for a product exists only
when people are both willing and able to purchase a product.
2.
Market price is the same thing as equilibrium price. WRONG!
The market price moves by trial and error toward the equilibrium price. RIGHT!
When demand and supply curves shift, the market is temporarily out of equilibrium.
The current market selling price might very well be a price that reflects the market not
yet being in equilibrium. The price may move along a demand or supply curve toward
the new equilibrium.
3.
Since the quantity bought must equal the quantity sold, every market is always in
equilibrium by definition. WRONG!
Although quantity bought equals quantity sold, there may be shortages or surpluses.
RIGHT!
Although the quantity actually bought does equal the quantity actually sold, there may
still be buyers who are willing and able to buy more of the good at the market price (a
market shortage exists) or sellers who are willing and able to sell more of the good at
the market price (a market surplus exists). If the market price is above the equilibrium
price, there will be too many goods (inventories begin to increase). As a result, sellers
will lower the prices toward the equilibrium price. If the market price is below the
equilibrium price, there will not be enough of the product (a shortage will exist). As a
result, buyers will bid up the prices toward the equilibrium price. The intersection of
supply and demand curves determines how much of a good or service will actually be
exchanged and the actual price of the exchange.
4.
A change in price changes the supply of goods produced by a firm. WRONG!
A change in price changes the quantity supplied by producers in a given time period.
RIGHT!
Economists differentiate the terms “quantity supplied” and “supply.” A change in the
quantity supplied usually refers to a movement along a supply curve as a result of a
change in price or production rate. A change in supply refers to a shift of the supply
curve as a result of a change in technology, price of resources, number of sellers, other
goods, expectations, or taxes.
5.
A change in price changes the demand for goods by consumers. WRONG!
A change in price changes the quantity demand by consumers in a given time period.
RIGHT!
Economists differentiate the terms “quantity demanded” and “demand.’ A change in
the quantity demanded usually refers to a movement along the demand curve as a
result of a change in price or production rate. A change in demand refers to a shift of
the demand curve as a result of a change in incomes, tastes, prices or availability of
other goods, or expectations.
6.
An upward shift in the supply curve is the same as an increase in supply. WRONG!
An upward shift in the supply curve is the same as a decrease in supply. RIGHT!
Students often perceive an increase in supply as an upward shift in supply. This is in
fact a decrease in supply. Be careful to explain that a shift in the supply curve is best
thought of as a shift right or a shift left: not a shift upward or a shift downward.
Chapter 3 – Supply and Demand – Page 48
HEADLINES
The six Headline boxes in this chapter give insights into several aspects of the supply, demand
and equilibrium relationship. The items and the ideas they highlight are:
“Higher Alcohol Prices and Student Drinking” (Law of Demand)
A Harvard survey shows that college students are affected by the price of alcohol,
reducing consumption by 33 percent after a $1 price increase. It may be possible
to reduce student drinking and associated problems by raising taxes.
“Natural Gas Prices Rise as Temps Fall” (Shifts of demand)
Colder winters and rising oils prices in 2003 increased demand for natural gas.
As a result natural gas prices are up more than 130 percent in one year.
“California Forced to Turn the Lights Off” (Supply Shift)
Out of power and out of options, California ordered rolling blackouts across the
state. If an underlying determinant of supply changes, the entire supply curve
shifts. Mechanical breakdowns and supplier anxiety about prospects for getting
paid reduced the quantity of electricity supplied at any given price in early 2000.
“Buyers Line up for Sony’s PlayStation 2” (Market Shortage)
Consumers line up outside stores to purchase the limited quantities of Sony’s
PlayStation 2 that were available for the year 2000 Christmas buying season.
Sony expects to ship 1.3 to 1.4 million PlayStation 2s to the U.S. market while
customer demand was expected to be 4 million. If price is below equilibrium, the
quantity demanded exceeds the quantity supplied. The willingness to pay $299
didn’t assure purchase of a PlayStation 2 in 2000.
"For Fans, What's 4 Nights for U2" (Market Shortage)
Explains why ticket prices are higher from scalpers. For prime concerts with
limited seating, box-office ticket pricing is often below equilibrium creating
market shortages and a market for scalped tickets. A below-equilibrium price
creates a market shortage. When that happens, another method of distributing
tickets – like time in line—must be used to determine who gets the available
tickets.
“U2 Tour Turning Out 2 be “Disaster” in Ticket Sales” (Market Surplus)
U2's “PopMart” tour, where ticket prices range from $37.50 to $52.50 plus
service charges per ticket, is the lowest-grossing stadium tour in the history of
Rock ‘n’ Roll. Although sold out on the opening night in San Diego, the second
night of the concert had many empty seats.
“Beef Prices on Way Up” (Shifts of Supply and Demand)
In 2003, US cattle prices hit a record high because of a combination of a change
in demand (increasing consumer demand partly because of popular high-protein
diets) and a change in supply (a ban on Canadian beef because of mad cow
disease.)
Chapter 3 – Supply and Demand – Page 49
ANNOTATED CONTENTS IN DETAIL
I.
II.
Introduction
A.
A few years ago, a Florida man tried to sell one of his kidneys. Even though this
was an illegal transaction, he was offered more than $100,000.
B.
Market
Definition: Market - Any place where goods are bought or sold
Market Participants
A.
Over 290 million individual consumers, about 20 million business firms, and
tens of thousands of government agencies participate directly in the U.S.
economy. Millions of foreigners also participate by buying and selling goods in
American markets.
B.
Goals
1.
Consumers - maximize happiness or satisfaction from consumption of
goods and services.
2.
Businesses - maximize profits.
3.
Government - maximize general welfare of society.
C.
Constraints
1.
All market participants have limited resources.
2.
Consumers need to make choices from available products given their
limited income.
3.
Producers must choose how to best use their limited resources.
4.
Government must also decide how best to use its limited resources.
D.
Specialization and Exchange –
1.
Why do we participate in exchange?
a.
We are incapable of producing all that we desire.
b.
We have limited amount of time, energy, and resources.
c.
Specialization increases total output.
Example - If each student were to move to the country, can
they be self-sufficient? In other words, could they
make all their own clothing, grow their own food,
build and provide their own transportation. If they
cannot, what will happen to their quality of life or
standard of living?
III. Market Interactions
A.
Four Separate Groups of Market Participants - (Figure 3.1)
1.
Consumers
2.
Business firms
3.
Governments
4.
Foreigners
B.
The Two Markets
Chapter 3 – Supply and Demand – Page 50
1.
Factor market
Definition: Factor market - Any place where factors of production
(e.g. land, labor, capital, entrepreneurship) are bought and
sold.
Example:
A car lot, a grocery store, cyberspace shopping, etc.
2.
Product market
Definition: Product Market - Any place where finished goods and
services (products) are bought and sold.
a.
Consumers buy and producers sell in the product market.
b.
Imports and exports are also a part of the product market.
c.
Government supplies products such as national defense, parks,
highways etc.
Locating Markets
a.
Markets are a medium where buyer and seller interact.
b.
A market exists wherever and whenever an exchange takes place.
3.
C.
Dollars and Exchange - (Figure 3.1)
1.
Barter
Definition: Barter - The direct exchange of one good for another,
without the use of money.
2.
An example of a market is a barter or cash exchange on eBay.
3.
Nearly every market transaction involves an exchange of dollars for goods
(in product markets) or resources (in factor markets).
4.
Money plays a critical role in facilitating market exchanges and the
specialization they permit.
D.
Supply and Demand
1.
Supply
Definition: Supply - The ability and willingness to sell (produce)
specific quantities of a good at alternative prices in a given
time period, ceteris paribus.
2.
Demand
Definition: Demand - The ability and willingness to buy specific
quantities of a good at alternative prices in a given time
period, ceteris paribus.
III. Demand
A.
Every market transaction involves an exchange and thus some element of both
supply and demand.
B.
Individual Demand - (Figure 3.2)
1.
A demand exists only if someone is willing and able to pay for the good.
2.
Opportunity cost
Definition: Opportunity Cost - The most desired goods or services
forgone in order to obtain something else.
3.
Demand schedule
Chapter 3 – Supply and Demand – Page 51
4.
Definition: Demand schedule - A table showing the quantities of a
good a consumer is willing and able to buy at alternative
prices in a given time period, ceteris paribus.
Demand curve
Definition: Demand curve - A curve describing the quantities of a
good a consumer is willing and able to buy at alternative
prices in a given time period, ceteris paribus.
Note: The demand curve does not state actual purchase, rather only
what consumers are willing and able to purchase.
5.
C.
Law of demand
Definition: Law of demand - The quantity of a good demanded in a
given time period increases as its price falls, ceteris
paribus.
Determinants of Demand - (Factors which shift the whole curve)
1.
Tastes (desire for this and other goods)
2.
Income (of the consumer)
3.
Other goods (their availability and price)
4.
Expectations (for income, prices, tastes)
5.
Number of buyers
Note: The number of buyers is a determinant of Market Demand.
6.
Headline: “Higher Alcohol Prices and Student Drinking” (Law
of Demand)
A Harvard survey shows that college students are affected by the price of
alcohol, reducing consumption by 33 percent after a $1 price increase. It
may be possible to reduce student drinking and associated problems by
raising taxes.
D.
Ceteris Paribus
Definition: Ceteris Paribus - The assumption of nothing else changing.
1.
We know that all the determinants of consumer demand affect the
decision to buy goods and services.
2.
To simplify the analysis, we focus on the relationship between quantity
demanded and price, i.e., what independent influence price has on
consumption decisions.
E.
Shifts in Demand - (Figure 3.3)
Definition: Shift in Demand - A change in the quantity demanded at any
given price.
1.
The demand schedule and curve remain unchanged only so long as the
underlying determinants of demand remain constant.
2.
Changes in any of the determinants of demand will cause the entire
demand curve to shift.
a.
The entire demand curve shifts to the right when income goes up.
b.
An increase in taste (desire) also shifts the demand curve to the
right.
Chapter 3 – Supply and Demand – Page 52
F.
Movement vs. Shifts
1.
Changes in quantity demanded -- Movements along a demand curve
are a response to price changes for that good.
2.
Changes in demand -- Shifts of the demand curve occur only when the
determinants of demand change.
G.
Market Demand
Definition: Market Demand - The total quantities of a good or service
people are willing and able to buy at alternative prices in a given
time period; the sum of individual demands.
Headline: “Natural Gas Prices Rise as Temps Fall” (Shifts of demand)
Colder winters and rising oils prices in 2003 increased demand for
natural gas. As a result natural gas prices are up more than 130 percent in
one year.
H.
The Market Demand Curve – The market demand curve is a picture of the
total quantities demanded by all consumers within a market at different price
levels (Table 3.1), (Figure 3.4).
Note: The number of potential buyers and their respective tastes, incomes, other
goods, and expectations determine the market demand. It is the
summation of all individual demand curves.
I.
IV.
The Use of Demand Curves
1.
Market demand helps predict the amount to produce for a given price.
2.
Market demand provides information about the appropriate price levels
for given output levels by showing how much consumers will spend at
different price levels.
Supply
A.
Market Supply
Definition: Market Supply - The total quantities of a good that sellers are
willing and able to sell at alternative prices in a given time period,
ceteris paribus.
B.
Determinants of Supply
1.
Technology
2.
Factor costs
3.
Taxes and subsidies
4.
Expectations
5.
Number of sellers
C.
The Market Supply Curve (Figure 3.5)
1.
Law of supply
Chapter 3 – Supply and Demand – Page 53
2.
D.
V.
Definition: Law of Supply - The quantity of a good supplied in a
given time period increases as its price increases, ceteris
paribus.
The market supply is an expression of sellers’ intentions, of the ability and
willingness to sell, not a statement of actual sales.
Shifts in Supply
1.
Changes in a quantity supplied - movements along a given supply curve.
2.
Changes in supply - shifts of the supply curve due to some change in a
determinant of supply.
3.
Headline: “California Forced to Turn the Lights Off” (Supply
Shift)
Out of power and out of options, California ordered rolling blackouts
across the state. If an underlying determinant of supply changes, the
entire supply curve shifts. Mechanical breakdowns and supplier anxiety
about prospects for getting paid reduced the quantity of electricity
supplied at any given price in early 2000.
Equilibrium A.
(Figure 3.6)
Equilibrium Price
Definition: Equilibrium Price - The price at which the quantity of a good
demanded in a given time period equals the quantity supplied.
B.
Market Clearing – Although not everyone gets full satisfaction from the
market equilibrium, that unique outcome is efficient. The equilibrium price and
quantity reflect a compromise between buyers and sellers. No other compromise
yields a quantity demanded that is exactly equal to the quantity supplied.
C.
Surplus and Shortage (Figure 3.6)
1.
Market Shortage
Definition: Market Shortage - The amount by which quantity
demanded exceeds the quantity supplied at a given price;
excess demand.
a.
Occurs when the selling price is lower than equilibrium price.
b.
Sellers supply less than buyers demand at that price.
2.
“Buyers Line up for Sony’s PlayStation 2” (Market Shortage)
Consumers line up outside stores to purchase the limited quantities of
Sony’s PlayStation 2 that were available for the year 2000 Christmas
buying season. Sony expected to ship 1.3 to 1.4 million PlayStation 2s to
the U.S. market while customer demand was expected to be 4 million. If
price is below equilibrium, the quantity demanded exceeds the quantity
supplied. The willingness to pay $299 didn’t assure purchase of a
PlayStation 2 in 2000.
3.
Market Surplus
Definition: Market Surplus - The amount by which quantity
supplied exceeds quantity demanded at a given price;
excess supply.
a.
Occurs when the selling price is higher than equilibrium price.
b.
Sellers supply more than the buyers demand.
Chapter 3 – Supply and Demand – Page 54
4.
5.
6.
7.
D.
4.
VI.
Headline: "For Fans, What's 4 Nights for U2" (Market
Shortage)
Explains why ticket prices are higher from scalpers. For prime concerts
with limited seating, box-office ticket pricing is often below equilibrium
creating market shortages and a market for scalped tickets. A belowequilibrium price creates a market shortage. When that happens, another
method of distributing tickets – like time in line—must be used to
determine who gets the available tickets.
Whenever the market price is set above or below the equilibrium price,
either a market surplus or a market shortage will emerge.
Headline: “U2 Tour Turning Out 2 be “Disaster” in Ticket Sales”
(Market Surplus) - U2's “PopMart” tour, where ticket prices range from
$37.50 to $52.50 plus service charges per ticket, is the lowest-grossing
stadium tour in the history of Rock ‘n’ roll. Although sold out on the
opening night in San Diego, the second night of the concert had many
empty seats.
Businesses often discover the equilibrium price through trial and error.
Changes in Equilibrium - (Figure 3.7)
1.
The collective actions of sellers and buyers create equilibrium price.
2.
Equilibrium price and quantity changes whenever supply or demand
curve shifts. This happens when the supply or demand determinants
change.
3.
Supply and Demand Shifts – Sometimes, both supply and demand change
simultaneously.
Headline: “Beef Prices on Way Up” (Shifts of Supply and Demand)
In 2003, US cattle prices hit a record high because of a combination of a
change in demand (increasing consumer demand partly because of
popular high-protein diets) and a change in supply (a ban on Canadian
beef because of mad cow disease.)
Disequilibrium Pricing - (Figure 3.8)
A.
Price Ceiling
Definition: Price Ceiling - Upper limit imposed on the price of a good or
service.
Example:
1.
2.
3.
B.
Rent control on housing.
Effective price ceilings increase the quantity demanded,
Decrease the quantity supplied, and
Create a market shortage.
Price Floor
Definition: Price Floor - Lower limit imposed on the price of a good or
service.
Example:
Price supports for sugar.
1.
Effective price floors increase quantity supplied,
2.
Decrease quantity demanded, and
3.
Create a market surplus.
Chapter 3 – Supply and Demand – Page 55
4.
Government Failure
Definition: Government Failure - Government intervention that
fails to improve economic outcomes.
a.
Government failure can result in the wrong mix of output
b.
An increased tax burden, and
c.
An altered distribution of income.
C.
Laissez-Faire
Definition: Laissez Faire - The doctrine of "leave it alone" nonintervention
by government in the market mechanism.
1.
In 1776, Adam Smith, the founder of modern economic theory, advocated
laissez-faire.
2.
Market mechanism
Definition: Market Mechanism - The use of market prices and sales
to signal desired outputs (or resource allocations).
D.
What, How, For Whom - The market mechanism helps resolve the basic
economic questions of:
1.
What to produce.
2.
How goods are produced.
3.
For whom to produce.
E.
Optimal, Not Perfect.
1.
Optimal outcomes are the best possible, given the level and distribution of
incomes and scarce resources.
2.
We expect the choices made in the marketplace to be the best possible
choices for each participant.
VII. Policy Perspectives
A.
Free Tuition in California!
1.
In 2000, the state of California introduced a free-tuition program for
residents of that state.
2.
Demand Effects – By reducing the effective price of tuition to zero, the
state will induce a movement down the demand curve to a much greater
quantity demanded.
3.
Supply Responses – The state will now have to focus on the supply side
of the market to assure the increased demand can be accommodated with
an increase in quantity supplied. If not, there will be a shortage in the
college market and a lot of frustrated applicants.
Chapter 3 – Supply and Demand – Page 56
IN-CLASS DEBATE, EXTENDING THE DEBATE, AND
DEBATE PROJECTS
In-class Debate
Should college be subsidized?
All US states subsidize education for college students, mostly by charging below-cost tuition.
Nearly free tuition is available in many European countries and has been proposed in California
(see p. 80).
Should the government subsidize college education so that it can be provided with very low
tuition? Or, should college education be allocated in a market system, in which prices are set by
supply and demand?
Using the accompanying chart based on the three basic economic questions (What? How? and
For Whom?), list the benefits of, and problems with, subsidized college education:
Benefits
Problems
How much college
education is produced?
(Suppose we measure the
quantity by counting the
number of students
attending.)
How is the college
education produced?
For whom is the college
education produced?
Chapter 3 – Supply and Demand – Page 57
Teaching notes
Classroom discussion often encourages students to debate one another. Although lively, such
discussion usually involves a minority of students. A cooperative controversy ensures that every
student is involved in the debate while using a relatively short period of class time. Moreover, it
can help students see the arguments on both sides of an issue, often a difficult task for college
students. Finally, the technique helps focus on an outcome such as identification of the strongest
argument on each side. These outcomes may be useful later, if students are assigned an
appropriate essay.
Format: Organize students into groups of two. (Use instructor assignment or random
assignment so that friends don’t work together.) One half of the groups take the pro side; the
other half take the con side. Each pair lists the strongest arguments for their position. Then,
pairs combine into groups of four, with one pair on each side of the debate. One pair reads their
reasons while the other side listens. Then they reverse roles and repeat. Finally, each group of
four selects the strongest argument on each side and, if appropriate, reaches a consensus on a
final position.
Extending the Debate
Should sugar be supported?
The text discusses the sugar price floor. A loan program for sugar farmers creates the price
floor. The program allows farmers to borrow money for production expenses from the
Department of Agriculture. When a loan falls due, a farmer must repay it, plus interest—unless
the price of sugar falls under 18 cents per pound. If that happens, the farmer can repay the loan,
at the rate of 18 cents per pound, by turning sugar over to the Department of Agriculture.
Use the following sources to research the loan program. List three arguments in favor of
maintaining the program and three in favor of eliminating it, or reducing its scope. Finally,
write your own conclusion regarding what should be done with the program, including
references to the sources you used.
The American Sugar Alliance—“a national coalition … dedicated to preserving a strong
domestic sweetener industry. “
www.sugaralliance.org
Farm Bill 2002 Information Home Page—The home page of a web site created by the
Department of Agriculture. It explains the 2002 farm bill. Click on “Commodity
Programs” and then “Sugar” to see the provisions of the farm bill relating to sugar.
http://www.usda.gov/farmbill/index.html
Coalition for Sugar Reform—a coalition of organizations representing food
manufacturers, environmentalists, and others.
http://www.sugar-reform.org/index.html
Chapter 3 – Supply and Demand – Page 58
Teaching notes:
In addition to the price floor, the Department of Agriculture intervenes in the market for sugar
in two other ways. First, it limits the amount of sugar that can be imported into the US. It does
this by setting quotas for producing countries. Second, it limits the amount of sugar that can be
sold by each producer of cane or beet sugar. The limit is called a marketing allotment. The
2002 farm bill directs the Department of Agriculture to use quotas and allotments to prevent the
price of sugar falling below 18 cents per pound, to avoid the expense of acquiring sugar from
farmers through the loan program.
Debate Project
Vouchers to Pay Private School Tuition
Two conditions that justify government intervention in a market are the presence of external
benefits and equity concerns (discussed in Chapter 6). Both these issues are present in the case
of primary and secondary education in the United States. We will consider these issues one at a
time, but first, think about what education without government education would look like.
In the absence of government intervention, all primary and secondary education in the US
would be private. Public school districts would not exist. Parents would need to pay private
firms (schools) to educate their children.
External benefits
If all education were private, it’s likely that people would buy too little education, from society’s
point of view. External benefits are one reason. When a child is educated, she benefits—and we
expect her parents to take those benefits into account when they purchase her education. But
there are additional benefits to society which her parents may ignore. As people become more
educated, they are less likely to be unemployed or be criminals and more likely to volunteer and
vote. The presence of these external benefits argues for government getting involved.
Equity
Equity concerns may also argue for a government role. Many families in the United States have
low incomes. Among all children in first through twelfth grades in 2001, 46% were from
families with incomes below $40,000. Since the cost of private education would be an
important share of these families’ incomes, most Americans would be concerned about the
fairness of relying on markets to decide how much education children receive. Current spending
by these families on private education provides some support for this concern. Of all children in
private school in 2001, only 25% were from families with incomes below $40,000.
Providing vs. producing education
Most economists think external benefits and equity concerns justify government intervention in
education. But it is important to distinguish between government production of education and
other forms of government intervention. At the level of elementary and secondary education—
K-12 education—government intervention today mostly means production of education by local
school districts. To benefit, children must attend public schools. But this is not the only form
Chapter 3 – Supply and Demand – Page 59
intervention could take. There are other markets where government intervention takes the form
of subsidizing people’s access to products—think of financial aid to college students, for
example. Many people in the US think that government should move from producing education
to subsidizing access.
One form that subsidy could take is government providing vouchers to parents. Parents would
use the voucher to, or help pay for, their child’s education in a private school. After it receives
the voucher, the school would turn it in and be paid by a local or state government.
Today there is a lively debate between people who think K-12 education should be delivered
publicly and people who think quality and efficiency would be higher if government provided
vouchers and the education was delivered by private schools. Some of these quality and
efficiency arguments are based on the mechanisms outlined in Chapter 6. Price competition
between private schools will pressure each one to produce efficiently. Competition for students
will lead private schools to offer programs of interest to parents and their children.
Important Questions
1) Will potential exit by students with vouchers lead to improvement in public
schools?
2) Will vouchers lead the best students to leave public schools, worsening the
education for the students left behind?
3) Do the students who receive vouchers and leave public schools for private schools
perform better in school as a result?
4) Would a universal voucher system—one available to all the children in a city, for
example—mostly benefit high income families?
Sources
The Census Bureau has a web page devoted to data on school enrollment. Look for table titles
including the phrase, “control of school,” to see contrasts between students in public school and
students in private school.
http://www.census.gov/population/www/socdemo/school.html
Education Week is a magazine for educators and the public. It seeks to provide timely, objective
information on important issues in education. This link is to a page that provides a brief
introduction to the voucher debate, with links to other Education Week articles relevant to the
subject. Reading these articles will require a free registration.
http://www.edweek.org/context/topics/issuespage.cfm?id=30
The Friedman Foundation was founded by the Nobel Prize winning economist, Milton
Friedman, and his wife, Rose Friedman. Milton Friedman came up with the idea of school
vouchers in the 1950s. The foundation aims to promote vouchers and other strategies to give
parents more choices about where to educate their children.
http://www.friedmanfoundation.org/
The Public Broadcasting Service has a public affairs series called Frontline. They have done a
number of TV shows on vouchers, or on the broader issue of school choice. These shows have
included interviews with experts on both sides of the voucher debate
http://www.pbs.org/wgbh/pages/frontline/shows/vouchers/choice/
Chapter 3 – Supply and Demand – Page 60
Rethinking Schools is a magazine for educators interested in school reform and making
American society fairer. It is critical of voucher programs. This link is to a page that provides
links to other Rethinking Schools articles related to the voucher issue.
http://www.rethinkingschools.org/special_reports/voucher_report/index.shtml
Salon.com is an online magazine that covers politics, culture, and society. This link is to a
debate between experts about vouchers, one that centers on whether vouchers violate the First
Amendment.
http://dir.salon.com/news/feature/2000/03/27/vouchers/index.html
ANSWERS TO QUESTIONS FOR DISCUSSION, WEB
ACTIVITIES AND PROBLEMS
QUESTIONS FOR DISCUSSION
1.
What does the supply and demand for human kidneys look like? If a market in kidneys
were legal, who would get them? How does a law prohibiting kidney sales affect the
quantity of kidney transplants or their distribution?
The need for kidneys is medically determined and therefore price is not an issue.
Anyone who has kidney disease and is in need of a kidney transplant is part of
the market demand for kidneys. The demand curve for kidneys would be
vertical line, illustrating its lack of responsiveness – zero elasticity – to a change
in price.
On the other hand, the quantity supplied of kidneys would increase as the price
increased. As the price increased, more people would be willing to give up a
kidney. However, the quantity supplied would probably not increase very much
as price increased due to the risks involved in the surgical procedure to remove
a kidney and the fact that the donor would only be left with one kidney. The
supply curve would start out at the point on the x-axis at the quantity that is
currently available at a price of zero. These are mostly from people who have
died and have signed organ donor cards. This quantity is lower than the
quantity demanded and therefore results in a shortage of kidneys when their
sale is prohibited by law.
If a market in kidneys were legal, the people who are most likely to get the
kidneys are those who are willing and able to pay the going market price.
People who do not have insurance or who cannot afford to pay the market price
will do without.
A law that prohibits kidney sales reduces the quantity of kidneys transplanted
because the law reduces the quantity supplied of available kidneys. The
allocation of kidneys relies on legal distribution through registered organ banks
and on the black market for kidneys.
Chapter 3 – Supply and Demand – Page 61
2.
In the web-tutoring market, what forces might cause
a.
A rightward shift of demand?
b.
A leftward shift of demand?
c.
A rightward shift of supply?
d.
A leftward shift of supply?
e.
An increase in the equilibrium price?
a.
b.
c.
d.
e.
An increase in any of the determinants of demand for web-tutoring would cause
the demand curve to shift right. Examples include: an increased desire to create
websites, increases in income resulting in more people purchasing computers
and connecting to the web, decreases in the prices of computers resulting in
more people purchasing computers and connecting to the web, decreases in the
price of monthly web connection fees, and changes in the expectations of how
many people will be accessing the web.
A decrease in any of the determinants of demand for web-tutoring would cause
the demand curve to shift to the left. Examples would include: a decreased
desire to create websites, decreases in income resulting in less people
purchasing computers and connecting to the web, increases in the prices of
computers resulting in less people purchasing computers and connecting to the
web, increases in the price of monthly web connection fees, and changes in the
expectations of how many people will be accessing the web.
An increase in any of the determinants of supply for web-tutoring would cause
the supply curve to shift to the right. Examples include: improvements in
technology that make it easier to design websites, decreases in the prices of
computers and web design software, a decrease in taxes on web design income,
increases in expectations income generated through web design, increases in the
number of sellers of web-tutoring.
A decrease in any of the determinants of supply for web-tutoring would cause
the supply curve to shift to the left. Examples include: increases in the prices of
computers and web design software, increases in taxes on web design income,
decreases in expectations of income generated through web design, decreases in
the number of sellers of web-tutoring.
An increase in the equilibrium price of web services can be caused by either an
increase in demand or a decrease in supply, ceteris paribus.
3.
Did the price of tuition at your school change this year? What might have caused that?
In almost all cases, the price of tuition at colleges and universities increased last
year. A market explanation of this price increase would include an increase in
the demand for a college education as more and more high school graduates
decide to go to college. In addition, the cost of providing that education, such as
salaries of faculty, staff, and administration, heating and cooling, rent on
buildings, etc., all increased, causing supply to decrease.
4.
What was the market situation for the 1992 and 1997 U2 concerts (pp. 72 and 74)?. Why
didn't the concert promoters set an equilibrium price?
The stories illustrate examples of a ticket prices that were set at a levels other
than the market clearing equilibrium price. In the first Headline, the $28.50
face-value price is well below the $150 the students suggest they would pay if
Chapter 3 – Supply and Demand – Page 62
they were employed full-time or the $1,200 ticket price for prime seats paid in
Los Angeles. In the second Headline, the prices were set too high, i.e., above the
equilibrium price, resulting in a surplus. The promoters did not set an
equilibrium price possibly because they set a market clearing national ticket
price, i.e., a common price for all tickets for the national tour, but each
individual market has its own equilibrium price depending on local conditions.
It is also possible that they miscalculated demand for the concert tickets, thus
setting the wrong price for the tickets.
5.
When concert tickets are priced below equilibrium, who gets them? Is this distribution
of tickets fairer than a pure market distribution? Is it more efficient? Who gains or loses
if all the tickets are resold (scalped) at the market-clearing price?
When tickets are priced below equilibrium, tickets are often distributed initially
on a first-come first-serve basis. It is often the case that these people then resell
their tickets at a higher price for a profit. Whether the distribution of tickets is
fairer than a pure market distribution system depends on your point of view. If
you have the time to stand in line early, or redial the phone continually until
you get in on the telephone order line, you probably think the system is fair. If
you do not have the time for these activities, you probably think the system is
unfair. This system of distribution is less efficient in that the tickets are not
being sold for their market value. If all of the tickets are resold at the marketclearing price, then there are mostly gainers. Those people who originally
purchased the tickets gain because they sell $28.50 tickets for a higher price and
they earn a profit. Those people who purchase the tickets at a higher price gain
because they are able to acquire tickets that they otherwise would not have been
able to purchase. There are some people who may not be able to afford to pay
the market-clearing price and thus cannot purchase the tickets.
6.
Is there a shortage of on-campus parking at your school? How might the shortage be
resolved?
Most schools have an on-campus parking shortage. This shortage could be
resolved in a number of ways. A non-market solution would be for the campus
administration to intervene and restrict the number of cars allowed on campus.
For example, some schools do not allow first and second year students to bring
cars on campus. This method, of course, harms first and second year students
who would otherwise bring cars to campus. A second method would be to
utilize the market and sell parking privileges. If the price of parking permits is
set appropriately, the parking problem will be resolved. Only those students
who perceive the benefit of parking to be greater than or equal to the cost of
parking will purchase the parking permit. Those who do not believe the benefits
received from parking on campus are worth the price will either not bring cars
to school or will park off campus.
7.
If departing tenants sell access to rent-controlled apartments, who is likely to end up
with the apartments? How else might scarce rent-controlled apartments be distributed?
If departing tenants sell access to rent-controlled apartments, the people who
end up with the apartments are those who can most afford to pay the access fee.
An alternative to this distribution system might be to set up a means test, i.e.
Chapter 3 – Supply and Demand – Page 63
have a maximum income requirement for rent-controlled apartments. People
who exceed the maximum income could not have access to the apartments
8.
If rent controls are so counterproductive, why do cities impose them? How else might
the housing of poor people be solved?
Where the leaders of a city have both a commitment to solving the housing
problems of the poor and the political pressures to act quickly, rent controls do
the job. They immediately put a lid on rents. Because this interference with the
market decreases the profitability of rental housing, rent controls also tend to
bring construction of new rental housing to a halt, so that the long-run housing
problem will still exist. An alternative approach would be to utilize the market
by either subsidizing the rents of low-income people, thereby enabling them to
pay the “high” rents or subsidizing landlords, thereby increasing supply and
lowering rents to a more acceptable level. Cities also increase the supply of
rental housing by creating government-owned public housing.
9.
In 2003, Cruz Bustamante, the lieutenant governor of California, proposed a price
ceiling on gasoline. Is this a good idea?
A price ceiling – a government-mandated below-equilibrium price – will result
in a shortage. Gasoline will then have to be allocated by something other than
price, most likely first-come, first-served. This will cause lines to form at the gas
stations, and people will horde gasoline, trying to keep their tanks as full as
possible. Price ceilings are generally disruptive and inefficient. If the problem is
that gasoline prices are perceived as being “too high,” then it would be better to
work within the market system to bring the price down, by either increasing
supply, decreasing demand, or both.
10.
Why did Sony set the initial price of the PlayStation 2 below equilibrium (see Headline,
P. 73)? Should Sony have immediately raised the price?
Sony might have been setting the price of their PlayStation2 based on a longterm pricing strategy rather than a short-term pricing strategy. The resale
market price for PlayStation 2s easily reached $600 during the 2000 Christmas
season. Although their initial price of $299 was well below the equilibrium price
during the Christmas season for 2000, Sony expected consumer demand and
supply to reach an equilibrium level well below this level after the Christmas
season was over. Instead of alienating consumers on this new product, they set
a price that allowed consumers who were willing and able to purchase the
product at $299 to have access to the product while still enticing other potential
consumers with the possibility that the price would drop after Christmas. In so
doing, they kept potential consumers in the market waiting for the shortage to
be alleviated. They also were able to use the shortage as a marketing strategy
to demonstrate their product to would-be buyers.
CHAPTER 3
Chapter 3 – Supply and Demand – Page 64
WEB ACTIVITIES
1.
Log on to www.whitehouse.gov/fsbr/income.html and find the data on real per capita
income?
a.
What has happened to the value of real per capita income?
b.
Assuming that the size of the workforce has remained relatively constant, use
supply and demand analysis to explain why real income has increased.
a.
b.
2.
The answer to this question will depend on the time that it is answered.
If the size of the workforce has remained relatively constant, there must have
been an increase in demand (a shift of the demand curve to the right) causing
real wages to increase.
Log on to http://www.cnn.com or www.msnbc.com and do a search using the key words
crude oil prices. Find an article that discusses recent changes in the price of crude oil.
a.
Discuss the reasons stated in the article explaining why the price of crude oil has
changed.
b.
Use supply and demand graphs to illustrate what is being discussed in the article.
The answer to this question depends on which article has been chosen. In general,
there will be either a change in supply or a change in demand. If production has
increased, the supply curve shifts right and equilibrium prices fall. If production has
decreased, the supply curves shifts left and equilibrium prices rise. If demand has
increased, the demand curve shifts right and price increases. If demand has decreased,
the demand curve shifts left and price decreases. It is possible that the shifts take place
simultaneously, in which case either price or quantity, but not both, will be
indeterminate.
3.
Log into www.ebay.com and record the price bids for some item during a 30-minute
period. Use supply and demand analysis to explain the initial shortage in the market and
how the bidding process is correcting the imbalance.
The answer to this question depends on the time in which you access the
information. All on-line bid markets begin with a price below the equilibrium price.
The shortage drives up price until an equilibrium is established in which quantity
supplied equals quantity demanded.
PROBLEMS
1.
Using Figure 3.7 as a guide, determine the approximate size of the market surplus or
shortage that would exist at a price of (a) $40, (b) $20.
Using Figure 3.7, and the new demand curve:(a) at a price 0f $40, there would
be surplus of 50 (b) at a price of $20, there would be a shortage of 87.5.
2.
Illustrate the different market situations for the 1992 and 1997 U2 concerts, assuming
constant supply and demand curves. What is the equilibrium price? (See Headlines on
p. 72 and p. 74)
Chapter 3 – Supply and Demand – Page 65
The equilibrium price for U2 tickets is somewhere between $52.50 (the price in
1997) and $28.50 (the price in 1992).
Supply
Surplus
$52.50
Price
$28.50
Shortage
Demand
Quantity
3.
Given the following data, (a) construct market supply and demand curves and identify
the equilibrium price; and (b) identify the amount of shortage or surplus that would exist at a
price of $4.
Participant
Price
Supply Side
Alice
Butch
Connie
Dutch
Ellen
Market Total
Quantity Supplied (per week)
$5
$4
$3
$2
$1
Participant
Price
Demand Side
Al
Betsy
Casey
Daisy
Eddie
Market Total
Quantity Demanded (per week)
$5
$4
$3
$2
$1
3
7
6
6
4
26
1
0
2
1
1
5
3
5
4
5
2
19
2
1
2
3
2
10
3
4
3
4
2
16
3
1
3
4
2
13
3
4
3
3
2
15
4
1
3
4
3
15
3
2
1
0
1
7
5
2
4
6
5
22
Chapter 3 – Supply and Demand – Page 66
Supply and Demand
Price (per unit)
$6
Supply
$5
$4
Demand 2
(for problem
#4)
$3
$2
$1
Demand 1
$0
0
5
10
15
20
25
30
Quantity (per week)
(a)
Equilibrium price is $2.
(b)
4.
At a price of $4, there would be a surplus of 9, the difference between the market
quantity supplied of 19 and the market quantity demanded of 10.
Suppose that the good described in problem 3 became so popular that every consumer
demanded one additional unit at every price. Illustrate this increase in market demand
and identify the new equilibrium. Which curve has shifted? Along which curve has
there been a movement of price and quantity?
The market demand curve will shift to the right by 5 units at every price. Given
this new demand curve, the new equilibrium will be approximately $3.50 and 17
units. The increase in price results in a movement along the supply curve,
resulting in an increase in quantity supplied.
5.
Illustrate each of the following events with supply or demand shifts in the domestic car
market:
a.
The U.S. economy falls into a recession.
b.
U.S. autoworkers go on strike.
c.
Imported cars become more expensive.
d.
The price of gasoline increases.
Chapter 3 – Supply and Demand – Page 67
S2, part b
Price
S1
D3
D1
D2, parts a and d
Quantity
6.
(a)
This would result in a decrease in demand (leftward shift of the demand curve)
due to a decline in buyer income.
(b)
This would result in a decrease in supply (leftward shift of the supply curve) due
to reduced ability to produce output.
(c)
This would result in an increase in demand (rightward shift of the demand
curve) as consumers substitute relatively less expensive domestic cars for the
now relatively higher priced imported cars.
(d)
This would result in a decrease in demand (leftward shift of the demand curve)
due to a higher price of a complementary good, gasoline.
Graph the effects on price and quantity of California’s free tuition program (See Policy
Perspectives beginning on p. 80)
Chapter 3 – Supply and Demand – Page 68
Tuition
S1
S2
D2
D1
Quantity
Normally, we do not extend demand curves to the quantity axis, as we are not
concerned about the quantity when the price is zero. In this case, with a college
education being offered for free, we do need to extend the demand curve to the axis.
The first effect of free tuition is that the quantity demanded would increase, i.e., there is
a downward movement along demand curve D1. Because expectations are altered,
demand shifts to demand curve D2.
The supply of public education is administratively determined and therefore the supply
curves are vertical. In other words, the state decides how much higher education it
wants to make available, regardless of the tuition (price). The purpose of the free
tuition was to make college education accessible to more people. That will not work
unless the supply is also increased, so the state decides to offer more education and the
supply increases (the supply curve shifts to the right).
7.
Assume the following data describe the gasoline market.
Price per gallon
$1.00 1.25 1.50 1.75 2.00 2.25 2.50
Quantity Demanded 26
25
24
23
22
21
20
Quantity Supplied
16
20
24
28
32
36
40
a.
b.
c.
d.
What is the equilibrium price?
If the quantity supplied at every price is reduced by 5 gallons, what will the new
equilibrium price be?
If the government freezes the price of gasoline at its initial price, how much of a
surplus or shortage will exist when supply is reduced as described above?
Illustrate your answers on a graph.
Chapter 3 – Supply and Demand – Page 69
a.
b.
c.
The equilibrium price is $1.50 where Qs=Qd.
If the quantity supplied at every price is reduced by 5 gallons, the new
equilibrium price would be $1.75.
If the government freezes the price of gasoline at its initial price of $1.50, the
reduction in supply will result in a shortage of gasoline of 5 gallons (24 – 19).
Price per gallon
Supply and Demand
2.75
2.5
2.25
2
1.75
1.5
1.25
1
0.75
0.5
0.25
0
Supply 2
Supply 1
Demand
0
10
20
30
40
50
Quantity
8. Graph the response of students to higher alcohol prices, as discussed in the Headline on pg.
62.
Chapter 3 – Supply and Demand – Page 70
Price
S2
S1
$3.17
$2.17
D1
Q2
Quantity
Q1
An increase in the tax on alcohol, for example, would decrease supply from S1 to S2. This in
turn would decrease the quantity demanded from Q1 to Q2.
9. Graph the changes in the beef market during 2003, as described in the Headline on p. 76.
Price
S2
P2
S1
D2
P1
D1
Q1
Chapter 3 – Supply and Demand – Page 71
Q2
Quantity
The decrease in supply due to the decrease in imported beef from Canada,
combined with the increase in demand due to a change in tastes, results in the
equilibrium price of beef increasing. For the equilibrium quantity to change, the
magnitude of the increase in demand must have been larger than the magnitude
of the supply decrease.
Chapter 3 – Supply and Demand – Page 72
MEDIA EXERCISE
Name: __________________
Chapter 3
Section: __________________
Supply and Demand
Grade: ___________________
Find an article that identifies changes in supply and demand in the media. Use the article to
fulfill the following instructions and questions:1.
Mount a copy (do not cut up newspapers or
magazines) of the article on a letter-sized page or
print an article from an Internet news agency
such as www.cnn.com, www.msnbc.com,
www.abc.com, www.nytimes.com, etc.
2.
Find an example in the article of one (and not more than one) of the following four
possible shifts of supply or demand: Leftward (upward) shift of the supply curve.
Rightward (downward) shift of the supply curve.
Leftward (upward) shift of the
demand curve.Rightward (downward) shift of the demand curve.
In the space below the article write the shift of demand or supply that is best represented in the
article. The shift may have already occurred, may be occurring currently, or may occur in the
future.3.
Use an arrow to indicate evidence in the article of whether the market is an
international, national, regional, or local market.4. Underline the single sentence (not more
than a sentence) that describes the change in
the determinant of demand or supply that
has caused the shift you chose in number 2 above.5.
Draw brackets around the passage
(not more than a sentence) that indicates through whom (buyer, seller) the change in the
determinant of demand or supply initially affects the market to cause the shift (in number 2
above), ceteris paribus. Under the article write “buyer” or “seller,” indicating with whom the
shift originates.6.
Circle the single sentence (not more than a sentence) that indicates a
change in price or
quantity that results from the shift in demand or supply. (Hint: Make
sure the changes
are consistent with the shift you chose in number 2 above.)7.
In the
remaining space below your article, indicate the source (name of newspaper,
magazine, or
web site), title (newspaper headline, magazine article, or web article title),
date, and page
for the article you have chosen. Use this format:
Source:
Date: ___________ Page: ______________
Title: ___________________________________________
If this information also appears in the article itself, circle each item.
8.
Neatness counts.
Chapter 3 – Supply and Demand – Page 73
PROFESSOR’S NOTE:Learning Objective for Media ExerciseTo test the
students’ understanding of the determinants of demand and supply.Suggestions for
Correcting Media Exercise1. Compare what is circled with the shift they have chosen to
check for consistency of price
and quantity movements.2. Check to see if the underlined
portion of the article is consistent with the shift chosen;
i.e. are the supply determinants
resulting in shifts of the supply or the demand curve?3.
If the seller experiences the initial
change then a supply shift should be involved. If the
buyer experiences the initial change,
then a demand shift is involved. Again, there
should be consistency between what is
bracketed and the shift chosen.Likely Student Mistakes and Lecture
Opportunities1. The most frequent student mistake is to find articles that suggest
movements along the demand or supply curves. In other words, the article describes a firm
changing its price
or output without any indication of the reasons (determinants of supply
or demand) for
its action.
2.
About one-third of the students who have a supply shift will show the supply curve
shifting in the wrong direction. They will have been caught by the common error of
believing that a downward shift in the supply curve means a reduction in supply. The
assignment serves as a great opportunity to correct this problem for the entire class.
3.
Some students will inevitably mix up supply and demand determinants, providing a
great opportunity to use anonymous examples from the incorrect assignments to elicit
the correct answers from the class. Some students will underline too much or will
underline more than one shift of demand or supply. This opens the opportunity for a
discussion of ceteris paribus and the richness of media articles in presenting many
different shifts at once.
SUPPLEMENTARY RESOURCESBergstrom, and John H. Miller,
Experiments with Economic Principles. New York: McGraw-Hill, 1997. In class
experiments, several teaching demand and supply.
Borenstein, Severin, “The Trouble With Electricity Markets: Understanding California’s
Restructuring Disaster,” The Journal of Economic Perspectives, Winter 2002,
pp. 191-212.
Chapter 3 – Supply and Demand – Page 74