Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
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