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Chapter 4Markets in Action

• Key Concepts• Summary• Practice Quiz• Internet Exercises

©2002 South-Western College Publishing

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What can cause a shift in a demand curve?

• Number of buyers in the market• Tastes and preferences• Income• Expectations of consumers• Prices of related goods

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$1200

$600

$300

4 8 12 16

D1

The Effects of Shift in Demand on Market Equilibrium

D2

Shortage

$900S

P

Q

4

$40

$30

$10

10 20 30 40D2

S

D1

Surplus

$20

The Effects of Shift in Demand on Market Equilibrium

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Increase in Demand

Increase in Equilibrium

Price

Increase in Quantity Supplied

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Decrease in Demand

Decrease in Equilibrium

Price

Decrease in Quantity Supplied

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What can cause a shift in a supply curve?

• Technology• Number of sellers in the market• Resource prices• Taxes and subsidies• Expectations of producers

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$4

$1

20 40 60 80

D

Surplus$3

$2

S1

The Effects of Shift in Supply on Market Equilibrium

S2

9

$800

$200

2 4 6 8

D

Shortage

$600 S1S2

$400

The Effects of Shift in Supply on Market Equilibrium

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Increase in Supply

Decrease in Equilibrium

Price

Increase in Quantity

Demanded

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Decrease in Supply

Increase in Equilibrium

Price

Decrease in Quantity

Demanded

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Can the laws of demand and supply be repealed?

In some markets, the objective of politicians is to prevent prices from reaching the equilibrium price

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What are the two types of price controls?

Price ceilingsPrice floors

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What is a price ceiling?A legally established maximum price a seller can charge

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$800

$600

$400

$200

2 4 6 8

D

SRent Control Results in a Shortage of Rental Units

ShortageRent ceiling

P

Q

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Rent Ceiling

Quantity Demanded exceeds the

quantity supplied

Shortage

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What is the purpose of price ceilings on rent?

So needy people will pay lower rent than the equilibrium rent

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Why may rent controls be counterproductive?

• Shortages• Illegal markets• Less maintenance• Discrimination

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What are other examples of price

ceilings?Wage and price controlsUsury laws

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What is a price floor?A legally established minimum price a seller can be paid

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Wm

We

QD QE QS

D

S

A Minimum Wage Results in a Surplus of Labor

UnemploymentMinimum wage

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Minimum wage

Unemployment

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What are examples of price floors?

Minimum wage lawAgricultural price supports

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Why do we have price ceilings and floors?Because of failures in

the free market

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What is market failure?A situation in which the price system creates a problem for society or fails to achieve society’s goals

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Who was Adam Smith?The father of modern economics who wrote The Wealth of Nations, published in 1776

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What did Adam Smith say about competition?There must be competition for markets to function properly

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What happens when competition is lacking?

Market failure results

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$2000

$500

50 100 200

Rigging the Personal Computer Market

D

$1500

S

1

S2

$1000

250

$2500

300150

Inefficient equilibrium

Efficient equilibrium

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What is an example of another market failure?

Externalities

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What is an externality?A cost or benefit imposed on people other than the consumers and producers of a good or service

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What is anegative externality?

An externality that is detrimental to third parties

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What is an example of a negative externality?

Pollution

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P2

Q1

External Cost of Pollution

P1

S1S2

Q2

Includes external costs of pollution

Excludes external costs of pollution

D

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What is apositive externality?An externality that is beneficial to third parties

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What is an example of a positive externality?

Vaccinations

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$10

Q1 Q2

D1

S

External Benefits of AIDS Vaccinations

D2P1

Excludes Vaccination benefits

Includes Vaccination benefits

P2

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External costs

Inefficient equilibrium

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External benefits

Inefficient equilibrium

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What is another example of a positive

externality?Public goods

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What is a public good?A good that, once produced, has two properties:

(1) users collectively consume benefits

(2) no one can be excluded

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What are examples of public goods?

• National defense• Public education• Roads

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What is another example of

market failure?Income inequality

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Key Concepts

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Key Concepts• What can cause a shift in a demand curve?• What can cause a shift in a supply curve?• What are the two types of price controls?• What is a price ceiling?• What is a price floor?• Why do we have price ceilings and floors?• What is market failure?

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Key Concepts cont.

• What happens when competition is lacking?• What is an externality?• What is a negative externality?• What is a positive externality?• What is a public good?• What is another example of market failure?

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Summary

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Price ceilings and price floors are maximum and minimum prices enacted by law, rather than allowing the forces of supply and demand to determine prices. A price ceiling is a maximum price mandated by government, and a price floor is a minimum legal price.

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$800

$600

$400

$200

2 4 6 8

D

S

If a price ceiling is set below the equilibrium price, a shortage will persist

ShortageRent ceiling

P

Q

50

Wm

We

QD QE QS

D

S

If a price floor is set above the equilibrium price, a surplus will persist

UnemploymentMinimum wage

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Market failure means that the market mechanism does not achieve desirable results. Sources of market failure include lack of competition, externalities, public goods, and income inequality. Although controversial, government intervention is a possible way to correct market failure.

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An externality is a cost or benefit of a good imposed on people who are not buyers or sellers of that good. Pollution is an example of an external cost, which means too many resources are used to produce the product responsible for the pollution. Two basic approaches to solve this market failure are taxes (like in pollution taxes) and regulation (like in vaccinations).

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P2

Q1

External Cost of Pollution

P1

S1S2

Q2

Includes external costs of pollution

Excludes external costs of pollution

D

54Q1 Q2

D1

S

External Benefits of AIDS Vaccinations

D2P1

Excludes Vaccination benefits

Includes Vaccination benefits

P2

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Public goods are goods that are consumed by everyone regardless of whether they pay or not. National defense, air traffic control, and other public goods can benefit many individuals simultaneously and are provided by the government.

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END