Chapter 4 Extensions of Demand and Supply...

1

Chapter 4Extensions of Demand

and Supply Analysis

Roger LeRoy Miller

Economics TodayTwelfth Edition

Copyright © 2004 Pearson Addison Wesley. All rights reserved. Slide 4-2

Introduction

Over the past decade, gasoline prices have been lower in inflation-adjusted terms than they were in 1980. What factors might account for this lower

price of energy?

Slide 4-3

Learning Objectives

� Discuss the essential features of the price system

� Evaluate the effects on the market price and equilibrium quantity of changes in demand and supply

� Understand the rationing function of prices

Slide 4-4

Learning Objectives

� Explain the effects of price ceilings

� Explain the effects of price floors

� Describe various types of government-imposed quantity restrictions on markets

2

Slide 4-5

� The Price System

� Exchange and Markets

� Changes in Demand and Supply

� Price Flexibility and Adjustment Speed

� The Rationing Function of Prices

Chapter Outline

Slide 4-6

� The Policy of Government-Imposed Price Controls

� The Policy of Controlling Rents

� Price Floors in Agriculture

� Price Floors in the Labor Market

� Quantity Restrictions

Chapter Outline

Slide 4-7

Did You Know That...

� According to the U.S. Customs Service, the second most serious smuggling problem along the Mexican border involves the refrigerant freon?

� When an older U.S. air conditioner needs fixing, it is often cheaper to pay a relatively high price for illegally smuggled freon than to modify the unit?

Slide 4-8

The Price System

� Price System (market system)– An economic system that allocates

resources based on relative prices determined by supply and demand

– Prices signal what is relatively scarce and relatively abundant

3

Slide 4-9

Exchange and Markets

� Markets– Emphasize voluntary exchange

– Determine the terms of exchange

– Facilitate exchange

Slide 4-10


� Voluntary Exchange– Acts of trading between individuals

that make both parties to the trade subjectively better off

� Terms of Exchange– The prices we pay for the desired items

Slide 4-11


� Transaction Cost– The costs associated with exchange

– Examples• Price shopping• Determining quality• Determining reliability• Service availability• Cost of contracting

Slide 4-12


� The role of middlemen– Middlemen (intermediaries) or brokers

reduce transaction cost by providing information to buyers and sellers.

– Examples• Real estate brokers• Stock brokers• Consignment shops• Car dealerships

4

Slide 4-13


� Observation– Consumers on the Internet rely on

intelligent shopping agents to act as middlemen

� Question– How has the increase in the number of

web pages affected the potential market for shopbot services?

Slide 4-14

Changes in Demand and Supply

� Changes in supply and demand create a disequilibrium

� The market price and quantity adjusts to a new equilibrium

Slide 4-15

Pinball’s Failure to Score with a New Generation Creates a Surplus

� Observations– Pinball machines have declined in popularity.

– There is a surplus of pinball machines.

� Question– What will happen to prices of pinball machines?

Slide 4-16

Responses to a Shift in Demand for Pinball Machines

Figure 4-2

5

Slide 4-17

Shifts in Demand and Supply: Determinate Results

Increase Demand with Supply Constant

D1

S

P1

Q1

E1

Slide 4-18

At price P1 quantitydemanded exceedsquantity supplied—a shortage exists



D1

S

P1

Q1

E1

Q3

D2

Slide 4-19



P1

Q1

S

E1

D2

Equilibrium price and quantity increase to P2 and Q2

E2

Q2

P2

D1

Slide 4-20

At price P1 quantitysupplied exceedsquantity demanded—a surplus exists.

Q2

D2

S


Decrease Demand with Supply Constant

D1

E1

Q1

P1

6

Slide 4-21


Decrease Demand with Supply Constant

P1

Q1

SE1

D2

Equilibrium priceand quantity decrease to P3 and Q3

D1

Q3

E3P3

Slide 4-22

S1


Increase Supply with Demand Constant

D

P1

Q1

E1

Slide 4-23

At price P1 quantitysupplied exceedsquantity demanded—a surplus exists



P1

Q1

E1

D

Q3

S2

S1

Slide 4-24



P1

Q1

E1

D

Q2

P2

E2

S2

S1Equilibrium price decreases and quantity increases to P2 and Q2

7

Slide 4-25



Decrease Supply with Demand Constant

D

S1

E1

Q1

P1

Q2

S3

Slide 4-26


Decrease Supply with Demand Constant

P1

Q1

E1

D

S3

S1

Equilibrium price decreases and quantity increases to P3 and Q3

Q3

P3

E3

Slide 4-27


� Summary– Increases in demand increase equilibrium

price and quantity.

– Decreases in demand decrease equilibrium price and quantity.

Slide 4-28


� Summary– Increases in supply decrease equilibrium

price and increase equilibrium quantity.

– Decreases in supply increase equilibrium price and decrease equilibrium quantity.

8

Slide 4-29


� When both demand and supply shift– Simultaneous changes in demand

and supply put conflicting pressure on price or quantity

– The resulting effect depends upon how much each shift

– Either equilibrium price or quantity will be indeterminate

Slide 4-30

D1

Shifts in Demand and Supply: Shortage

Increase Demand > Increase Supply

S1

P1

Q1

E1

D2

S2

Slide 4-31


P1

Q1

E1

S2S1

D2D1



Qs QdSlide 4-32



P1

Q1

S2S1

D2

Q2

P2 E2

Equilibrium price increases and quantity decreases to P2 and Q2

E1

D1

9

Slide 4-33


Decrease Demand < Decrease Supply

D1

QdQs


S1

D2

P1

Q1

E1

S2

Slide 4-34


Decrease Demand < Decrease Supply

P1

Q1

S2 S1

D2 D1

E1

Q2

Equilibrium price increases and quantity decreases to P2 and Q2P2 E2

Slide 4-35


Increase Demand > Decrease Supply

S1

D2D1

P1

Q1

E1

S2

Slide 4-36


Increase in Demand > Decrease in Supply

P1

Q1

S2S1

D2

E1

D1

QdQs


10

Slide 4-37


Increase Demand > Decrease in Supply

P1

Q1

S2S1

D2

E1

D1

Q2


E2P2

Slide 4-38


Increase Demand < Decrease in Supply

S1

D1 D2

P1

Q1

E1

S2

Slide 4-39



P1

Q1

S2 S1

D2

E1

D1

QdQs


Slide 4-40



P1

Q1

S2 S1

D2

E1

D1


Q2

E2P2

11

Slide 4-41

D1

Shifts in Demand and Supply: Surplus

Increase Supply > Increase in Demand

S2S1

D2

P1

Q1

E1

Slide 4-42



P1

Q1

S1 S2

D2

E1

D1

Qd Qs


Slide 4-43



P1

Q1

S1 S2

D2

E1

D1

Q2

Equilibrium price decreases and quantity increases to P2 and Q2

E2P2

Slide 4-44


Decrease Demand > Decrease in Supply

S1

D1

D2

S2

Q1

E1P1

12

Slide 4-45



Q1

S1S2

D2

E1

D1

P1

Qd Qs


Slide 4-46



Q1

S1S2

D2

E1

D1

P1

Qd

E2P2

Equilibrium price decreases and quantity decreases to P2 and Q2

Slide 4-47


Increase Supply > Decrease in Demand

S1

D1

D2

S2

Q1

E1P1

Slide 4-48



Q1

S1

S2

D2

E1

D1

P1

Qd Qs


13

Slide 4-49



Q1

S1

S2

D2

E1

D1

P1

Equilibrium price decreases and quantity decreases to P2 and Q2

Q2

P2

E2

Slide 4-50


Increase Supply < Decrease in Demand

S1

D1

E1

Q1

P1

D2

S2

Slide 4-51



Q1

S1 S2

D2

E1

D1

P1

Qd Qs


Slide 4-52



Q1

S1 S2

D2

E1

D1

P1 Equilibrium price decreases and quantity decreases to P2 and Q2

Q2

P2

E2

14

Slide 4-53


� When both demand and supply increase– Change in price is indeterminate

– Quantity will increase

� When both demand and supply decrease– Change in price is indeterminate

– Quantity will decrease

Slide 4-54


� When supply decreases and demand increases– Price will increase

– Change in quantity is indeterminate

� When supply increases and demand decreases– Price will decrease

– Change in quantity is indeterminate

Slide 4-55

Price Flexibilityand Adjustment Speed

� Flexibility and indirect adjustment– Quality

– Service

– Rebates

Slide 4-56

Price Flexibilityand Adjustment Speed

� Adjustment speed– Market characteristics influence

adjustment speed

– Markets may overshoot in the adjustment process

15

Slide 4-57

The Rationing Function of Prices

� When surpluses and shortages exist price adjusts to clear the market.

� This adjustment is the rationing function of price.

Slide 4-58


� When prices cannot adjust non-price rationing occurs– Rationing by queues

– Rationing by lotteries

– Rationing by coupons

Slide 4-59


� The essential role of rationing– With scarcity rationing must occur

– We must choose the rationing mechanism: price or non-price

– Price rationing is the most efficient• Further trades could not occur without making

somebody worse-off

Slide 4-60


� Question– If price rationing is the most efficient

is it the best way to ration?

16

Slide 4-61

The Policy of Government-Imposed Price Controls

� Price Controls– Government-mandated minimum

or maximum prices

� Price Ceiling– A legal maximum price

� Price Floor– A legal minimum price

Slide 4-62


� Price ceiling and black markets– Price ceilings may prevent the equilibrium

price from being achieved if it is above the ceiling price.

Slide 4-63


� Non-Price Rationing Devices– All methods used to ration scarce goods

that are price-controlled

� Black Market– A market in which price-controlled goods

are sold at an illegally high price

Slide 4-64

Black Markets

Figure 4-3

D

Qe

Pe

Qs

P1

P2

Qd

S’Implicit supply schedule at P1 < Pe

Shortage

Pric

e

Quantity per Unit Time Period

17

Slide 4-65

� The functions of rental prices– Promote the efficient maintenance

and construction of housing

– Allocate existing housing

– Ration the use of housing

The Policy of Controlling Rents

Slide 4-66

� Rent controls and construction– Controls discourage construction

• With a 16% vacancy rate and no controls, Dallas recently built 11,000 new rental units.

• With a 1.6% vacancy rate and controls, San Francisco recently built 2,000 new rental units.


Slide 4-67

� Effects on the existing supply of housing– Property owners cannot recover costs


Slide 4-68

� Rationing the current use of housing– Reduces mobility

• New York’s “housing gridlock”


18

Slide 4-69

� Attempts at evading rent controls– Forcing tenants to leave

– Tenants subletting apartments

– Housing courts


Slide 4-70

� Who gains and who loses from rent controls?– Losers

• Property owners• Low-income individuals

– Benefits• Upper-income professionals


Slide 4-71

Price Floors in Agriculture

� Support Price– the governmentally established minimum

price farmers are to receive for a particular agricultural product.

Slide 4-72

Agricultural Price Supports

Figure 4-4

D

Pe

QeQd

Ps

Qs

Excess quantity supplied

Dol

lars

per

Uni

t

Quantity of Wheat per Time Period

S

E

19

Slide 4-73

Price Floors in Agriculture

� Questions– How could the government keep the price

from falling?

– Who benefits from agricultural price supports?

Slide 4-74

Price Floors in the Labor Market

� Minimum Wage– Lowest hourly wage rate that firms

may legally pay their workers

Slide 4-75

The Effect of Minimum Wages

Figure 4-5

D

We

QeQd

Wm

Qs

Wag

e R

ate

per U

nit

Quantity of Labor per Time Period

S

E

A B C

Reduction in quantity

of labor demanded

Excess quantity supplied at wage Wm

Increase in quantity of labor

supplied

Slide 4-76

Quantity Restrictions

� Prohibitions on the ownership or trading of a good– Human organs

– Drugs

– Hospital beds

20

Slide 4-77

Quantity Restrictions

� Import Quota– Supply restriction that prohibits

the importation of more than a specified quantity of a particular good in a one-year period

Slide 4-78

� Short-term variations in the price of gas are dramatic and receive media coverage.

� When a decrease in supply occurs simultaneously with an increase in demand, the retail price will spike upward.

� Less attention is paid to the long-term decline in real gasoline prices.

Issues and Applications:Why Gas Really Is Cheap

Slide 4-79

The Inflation-Adjusted Price of Gasoline and Gasoline Consumption Relative to Output of

Goods and Services

Slide 4-80

The Inflation-Adjusted Price of Gasoline and Gasoline Consumption Relative to Output of

Goods and Services

21

Slide 4-81

Summary Discussion of Learning Objectives

� Essential features of the price system– A price system (market system) allows

prices to respond to changes in supply and demand for different commodities.

– The terms of exchange—prices—are communicated in markets that tend to minimize transactions costs.

Slide 4-82


� How changes in demand and supply affect market price and equilibrium quantity– Increases in demand increase equilibrium price

and quantity. Decreases in demand decrease equilibrium price and quantity.

– Increases in supply decrease market price and increase equilibrium quantity. Decreases in supply increase market price and decrease equilibrium quantity.

Slide 4-83


� How changes in demand and supply affect market price and equilibrium quantity– When both demand and supply shift

at the same time, indeterminate results occur.

Slide 4-84


� The rationing function of prices– In a market system, prices ration

scarce goods and services.

� The effect of price ceilings– A price ceiling set below the market

(equilibrium) price results in a shortage.– The resulting shortage can lead to non-

price rationing devices and black markets.

22

Slide 4-85


� The effects of price floors– If the price floor is set above

the market price, a surplus results.– A price floor can take the form

of a government-imposed price support or minimum wage.

– Quantity restrictions can take the form of import quotas.

Slide 4-86


� Government-imposed restrictions on market quantities– Bans on sale or ownership

– Licensing restrictions

– Import quotas

Slide 4-87

Shifts in Demand and in Supply: Determinate Results

Figure 4-1

Panel (a)

P1

Q1

D1

S

E1

Q2

P2

D2

E2

Panel (b)

Q1

P1

S

D3

P3

Q2

D1

E1

E3

Panel (c)

Q1

P1

E1

S1

D

P2

Q2

E2

S2

Panel (d)

P1

Q1Q3

P3 S1

D

E1

E3

S3

Chapter 4Extensions of Demand

and Supply Analysis

End of Chapter

Copyright © 2004 Pearson Addison Wesley. All rights reserved.

Chapter 4 Extensions of Demand and Supply...

Documents

Transcript of Chapter 4 Extensions of Demand and Supply...