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Chapter 4 – Applications of Demand and
Supply.
Read pages 84 – 99.
I Illustration 1 – The Personal Computer
Market.
A) Observations
1) More producers.
2) Prices have fallen over time.
B) Graphical depiction.
II Illustration 2 – The Market for stock on
Intel.
A) Terminology on ownership categories
1) A firm owned by one individual is a sole
proprietorship.
2) A firm owned by several individuals is a
partnership.
3) A firm owned by many individuals who
own stock in the firm is called a
corporation.
4) The stock market is the set of institutions in
which shares of a stock are bought and
sold.
B) The market for Intel stock.
1) Suppose that Intel announces a new
generation of computer chips that will lead
to faster computers with larger memories.
What will happen to its stock price?
C) Other possibilities
1) A competitor of Intel offers a more
advanced processor which is likely to steal
market share from Intel.
2) The economy appears headed into a
recession and consequently there are
forecasts for declining revenues at Intel.
III Government Intervention In Market Prices:
Price Floors
A) Terminology
1) A minimum allowable price is a price
floor.
B) Examples
1) Agricultural price supports.
2) Minimum wage laws.
C) Impact on the market.
1) Price is above equilibrium.
2) There is a surplus of goods.
D) Graphical depiction of the price support
for the wheat industry.
E) Two ways to implement it.
1) Government buys the surplus. (Pre 1973)
This tends to push up consumer prices. It
also leaves the government with unwanted
surplus product.
2) Government pays the difference between
the target price and the market price (Post
1973). This keeps consumer prices low
and reduces the surplus. However, it still
forces the government to pay substantial
amounts to support the program.
IV Government Intervention In Market Prices
: Price Ceilings
A) Terminology
1) A price ceiling is a maximum allowable
price.
B) Examples
1) Rent control.
2) Utility prices.
C) Impact on the Market
1) Prices are below equilibrium.
2) There is a shortage of goods.
D) Graphical depiction of the price ceiling in
the rental apartment market.
V The Market for Health-Care Services.
A) Basics of this market
1) Has experienced a steady rise in its
percentage of GDP from about 5% in 1960
to 13.5% in 1997.
2) One feature of the market is the presence
of insurance companies and government
programs which pay part of the price of
the service. These institutions are called
third party payers.
B) What the market for health care would
look like if there were no third party
payers.
1) The equilibrium price would occur where
the demand curve (reflecting peoples
willingness and ability to purchase the
good) cross the supply curve (reflecting
providers willingness to sell the good).
2) Total expenditures on health care will be
price times quantity which in the diagram
is $30.00 x 1,000,000 = $30,000,000.
C) What the market for health care looks like
when there are third party payers.
1) Because third party payers effectively
reduce the price to the consumer,
consumers will purchase more of the
good.
2) This means that providers (suppliers) of
health care get a higher price for each unit
of health care (since the quantity is further
up the supply curve).
3) It also means that the total expenditures in
the economy on health care go up. In the
diagram the total is now
$50.00 x 1,500,000 = $75,000,000
which is more than double. Also note that
consumers now only pay
$10.00 x 1,500,000 = $15,000,000
while the third part payers pay
($50.00-$10.00) x 1,500,000 = $60,000,000.
VI Some concluding thoughts
1) Government intervention into markets typically
result in equilibrium prices and allocations that
are different than when there is no intervention.
2) Statements about the price and quantity outcomes
of a government intervention are positive
economic statements.
3) Statements about whether one supports a
government intervention are normative economic
statements. Although most programs appear
undesirable because they lead to improper
allocations of resources, they can be defended on
normative grounds.
IV Sample problems
1) In the market for health care:
a) Equilibrium occurs at the intersection of
supply and demand, just as it does with
most goods.
b) The effect of third-party payers decreases
the price that consumers pay.
c) Providers are encouraged to supply a
greater quantity than they would without
third party payers.
d) B and D are true.
2) A cost that farm subsidies and price floors
imposes on the rest of the economy is:
a) Excessively mobile farm resources.
b) Higher consumer commodity prices.
c) Less government-funded agricultural
research.
d) Efficient farmers that leave the farming
industry.
Read the “Case in Point” on page 91.
3) The unusually heavy rainfall in southern
California in 1997 caused:
a) An increase in the quantity demanded for
roof repairs.
b) An increase in the quantity supplied of roof
repairs.
c) An increase in both the demand for and
supply of roof repairs.
d) An increase in the supply of roof repairs
that was greater than the increase in
demand for roof repairs.
Read the “Case in Point” on page 77.
4) ABC corporation reluctantly announces that its latest
product development has failed and that revenue
projections are being revised downward. When this
first reaches the public, what would likely happen in
the market for ABD stock?
a) The demand and supply would fall, causing the price
to decline.
b) The demand would fall and the supply would rise,
causing price to fall with an indeterminate number of
shares traded.
c) The demand would fall and supply would rise, causing
price to fall with fewer shares traded.
d) The demand would fall and supply would rise, causing
price to fall with more shares traded.
b) Is the correct answer.