Transcript Ch04
A Lecture Presentation in PowerPoint to accompany Exploring Economics by Robert L. Sexton and Peter Fortura Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Chapter 4 Supply and Demand Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.1 Markets A market is the process of buyers and sellers exchanging goods services. Supermarkets, the Toronto Stock Exchange, drug stores, roadside stands, garage sales, Internet stores are all markets. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.1 Markets Every market is different. Some markets are local but numerous(such as housing or the market for cement), others are global (such as automobiles or gold). The important point about a market is not what it looks like, but what it does–it facilitates trade. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.1 Markets Buyers, as a group, determine the demand side of the market, whether it is consumers purchasing goods or firms purchasing inputs. Sellers, as a group, determine the supply side of the market, whether it is firms selling their goods or resource owners selling their inputs. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.2 Demand According to the law of demand, the quantity of a good or service demanded varies inversely with its price, ceteris paribus. More directly, other things equal, when the price of a good or service falls, the quantity demanded increases. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.2 Demand The law of demand puts the concept of basic human “needs” to rest as an analytical tool. Needs are those things that you must have at any price. That is, there are no substitutes. But there are usually plenty of substitutes available for any good, some better than others. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.2 Demand The primary reason for the inverse relationship between price and quantity demanded is the substitution effect. At higher prices, buyers have an incentive to substitute other goods for the good that now has a higher relative price. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.2 Demand An individual demand schedule reveals the different amounts of a particular good a person would be willing and able to buy at various possible prices in a particular time interval, other things equal. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 1: Elizabeth's Demand Schedule for Apples Price (per kilogram) $5 Quantity Demanded (kilograms per year) 5 4 10 3 15 2 20 1 25 Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.2 Demand An individual demand curve for a particular good illustrates the same information as the individual demand schedule. It reveals the relationship between the price and the quantity demanded, showing that when the price is higher, the quantity demanded is lower. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 2: Elizabeth's Demand Curve for Apples Price of Apples (per kilogram) $5 4 Elizabeth’s demand curve 3 2 1 0 5 10 15 20 25 30 Quantity of Apples Demanded (kilograms per year) Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.2 Demand Economists usually speak of the demand curve in terms of large groups of people. The horizontal summing of the demand curves of many individuals is called the market demand curve for a product. It reflects the fact that the total quantity purchased in the market at a price is the sum of the quantities purchased by each demander. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 3: Creating a Market Demand Curve The market demand curve shows the amounts that all the buyers in the market would be willing to buy at various prices. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 4: A Market Demand Curve Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.2 Demand The money (or absolute or nominal) price of a good is the price you would pay for it in dollars and cents, expressed in dollars of current purchasing power. While money prices have fallen over time for some goods and services, they have risen over time for most. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.2 Demand The relative price of a good is the price of one good relative(compared) to other goods. In a world where virtually all prices are changing, relative prices are crucial to economic decisions. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.2 Demand The money price of a good can be higher than in the past, and yet have a lower relative price than in the past. For example, gasoline prices are higher than in the past in money terms, yet they are cheaper relative to other goods and service than they have been in the past. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Consumers are influenced by the prices of goods when they make their purchasing decisions. At lower prices, people prefer to buy more of a good than at higher prices, holding other factors constant, primarily because many goods are substitutes for one another. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve A change in a good's price leads to a change in quantity demanded, illustrated by moving along a given demand curve. But price is not the only thing that affects the the quantity of a good people buy. The other factors that influence the demand curve are called determinants of demand and they shift the entire demand curve—a change in demand. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Some of the possible demand shifters are: the prices of related goods the incomes of demanders the number of demanders the tastes of demanders the expectations of demanders Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve An increase in demand is represented by a rightward shift in the demand curve. A decrease in demand is represented by a leftward shift in the demand curve. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Price Exhibit 1: Demand Shifts Decrease Increase in in Demand Demand D2 0 Quantity Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . D0 D1 4.3 Shifts in the Demand Curve A major variable that shifts the demand curve is the prices of related goods. Two goods are called substitutes if an increase in the price of one causes a an increase in the demand for the other good. The opposite also applies: Two goods are called substitutes if a decrease in the price of one causes a decrease in the demand for the other good. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Because personal tastes differ, what are substitutes for one person may not be so for another person. For most people good substitutes might include: movie tickets and video rentals; jackets and sweaters; 7-up and Sprite and peas and carrots. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . SUBSTITUTE GOODS Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Two goods are complements if an increase in the price of one good causes a decrease in the demand for the other good. The opposite is also true: Two goods are complements if a decrease in the price of one good causes an increase in the demand for the other good. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Complements are goods that “go together.” They are often consumed or used simultaneously. For examples, skis and bindings; hot dogs and mustard; motorcycles and motorcycle helmets; DVD’s and DVD players. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . COMPLEMENTARY GOODS Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Generally the consumption of goods and services is positively related to the income available to consumers. As individuals receive more income, they tend to increase their purchases of most goods and services. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Other things equal, an increase in income usually leads to an increase in demand for goods (rightward shift). A decrease in income usually leads to a decrease in the demand for goods (leftward shift). Such goods are called normal goods. For example, CDs, and movie tickets. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Some goods exist for which rising (or falling) income leads to reduced (or increased) demand. These are called inferior goods. The term inferior does not refer to the quality of the good but it merely shows that when income changes demand changes in the opposite direction(inversely). For example, thrift shop clothes, storebrand products, and bus rides. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . NORMAL AND INFERIOR GOODS Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve The demand for a good or service will vary with the size of the potential consumer population—the number of buyers. An increase in the potential consumer population will increase (shift right) the demand for a good or service. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Changes in fashions, fads, advertising, etc. can change tastes or preferences. An increase in tastes or preferences for a good or service will increase (shift right) the demand for a good or service. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve While changes in preferences lead to shifts in demand, much of the predictive power of economic theory stems from the assumption that tastes are relatively stable over a substantial period of time. We cannot precisely and accurately measure taste changes. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Sometimes the demand for a good or service in a given time period will dramatically increase or decrease because consumers expect the good to change in price or availability at some future date. An increase in the expected future price of a good or a decrease in its expected future availability will increase (shift right) the current demand for it. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve A decrease in the expected future price of a good or an increase in its expected future availability will decrease (shift left) the current demand for it. However, what is important in terms of demand is what people expected to happen, rather than what actually happened. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.3 Shifts in the Demand Curve Changes in demand versus changes in quantity demanded revisited: If the price of a good changes, we say this leads to a change in quantity demanded. If one of the other factors (determinants of demand) influencing consumer behaviour changes, we say there is a change in demand. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 2: Possible Demand Shifters Price Price of complement falls or price of substitute rises D0 0 Quantity Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . D1 Exhibit 2: Possible Demand Shifters Price Income increases (normal good) D0 0 Quantity Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . D1 Exhibit 2: Possible Demand Shifters Price Income increases (inferior good) D1 0 Quantity Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . D0 Exhibit 2: Possible Demand Shifters Price Increase in the number of buyers in the market D0 0 Quantity Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . D1 Exhibit 2: Possible Demand Shifters Price Tastes change in favor of the good D0 0 Quantity Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . D1 Exhibit 2: Possible Demand Shifters Price Future price increase expected D0 0 Quantity Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . D1 Exhibit 3: Changes in Demand versus Changes in Quantity Demanded Price of CDs A A C Change in demand C $10 A B Change in quantity demanded B $5 D0 0 QA QB D1 QC Quantity of CDs Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply The law of supply states that, other things equal, the quantity supplied will vary directly with the price of the good. According to the law of supply, the higher the price of the good, the greater the quantity supplied, and the lower the price of the good, the smaller the quantity supplied. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply The quantity supplied is positively related to the price, because firms supplying goods and services want to increase their profits, and the higher the price per unit, the greater the profitability generated by supplying more of that good or service. Also, if costs are rising for producers as they produce more units, they must receive a higher price to compensate producers for their higher costs. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply An individual supply schedule reveals the different amounts of a product that a producer is willing and able to supply at various prices in a particular time interval, other things equal. An individual supply curve illustrates that information graphically. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 1: An Individual Supply Curve Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply The market supply curve for a product is the horizontal summation of the supply curves for individual firms. It shows the amount of goods and services suppliers are willing and able to supply at various prices. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 2: A Market Supply Curve Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply Changes in the price of a good lead to changes in quantity supplied, which are shown as movements along a given supply curve. Changes in supply occur for other reasons than changes in the price of the product itself. A change in any other factor that can affect supplier behaviour results in a shift of the entire supply curve. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply These other factors include: supplier input prices the prices of related products expectations number of suppliers technology regulations taxes subsidies weather Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply An increase in supply shifts the supply curve to the right. A decrease in supply shifts the supply curve to the left. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 3: Supply Shifts Price S2 0 S0 Decrease Increase in in Supply Supply Quantity Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . S1 4.4 Supply Higher input prices increase the cost of production causing the supply curve to shift to the left at each and every price. Lower input prices decrease the cost of production causing the supply curve to shift to the right at each and every price. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply The supply of a good can be influenced by the prices of related products. Firms producing a product can sometimes use their resources to produce alternative products. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply Suppose a farmer’s land can be used to grow either barley or wheat. If the farmer is currently growing barley and the price of barley falls then this provides an incentive for the farmer to shift acreage out of barley and into wheat. Thus a decrease in the price of barley will increase the supply of wheat. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 4: Substitutes in Production S P0 P1 0 Q1 Q0 Quantity of Barley Supplied Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . b. Market for Wheat Price of Wheat Price of Barley a. Market for Barley S0 S1 0 Quantity of Wheat Supplied 4.4 Supply If producers expect a higher price in the future, they will supply less now. They would prefer to wait and sell when their goods will be more valuable. If producers currently expect that the price will be lower later they will supply more now. Otherwise, if they wait to sell, then their goods will be worth less. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply The market supply curve is the horizontal summation of the individual supply curves. So an increase in the number of suppliers will increase market supply. A decrease in the number of suppliers will decrease market supply. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply Technological progress can lower the cost of production and increase supply. Supply may also change because of changes in the legal and regulatory environment in which firms operate (e.g., safety and pollution regulations, minimum wages, taxes, etc.) If such changes increase costs, they will decrease supply. If they decrease costs, they will increase supply. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply An increase in costly government regulations, taxes or adverse production conditions will increase the cost of production, decreasing supply. Subsidies, the opposite of a tax can lower the cost of production and shift the supply curve to the right. In addition, weather can affect the supply of certain commodities. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.4 Supply If the price of a good changes, it leads to a change in its quantity supplied, but not its supply. If one of the other factors influences sellers' behaviour, it leads to a change in supply. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 5: Possible Supply Shifters S0 Quantity Supplier’s input price (wages) increases S1 Price 0 S0 0 Quantity Supplier’s input price (fuel) falls Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . S1 Price S0 Price S1 0 Quantity Price of related products fall Exhibit 5: Possible Supply Shifters S1 Quantity Producer expects now that the price will be lower later S1 Price 0 S0 0 Quantity Number of suppliers increases Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . S0 Price S1 Price S0 0 Quantity Taxes rise Exhibit 5: Possible Supply Shifters S1 0 S1 S0 Price Price S0 Quantity Technological advance occurs Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 0 Quantity Bad weather Exhibit 6: Change in Supply versus Change in Quantity Supplied Price of Wheat S0 B P1 P0 0 C S1 A B Change in quantity supplied B C Change in supply A QA QB QC Quantity of Wheat Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.5 Market Equilibrium Price and Quantity The price at the intersection of the market demand curve and the market supply curve is called the equilibrium price. The quantity at the intersection of the market demand curve is called the equilibrium quantity. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.5 Market Equilibrium Price and Quantity At the equilibrium market price, the amount that buyers are willing and able to buy is exactly equal to the amount that sellers are willing and able to produce. If the price is set above or below the equilibrium price, there will be shortages or surpluses. However, the actions of many buyers and sellers will move the price back to the equilibrium level. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.5 Market Equilibrium Price and Quantity What is wrong with the table in the next slide? If the quantity demanded is greater than the quantity supplied is that a surplus or a shortage? Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 1: A Hypothetical Market Supply and Demand Schedule for Apples Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 1: A Hypothetical Market Supply and Demand Schedule for Apples $6 Supply Price of Apples (per kilogram) 5 4 Surplus QS>QD 3 2 Shortage QD>QS 1 Demand 0 2 4 6 8 10 12 14 Quantity Demanded and Supplied of Apples (thousands of kilograms/year) Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.5 Market Equilibrium Price and Quantity At the equilibrium price, the quantity demanded equals the quantity supplied—the amount that buyers are willing and able to buy is exactly equal to the amount that sellers are willing and able to produce. If the market price is at any other price, their will be a shortage or a surplus. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.5 Market Equilibrium Price and Quantity At a price greater than the equilibrium price, a surplus, or excess quantity supplied, would exist. Sellers would be willing to sell more than demanders would be willing to buy. Frustrated suppliers would cut their price and cut back on production, and consumers would buy more. This would eliminate the unsold surplus and return the market to equilibrium. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.5 Market Equilibrium Price and Quantity At a price less than the equilibrium price, a shortage, or excess quantity demanded, would exist. Buyers would be willing to buy more than sellers would be willing to sell. Frustrated buyers would compete for the existing supply, causing the price to rise, and producers to increase the quantity supplied. This would decrease the quantity demanded, eliminate the shortage, and return the market to equilibrium. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 2: Shortages Price of Chicken Supply PE PBE Shortage Demand 0 QS QD Quantity of Chicken Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity Demand curves shift when any of the other factors that affect buyers' behaviour change (but not the price of the good itself). Supply curves shift when any of the other factors that affect sellers' behaviour change (but not the price of the good itself). These changes (shifts) in the demand and supply curves will lead to changes in the equilibrium price and equilibrium quantity. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity An increase in demand results in a greater equilibrium price and a greater equilibrium quantity. Conversely, a decrease in demand results in a lower equilibrium price and a lower equilibrium quantity. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 1: Higher Gasoline Prices in the Summer Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Application: A Change in Demand Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Application: A Change in Demand Notice that in both Exhibit 1 and the Whistler application that the seasonal increases in demand led to a shortage at the original(out of season) price. When a shortage exists the price will rise until the new equilibrium is reached. In this case, at the intersection of the inseason demand curve and the the supply curve. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity A decrease in supply results in a higher equilibrium price and a lower equilibrium quantity. Conversely, an increase in supply results in a lower equilibrium price and a higher equilibrium quantity. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 2: The Market for Strawberries Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity The supply of strawberries is larger during in-season than out-of-season. At the higher winter price for strawberries there would be a surplus of strawberries in-season. This surplus forces the in-season price down to P1. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity Very often, supply and demand will both shift in the same time period. That is, supply and demand will shift simultaneously. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity When supply and demand move at the same time, we can predict the change in one variable (price or quantity), but we are unable to predict the direction of effect on the other variable. This change in the second variable, then, is said to be indeterminate, because it cannot be determined without additional information about the relative changes in supply and demand. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity We can predict what will happen to equilibrium prices and equilibrium quantities in situations where both supply and demand change. We can predict this by breaking them down into their individual effects, then putting together the price and quantity effects that each of the shifts would have separately. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity An increase in supply decreases the equilibrium price and increases the equilibrium quantity. A decrease in demand decreases both the equilibrium price and quantity. Taken together, they will decrease the equilibrium price, but result in an indeterminate change in the equilibrium quantity. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity The change in quantity will depend on the relative changes in supply and demand. If the decrease in demand is greater than the increase in supply, the equilibrium quantity will decrease. If the increase in supply is greater than the decrease in demand, the equilibrium quantity will increase. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 3: Shifts in Supply and Demand a. A Little Increase in Supply and a Big Decrease in Demand S0 E0 S1 Price P0 E1 P1 D1 0 Q1 Q 0 Quantity Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . D0 Exhibit 3: Shifts in Supply and Demand b. A Big Increase in Supply and a Little Decrease in Demand S0 Price P0 P1 S1 E0 E1 D0 D1 0 Q0 Q1 Quantity Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity An increase in demand increases the equilibrium price and equilibrium quantity. An increase in supply decreases the equilibrium price and increases the equilibrium quantity. Together, they increase the equilibrium quantity. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.6 Changes in Equilibrium Price and Quantity The change in equilibrium price depends on the relative sizes of the demand and supply shifts. If supply shifted more than demand, the equilibrium price would drop. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 4: An Increase in the Demand and Supply of VCRs Price of VCRs S0 S1 E0 P0 E1 P1 D0 D1 0 Q0 Q1 Quantity of VCRs Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 5: Shifts in Both Supply and Demand S0 S1 E0 P0 E1 P1 D 0 Q0 Q1 Quantity of LongDistance Calls Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Price of Long-Distance Calls Price of Long-Distance Calls a. Increase in Supply b. Simultaneous Increase in Supply and Demand S0 S1 E0 E1 P0 D0 0 Q0 D1 Q1 Quantity of LongDistance Calls 4.6 Changes in Equilibrium Price and Quantity The eight possible changes in demand and/or supply are presented, along with the resulting changes in equilibrium price and equilibrium quantity. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 6: The Effect of Changing Demand and/or Supply Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Exhibit 7: The Combinations of Supply and Demand Shifts D unchanged, S D, S unchanged S0 S0 Price E1 P1 P0 E0 D1 D, S unchanged P0 E0 P1 E1 D0 0 Q0 D S0 Q1 Quantity (1) Price Price S1 P0 P1 E1 D0 0 Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Q1 Q0 Quantity (2) Q0 Q1 Quantity (3) E0 D1 0 Exhibit 7: The Combinations of Supply and Demand Shifts D unchanged, S D, S E1 S0 S0 P1 P0 Price Price S1 S1 E0 E1 P0 E0 D1 D0 D 0 Q1 Q0 Quantity (4) Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 0 Q0 Q1 Quantity (5) Exhibit 7: The Combinations of Supply and Demand Shifts D, S D, S S1 S0 Price S1 E1 E0 P0 D1 0 Q1 D0 S1 Q0 Quantity (6) E1 S0 E0 Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Q0? Quantity (7) E1 0 Q0? Quantity (8) D0 0 P0 D1 P1 P0 E0 P1 D, S Price Price S0 D1 D0 4.7 Price Controls While non-equilibrium prices occur naturally in the private sector, reflecting uncertainty, they seldom last for long. Governments, however, may impose non-equilibrium prices for significant time periods. Price controls involve the use of the power of the government to establish prices different from the equilibrium prices that would otherwise prevail. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls The motivations for price controls vary with the market under consideration. A price ceiling, or a legal maximum price, is often set for goods deemed important to low income households, like housing. A price floor, or a legal minimum price, may be set on wages because wages are the primary source of income for most people. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls Price ceiling example: rent control. Under rent control the price (or rent) of an apartment is held below market rental rates, over the tenure of an occupant. When an occupant moves out, the owner can sometimes, but not always, raise the rent to a near-market level for the next occupant. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Price of Apartments (Rent) Exhibit 1: Rent Control Supply P* PRC Shortage 0 QS Rent Control Price Demand Q* QD Quantity of Apartments Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls Some results of rent controls: Because living in rent controlled apartments is a good deal, one which would be lost by moving, tenants are very reluctant to move and give up their governmentally granted right to a belowmarket rent apartment. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls Some results of rent controls: Because the rents received by landlords are constrained at below market levels, the rate of return on housing investments falls compared to that on other forms of real estate not subject to rent controls, reducing the incentives to construct new rental housing. Where rent controls are truly effective, there is generally little new construction going on and a shortage of apartments that grows over time. Copyright © 2007,persists Nelson, a division ofand Thomson Canada Ltd. . 4.7 Price Controls Some results of rent controls: Since landlords are limited in what rent they can charge, there is little incentive to improve or upgrade rental apartments in order to get more rent. In fact, there is some incentive to avoid routine maintenance, thereby lowering the cost of apartment ownership to a figure approximating the controlled rental price. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls Some results of rent controls: With rent controls, there are likely to be many families wanting to rent an apartment because the rent is at a below-equilibrium price. Some of these tenants are seen as desirable by the landlord and some undesirable. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls Price floor example: the minimum wage. The federal government has, by legislation, made it illegal to pay most workers an amount below a legislated minimum wage (price for labour services). Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls Some results of the minimum wage: Because it would produce willing workers who will be unable to find jobs, an increase in the minimum wage would create additional unemployment for low skill workers. The unemployment impact of the minimum wage falls mainly on the least experienced, least skilled persons, often teenagers, holding the lowest paying jobs. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls Some results of the minimum wage: They lose their jobs or are unable to get them in the first place, and suffer a decline in earnings, not a gain. Those who continue to hold jobs with the same hours and working conditions after the minimum wage is increased gain substantially, and therefore are supporters of efforts to increase the minimum. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls The analysis does not “prove” minimum wages are “bad.” There is an empirical question of how much unemployment is caused by minimum wages. Some might believe that the cost of unemployment resulting from a minimum wage is a reasonable price to pay for assuring that those with jobs get a decent wage. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls But they do impose a cost It falls not only on unskilled workers and employers, but also on consumers of products that were made more costly by the minimum wage. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . Wage (price of labour) Exhibit 2: The Unemployment Effects of a Minimum Wage SLABOUR Unemployed (labour surplus) WMIN WE DLABOUR 0 QD QE QS Copyright © 2007, Nelson, a division of Thomson CanadaQuantity Ltd. of Labour . 4.7 Price Controls In the market for skilled and experienced workers the minimum wage is not binding because workers are earning wages that far exceed the minimum wage Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls There is no impact of a price floor on the market for skilled and experienced workers. In this market the price floor (minimum wage) is not binding Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls When markets are altered for policy reasons, it is wise to remember that the actual results of actions are not always as intended, as seen in the cases of rent control and the minimum wage. We must always look for unintended consequences, the secondary effects of an action that may occur along with the intended effects. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. . 4.7 Price Controls The unintended effects may sometimes completely undermine the intended effects. Copyright © 2007, Nelson, a division of Thomson Canada Ltd. .