Transcript Chapter 4 - The Citadel

Chapter 4
Extensions of
Demand and
Supply Analysis
Introduction
Water covers 71% of the Earth, but only
2.5% is fresh water.
People in many locales complain of
“shortages” of safe drinking water.
In this chapter you will learn more
about shortages.
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4-2
Learning Objectives
• Discuss the essential features of the
price system
• Evaluate the effects of changes in
demand and supply on the market price
and equilibrium quantity
• Understand the rationing function
of prices
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4-3
Learning Objectives (cont'd)
• Explain the effects of price ceilings
• Explain the effects of price floors
• Describe various types of governmentimposed quantity restrictions
on markets
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4-4
Chapter Outline
• The Price System and Markets
• Changes in Demand and Supply
• The Rationing Function of Prices
• The Policy of Government-Imposed
Price Controls
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4-5
Chapter Outline (cont'd)
• The Policy of Controlling Rents
• Price Floors in Agriculture
• Price Floors in the Labor Market
• Quantity Restrictions
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4-6
Did You Know That...
• The inflation-adjusted value of the U.S.
minimum wage peaked at about $8 in 1964?
• We can use supply and demand analysis to
analyze effects of the minimum wage?
• The model of supply and demand can explain
instances of a gap between quantity supplied
and quantity demanded?
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4-7
The Price System and Markets
• Price System or Market System
 An economic system in which relative
prices are constantly changing to reflect
changes in supply and demand
 Prices
signal what is relatively scarce and
relatively abundant.
 Prices
provide information to individuals
and businesses.
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4-8
The Price System
and Markets (cont'd)
• Markets
 Emphasize voluntary exchange
 Determine the terms of exchange
 Facilitate exchange
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4-9
The Price System
and Markets (cont'd)
• 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
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4-10
The Price System
and Markets (cont'd)
• Transaction Costs
 The costs associated with exchange
 Examples
 Price shopping
 Determining quality
 Determining reliability
 Service availability
 Cost of contracting
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4-11
The Price System
and Markets (cont'd)
• The role of middlemen
 Middlemen (intermediaries) or brokers
reduce transaction costs by providing
information to buyers and sellers
 Examples
 Real estate brokers
 Stock brokers
 Consignment shops
 Car dealerships
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4-12
Policy Example: Profiting by Lowering
Transaction Costs of Junking Computers
• Transaction costs can be lowered by
middlemen (intermediaries).
 Consumers and businesses can dispose of
old computer equipment.
• Intermediaries can refurbish
old computers.
 Useable parts and computer upgrades can
be resold.
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4-13
Changes in Demand and Supply
• Changes in supply and demand create
a disequilibrium.
• The market price and quantity adjust to
a new equilibrium.
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4-14
Figure 4-1 Shifts in Demand and in
Supply: Determinate Results, Panel (a)
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4-15
Figure 4-1 Shifts in Demand and in
Supply: Determinate Results, Panel (b)
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4-16
Figure 4-1 Shifts in Demand and in
Supply: Determinate Results, Panel (c)
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4-17
Figure 4-1 Shifts in Demand and in
Supply: Determinate Results, Panel (d)
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4-18
Changes in Demand
and Supply (cont'd)
• Summary
 Increases in demand increase equilibrium
price and quantity.
 Decreases in demand decrease
equilibrium price and quantity.
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4-19
Changes in Demand
and Supply (cont'd)
• Summary
 Increases in supply decrease equilibrium
price and increase equilibrium quantity.
 Decreases in supply increase equilibrium
price and decrease equilibrium quantity.
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4-20
Changes in Demand
and Supply (cont'd)
• 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 curve shifts.

Either equilibrium price or quantity will
be indeterminate.
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4-21
Changes in Demand
and Supply (cont'd)
• 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
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4-22
Changes in Demand
and Supply (cont'd)
• 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
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4-23
Example: Why Gasoline Prices
Have Increased
• One factor—an increase in demand,
shown by a rightward shift in the
demand curve
• Another factor—a reduction in
supply, shown by a leftward shift in
the supply curve
• As a result, the market clearing price of
gasoline increased.
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4-24
Figure 4-2 The Effects of a Simultaneous
Decrease in Gasoline Supply and Increase
in Gasoline Demand
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4-25
Price Flexibility
and Adjustment Speed
• Prices quite flexible in unfettered
markets can be less flexible in other
market scenarios.
 May experience indirect adjustments such
as hidden payments, quality changes
 May not reach equilibrium right away
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4-26
Price Flexibility
and Adjustment Speed (cont'd)
• Adjustment speed
 Market characteristics influence
adjustment speed.
 Markets may overshoot in the
adjustment process.
 Markets are subject to energy shocks,
labor strikes, severe weather.
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4-27
The Rationing Function of Prices
• Synchronization of decisions of buyers
and sellers that leads to equilibrium is
called the rationing function of prices.
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4-28
The Rationing Function
of Prices (cont'd)
• Methods of non-price rationing
 Rationing by queues (waiting in line)
 Rationing by random assignment,
and/or coupons
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4-29
The Rationing Function
of Prices (cont'd)
• The essential role of rationing (with
scarcity rationing must occur)
 We must choose the rationing mechanism:
price or non-price.
 Price
rationing leads to most efficient use of
available resources; all gains from mutually
beneficial trade are captured.
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4-30
The Rationing Function
of Prices (cont'd)
• Question
 If price rationing is the most efficient is it
the “best” way to ration?
• Answer
 Economists cannot say which system is
“best.” They can say rationing via the price
system leads to the most efficient use of
available resources.
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4-31
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
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4-32
The Policy of Government-Imposed
Price Controls (cont'd)
• Price ceiling and black markets
 Price ceilings may prevent the equilibrium
price from being achieved if it is above
the ceiling price.
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4-33
The Policy of Government-Imposed
Price Controls (cont'd)
• 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
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4-34
Figure 4-3 Black Markets
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4-35
Example: Preventing Price Gouging
Promotes Black Markets in Florida
• Florida’s antigouging law penalizes a seller for selling
an item for a high price during an emergency.
• After a hurricane, temporary shortages exist, causing
prices to rise, but antigouging laws prevent price
increases from occurring.
• When prices are fixed, producers have less incentive
to deliver, and a parallel, or black, market develops.
• So who wins and who loses?
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4-36
The Policy of Controlling Rents
•
The functions of rental prices
1. Promote the efficient maintenance and
construction of housing
2. Allocate existing housing
3. Ration the use of housing
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4-37
The Policy of Controlling
Rents (cont'd)
• 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.
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4-38
The Policy of Controlling
Rents (cont'd)
• Effects on the existing supply of
housing and current use of housing
 Property owners cannot recover costs
 Maintenance,
repairs, capital improvements
 Rations the current use of housing
 Reduces
mobility, e.g., New York’s
“housing gridlock”
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4-39
The Policy of Controlling
Rents (cont'd)
• Attempts to evade rent controls
 Forcing tenants to leave
 Tenants subletting apartments
 Housing courts
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4-40
The Policy of Controlling
Rents (cont'd)
• Who gains and who loses from
rent controls?
 Losers
 Property
owners
 Low-income
individuals
 Gainers
 Upper-income
professionals
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4-41
Price Floors in Agriculture
• Support Price
 The governmentally established price floor
 Associated
with agricultural products
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4-42
Figure 4-4
Agricultural Price Supports
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4-43
Price Floors in Agriculture (cont'd)
• Questions
 How could the government keep the price
from falling?
 Who benefits from agricultural
price supports?
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4-44
International Policy Example: The High
Cost of European Sugar Subsidies
• Sugar is most efficiently extracted from sugar
cane grown in warm, moist climates.
• Extracting sugar from beets is four times
more costly.
• European taxpayers pay $1.5 billion per year
to subsidize beet sugar production.
• Why do you suppose governments in
developing countries complain?
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4-45
Price Floors in the Labor Market
• Minimum Wage
 A wage floor, legislated by government,
setting the lowest hourly wage rate that
firms may legally pay their workers
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4-46
Figure 4-5
The Effect of Minimum Wages
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4-47
Quantity Restrictions
• Governments can impose quantity
restrictions, most obvious—banning
ownership or trading of a good
 Human organs
 Drugs
 Hospital beds
 Gold from 1933 to 1973
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4-48
Quantity Restrictions (cont'd)
• Government Prohibitions and
Licensing Requirements
 Some commodities cannot be purchased
at all legally; others require a license
• Import Quota
 Supply restriction that prohibits the
importation of more than a specified
quantity of a particular good
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4-49
Issues and Applications: Coping with a
Growing Global Demand for Fresh Water
• Today, about 2.5 billion people have safe
drinking water; nearly 4 billion do not,
resulting in 2 million deaths annually.
• Price controls make a scarce resource, such
as water, harder to obtain.
• What rationing method do you think can best
ensure greater access to safe drinking
water?
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4-50
Figure 4-6
How to Generate a Water Shortage
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4-51
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.
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4-52
Summary Discussion
of Learning Objectives (cont'd)
• 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.
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4-53
Summary Discussion
of Learning Objectives (cont'd)
• How changes in demand and
supply affect market price and
equilibrium quantity
 When both demand and supply shift at the
same time, the result is indeterminate.
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4-54
Summary Discussion
of Learning Objectives (cont'd)
• The rationing function of prices
 In a market system, prices ration scarce
goods and services.
 Other ways of rationing include first come,
first served; political power; physical force;
random assignment; and coupons.
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4-55
Summary Discussion
of Learning Objectives (cont'd)
• The effects 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.
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4-56
Summary Discussion
of Learning Objectives (cont'd)
• 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.
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4-57
Summary Discussion
of Learning Objectives (cont'd)
• Government-imposed restrictions
on market quantities
 Bans on sale or ownership
 Licensing restrictions
 Import quotas
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4-58
End of
Chapter 4
Extensions
of Demand
and Supply
Analysis