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Chapter 4. Extensions of Demand and Supply Analysis. Shipping companies have found in recent years that there has been a shortage of available space at U.S. seaports. What market condition would give rise to a persistent shortage?. Introduction. Learning Objectives.

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chapter 4

Chapter 4

Extensions of Demandand Supply Analysis

introduction

Shipping companies have found in recent years that there has been a shortage of available space at U.S. seaports. What market condition would give rise to a persistent shortage?

Introduction
learning objectives
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
learning objectives4
Learning Objectives
  • Explain the effects of price ceilings
  • Explain the effects of price floors
  • Describe various types of government-imposed quantity restrictions on markets
chapter outline
Chapter Outline
  • The Price System
  • Exchange and Markets
  • Changes in Demand and Supply
  • Price Flexibility and Adjustment Speed
  • The Rationing Function of Prices
chapter outline6
Chapter Outline
  • The Policy of Government-Imposed Price Controls
  • The Policy of Controlling Rents
  • Price Floors in Agriculture
  • Price Floors in the Labor Market
  • Quantity Restrictions
did you know that
Did You Know That...
  • A shortage of flu vaccine arose in 2003?
  • Persistent shortages and surpluses may be observed in various markets?
  • The model of supply and demand can explain many of these instances of a gap between quantity supplied and quantity demanded?
the price system
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
exchange and markets
Exchange and Markets
  • Markets
    • Emphasize voluntary exchange
    • Determine the terms of exchange
    • Facilitate exchange
exchange and markets10
Exchange and Markets
  • 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
exchange and markets11
Exchange and Markets
  • Transaction Cost
    • The costs associated with exchange
    • Examples
      • Price shopping
      • Determining quality
      • Determining reliability
      • Service availability
      • Cost of contracting
exchange and markets12
Exchange and Markets
  • 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
exchange and markets13
Exchange and Markets
  • 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?
changes in demand and supply
Changes in Demand and Supply
  • Changes in supply and demand create a disequilibrium
  • The market price and quantity adjust to a new equilibrium
shifts in demand and supply determinate results

E1

D1

Shifts in Demand and Supply: Determinate Results

Increase Demand with Supply Constant

S

P1

Q1

Figure 4-1

shifts in demand and supply determinate results16

D2

Shifts in Demand and Supply: Determinate Results

Increase Demand with Supply Constant

S

At price P1 quantity

demanded exceeds

quantity supplied—

a shortage exists

E1

P1

D1

Q1

Q2

Figure 4-1

shifts in demand and supply determinate results17

E2

P2

D2

Q2

Shifts in Demand and Supply: Determinate Results

Increase Demand with Supply Constant

S

Equilibrium price and quantity increase to P2and Q2

E1

P1

D1

Q1

Figure 4-1

shifts in demand and supply determinate results18

D2

Shifts in Demand and Supply: Determinate Results

Decrease Demand with Supply Constant

S

E1

At price P1 quantity

supplied exceeds

quantity demanded—

a surplus exists.

P1

D1

Q2

Q1

Figure 4-1

shifts in demand and supply determinate results19

E3

P3

Q3

Shifts in Demand and Supply: Determinate Results

Decrease Demand with Supply Constant

S

E1

Equilibrium price

and quantity decrease to P3and Q3

P1

D1

D3

Q1

Figure 4-1

shifts in demand and supply determinate results20

S1

E1

D

Shifts in Demand and Supply: Determinate Results

Increase Supply with Demand Constant

P1

Q1

Figure 4-1

shifts in demand and supply determinate results21
Shifts in Demand and Supply: Determinate Results

Increase Supply with Demand Constant

At price P1 quantity

supplied exceeds

quantity demanded—

a surplus exists

S1

S2

E1

P1

D

Q1

Q3

Figure 4-1

shifts in demand and supply determinate results22

E2

P2

Q2

Shifts in Demand and Supply: Determinate Results

Increase Supply with Demand Constant

Equilibrium price decreases and quantity increases to P2and Q2

S1

S2

E1

P1

D

Q1

Figure 4-1

shifts in demand and supply determinate results23

S3

S1

E1

P1

D

Q1

Q2

Shifts in Demand and Supply: Determinate Results

Decrease Supply with Demand Constant

At price P1 quantity

demanded exceeds

quantity supplied—

a shortage exists

Figure 4-1

shifts in demand and supply determinate results24

S3

E3

P3

P1

Q1

Shifts in Demand and Supply: Determinate Results

Decrease Supply with Demand Constant

Equilibrium price decreases and quantity increases to P3and Q3

S1

E1

D

Q3

Figure 4-1

changes in demand and supply25
Changes in Demand and Supply
  • Summary
    • Increases in demand increase equilibrium price and quantity.
    • Decreases in demand decrease equilibrium price and quantity.
changes in demand and supply26
Changes in Demand and Supply
  • Summary
    • Increases in supply decrease equilibrium price and increase equilibrium quantity.
    • Decreases in supply increase equilibrium price and decrease equilibrium quantity.
changes in demand and supply27
Changes in Demand and Supply
  • 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
changes in demand and supply28
Changes in Demand and Supply
  • 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
changes in demand and supply29
Changes in Demand and Supply
  • 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
price flexibility and adjustment speed
Price Flexibilityand Adjustment Speed
  • Flexibility and indirect adjustment
    • Quality
    • Service
    • Rebates
price flexibility and adjustment speed31
Price Flexibilityand Adjustment Speed
  • Adjustment speed
    • Market characteristics influence adjustment speed
    • Markets may overshoot in the adjustment process
example why plywood prices have soared
Example:Why Plywood Prices Have Soared
  • The supply has decreased, due to some lumber sellers going out of business and to delays in timber harvesting as a result of wet weather.
  • Demand has increased both from the private sector and from government purchases for the military.
the rationing function of prices
The Rationing Function of Prices
  • When surpluses and shortages exist, the price adjusts to clear the market.
  • This adjustment is the rationing function of price.
the rationing function of prices35
The Rationing Function of Prices
  • When prices cannot adjust non-price rationing occurs
    • Rationing by queues
    • Rationing by lotteries
    • Rationing by coupons
the rationing function of prices36
The Rationing Function of Prices
  • 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
the rationing function of prices37
The Rationing Function of Prices
  • Question
    • If price rationing is the most efficient is it the best way to ration?
the policy of government imposed price controls
The Policy of Government-Imposed Price Controls
  • Price Controls
    • Government-mandated minimum or maximum prices
  • PriceCeiling
    • A legal maximum price
  • PriceFloor
    • A legal minimum price
the policy of government imposed price controls39
The Policy of Government-Imposed Price Controls
  • Price ceiling and black markets
    • Price ceilings may prevent the equilibrium price from being achieved if it is above the ceiling price.
the policy of government imposed price controls40
The Policy of Government-Imposed Price Controls
  • Non-Price Rationing Devices
    • All methods used to ration scarce goods that are price-controlled
  • BlackMarket
    • A market in which price-controlled goods are sold at an illegally high price
black markets

S’

Implicit supply schedule at P1 < Pe

P2

Pe

P1

Shortage

D

Qd

Qe

Qs

Black Markets

Price

Quantity per Unit Time Period

Figure 4-3

example vaccine shortages
Example:Vaccine Shortages
  • Government mandates have resulted in a substantial portion of childhood vaccines being sold at prices below the market price.
  • As a consequence, pharmaceutical companies are cutting back on the production of vaccines.
the policy of controlling rents
The Policy of Controlling Rents
  • 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 rents44
The Policy of Controlling Rents
  • 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.
the policy of controlling rents45
The Policy of Controlling Rents
  • Effects on the existing supply of housing
    • Property owners cannot recover costs
the policy of controlling rents46
The Policy of Controlling Rents
  • Rationing the current use of housing
    • Reduces mobility
      • New York’s “housing gridlock”
the policy of controlling rents47
The Policy of Controlling Rents
  • Attempts at evading rent controls
    • Forcing tenants to leave
    • Tenants subletting apartments
    • Housing courts
the policy of controlling rents48
The Policy of Controlling Rents
  • Who gains and who loses from rent controls?
    • Losers
      • Property owners
      • Low-income individuals
    • Benefits
      • Upper-income professionals
price floors in agriculture
Price Floors in Agriculture
  • Support Price
    • the governmentally established minimum price farmers are to receive for a particular agricultural product.
agricultural price supports

Excess quantity supplied

S

Ps

Pe

E

D

Qs

Qe

Qd

Agricultural Price Supports

Dollars per Unit

Quantity of Peanuts per Time Period

Figure 4-4

price floors in agriculture51
Price Floors in Agriculture
  • Questions
    • How could the government keep the price from falling?
    • Who benefits from agricultural price supports?
policy example agricultural subsidies in the european union
Policy Example:Agricultural Subsidies in the European Union
  • The European Union pays farmers for using environmentally sound agricultural practices.
  • In some cases, the preferred practice may be not to farm at all.
  • In effect, this is a program of agricultural price supports.
price floors in the labor market
Price Floors in the Labor Market
  • Minimum Wage
    • Lowest hourly wage rate that firms may legally pay their workers
the effect of minimum wages

S

A

B

C

Wm

Excess quantity supplied at wage Wm

We

E

Reduction in quantity of labor demanded

Increase in quantity of labor supplied

D

Qs

Qe

Qd

The Effect of Minimum Wages

Wage Rate per Unit

Quantity of Labor per Time Period

Figure 4-5

quantity restrictions
Quantity Restrictions
  • Prohibitions on the ownership or trading of a good
    • Human organs
    • Drugs
    • Hospital beds
quantity restrictions56
Quantity Restrictions
  • Government Prohibitions or 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 in a one-year period
policy example u s textile quotas abound
Policy Example: U.S. Textile Quotas Abound
  • There are legal restrictions on the amount of textiles and the number of apparel products that can be imported into the U.S. each year.
  • These numbers are specific to the country of origin.
issues and applications traffic jams in u s seaports
Issues and Applications:Traffic Jams in U.S. Seaports
  • Demand for dock space has increased due to the increased volume of cruise travel.
  • Fees charged for the use of such space are government regulated. Regulators have been slow to respond.
  • A shortage has arisen because the price remains below the market-clearing level.
summary discussion of learning objectives
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.
summary discussion of learning objectives61
Summary Discussion of Learning Objectives
  • 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.
summary discussion of learning objectives62
Summary Discussion of Learning Objectives
  • 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.
summary discussion of learning objectives63
Summary Discussion of Learning Objectives
  • 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.
summary discussion of learning objectives64
Summary Discussion of Learning Objectives
  • 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.
summary discussion of learning objectives65
Summary Discussion of Learning Objectives
  • Government-imposed restrictions on market quantities
    • Bans on sale or ownership
    • Licensing restrictions
    • Import quotas
end of chapter 4

End of Chapter 4

Extensions of Demandand Supply Analysis