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Using Supply and Demand 5 It is by invisible hands that we are bent and tortured worst. — Nietzsche CHAPTER 5 Copyright © 2010 by the McGraw-Hill Companies,

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Presentation on theme: "Using Supply and Demand 5 It is by invisible hands that we are bent and tortured worst. — Nietzsche CHAPTER 5 Copyright © 2010 by the McGraw-Hill Companies,"— Presentation transcript:

1 Using Supply and Demand 5 It is by invisible hands that we are bent and tortured worst. — Nietzsche CHAPTER 5 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2 Using Supply and Demand 5 Chapter Goals Explain real-world events using supply and demand Explain the effects of excise taxes and tariffs Discuss how exchange rates are determined Explain the effect of a third-party-payer system Demonstrate the effect of a price ceiling and price floor 5-2

3 Using Supply and Demand 5 Application: Bananas in Australia D0D0 Q The cyclone damage caused the supply curve to shift left Cyclone Larry destroyed 80% of the banana crop S1S1 Price rose from $1 to $2 where quantity demanded = quantity supplied Q1Q1 $2 S0S0 P $1 Q0Q0 Bananas Excess demand 5-3

4 Using Supply and Demand 5 Application: Sales of SUVs in the U.S. P0P0 Q1Q1 P1P1 Increasing gas costs causes the demand curve to shift left Gasoline in the U.S. is increasingly expensive Price for SUVs fell from P 0 to P 1 where Q demanded = Q supplied S0S0 D0D0 P Q Q0Q0 SUVs Excess supply D1D1 5-4

5 Using Supply and Demand 5 Application: Edible Oils in the World S0S0 D0D0 P Q Growing middle class in Asia has increased demand for oils S1S1 At the same time, U.S. farmers are growing more corn and less soy (less soy oil) Edible Oils P0P0 P1P1 D1D1 The result is increased prices for edible oils 5-5

6 Using Supply and Demand 5 The Price of a Foreign Currency The market for foreign currencies is called the foreign exchange (forex) market Exchange rates are determined by supply and demand The exchange rate is the price of one currency in terms of another one People demand foreign currencies to buy those countries’ goods and assets 5-6

7 Using Supply and Demand 5 Examples of U.S. dollar foreign-exchange rates Country currencyIn US$Per US$ US$ vs. YTD change (%) Mexico peso China yuan United Kingdom pound Poland zloty Israel shekel Kuwait dinar

8 Using Supply and Demand 5 Application: The Market for Euros The 16 members of the European Union use a common currency, the euro 1. U.S. interest rates decreased and Europeans bought fewer U.S. financial assets, so the supply of euros decreased The value of a euro was $0.85 in 2001 By the early 2000s the euro had risen to $1.50 because: 2. Americans increased their demand for euros in order to buy European financial assets 5-8

9 Using Supply and Demand 5 Application: The Market for Euros S0S0 D0D0 P Q Euros The quantity of euros is on the horizontal axis The price is in terms of dollars, how many dollars it takes to buy or sell one euro The supply of euros represents people who want to sell euros and buy dollars The demand for euros represents people who want to buy euros and sell dollars 5-9

10 Using Supply and Demand 5 S0S0 D1D1 P Q $0.85 Euros Application: The Market for Euros Europeans buy fewer U.S. financial assets and supply decreases Americans buy more European financial assets and demand increases $1.30 S1S1 D0D0 The price of euros increases to $

11 Using Supply and Demand 5 A Review of Changes in Supply and Demand No change in Supply Supply shifts outSupply shifts in No change in Demand No Change Price falls, Quantity rises Price rises, Quantity falls Demand shifts out Price rises, Quantity rises Quantity rises, Price could rise or fall Price rises, Quantity could rise or fall Demand shifts in Price falls, Quantity falls Price falls, Quantity could rise or fall Quantity falls, Price could rise or fall 5-11

12 Using Supply and Demand 5 Government Intervention in the Market Price ceilings and price floors Third-party-payer markets Excise taxes Quantity restrictions The invisible hand is not the only factor in determining prices, social and political forces also determine price Other factors include: 5-12

13 Using Supply and Demand 5 Price Ceiling When a government wants to hold prices down to favor buyers, it imposes a price ceiling A price ceiling is a government-imposed limit on how high a price can be charged With price ceilings, existing goods are no longer rationed entirely by price so other methods of rationing arise Price ceilings create shortages Price ceilings below equilibrium price will have an effect on the market 5-13

14 Using Supply and Demand 5 S0S0 D0D0 P (rent) Q (housing) $17 $2.50 QDQD QSQS Shortage Housing The rent controls caused a housing shortage After WWII, rent controls (a form of price ceiling) were put in place There would not be a shortage if rents had been allowed to increase to the equilibrium price of $17 Application: Rent Controls in Paris 5-14

15 Using Supply and Demand 5 Price Floor When a government wants to prevent a price from falling below a certain level to favor suppliers, it imposes a price floor A price floor is a government-imposed limit on how low a price can be charged Price floors above equilibrium price will have an effect on the market Price floors create excess supply 5-15

16 Using Supply and Demand 5 S0S0 D0D0 P (wage) Q (of workers) W0W0 W min QDQD QSQS Excess supply = unemployment Labor Minimum wages cause unemployment A minimum wage is a type of price floor, it is the lowest wage a firm can legally pay an employee Application: A Minimum Wage 5-16

17 Using Supply and Demand 5 Excise Taxes An excise tax is a tax that is levied on a specific good A tariff is an excise tax on an imported good The result of taxes and tariffs is an increase in equilibrium prices and reduce equilibrium quantities Government impacts markets through taxation 5-17

18 Using Supply and Demand 5 Application: The Effect of an Excise Tax S0S0 D0D0 P Q $65, The supply curve shifts up by the amount of the tax Government imposes a $10,000 luxury tax on the suppliers of boats S1S1 The price of boats rises by less than the tax to $70,000 Tax = $10,000 Luxury Boats $60,000 $70,

19 Using Supply and Demand 5 Quantity Restrictions Government regulates markets with licenses, which limit entry into a market Many professions require licenses, such as doctors, financial planners, cosmetologists, electricians, or taxi cab drivers The results of limited number of licenses in a market are increases in wages and an increases in the price of obtaining the license 5-19

20 Using Supply and Demand 5 Application: The Effect of a Quantity Restriction QRQR D0D0 12,000 When the demand for taxi services increased, because the number of taxi licenses was limited, wages increased Successful lobbying by taxi cab drivers in NYC resulted in quantity restrictions (medallions) NYC Taxi Drivers $15 P (wage) Q (of drivers) D1D1 5-20

21 Using Supply and Demand 5 Application: The Effect of a Quantity Restriction QRQR D0D0 12,000 The demand for taxi medallions also increased because wages were increasing. But because the number of taxi licenses was limited, the price of a medallion also increased NYC Taxis Medallions $400,000 P Q (of medallions) D1D1 Initial Fee 5-21

22 Using Supply and Demand 5 Third-Party-Payer Markets In third-party-payer markets, the person who receives the good differs from the person paying for the good Equilibrium quantity and total spending can be much higher in third-party-payer markets Under a third-party-payer system, the person who chooses how much to purchase doesn’t pay the entire cost Goods from a third-party-payer system will be rationed through social and political means 5-22

23 Using Supply and Demand 5 Application: Third-Party-Payer Markets D0D0 10 Health Care $25 P Q $45 $5 S0S0 18 The consumer pays the entire cost Total expenditures for 18 units of health care With a copayment of $5, consumers demand 18 units Sellers require $45 per unit for that quantity …are greater than when… 5-23

24 Using Supply and Demand 5 Chapter Summary You can describe almost all events in terms of supply and demand Price floors, government-imposed limits on how low a price can be charged, create surpluses The determination of foreign exchange rates can be analyzed with the supply and demand model Price ceilings, government imposed limits on how high a price can be charged, create shortages 5-24

25 Using Supply and Demand 5 Chapter Summary Taxes and tariffs paid by suppliers shift the supply curve up by the amount of the tax or tariff and increase equilibrium price and decrease quantity Price floors, government-imposed limits on how low a price can be charged, create surpluses Price ceilings, government-imposed limits on how high a price can be charged, create shortages 5-25

26 Using Supply and Demand 5 Differentiate traditional economic building blocks from behavioral economic building blocks Distinguish an empirical model from a formal model and explain the advantages of each Explain what heuristic models are and how traditional and behavioral heuristic economic models differ List three types of formal models used by modern economists Discuss how modern economics and traditional economics differ in their policy prescriptions Preview of Chapter 6: Thinking Like a Modern Economist 5-26


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