2. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 1 1.0 Demand and Supply Analysis CHAPTER 3 Real World Examples FLU SHOTS Illustrates a market shortage OIL CARTELS Illustrates how supply shifts change transportation costs THE MINIMUM WAGE Illustrates a price floor © Prof. Harmon The table of contents in the left frame : has links to each slide. The slide with the LECTURE OUTLINE lists the main topic s. These topics begin with a whole number (e.g. “2.0” ). The bottom frame : has options to print each slide and to display closed captioning of the audio. The image of the house appears on every slide in the upper left and operates as a hyper link to the slide “LECTURE OUTLINE” Tips for Navigation in the Video Lecture:

3. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 1.1 Flu Shots Each November there never seems to be enough supply. Like HealthCare it’s a shortage problem Republicans and Democrats debate whether there should be government production. We will use Supply and Demand to show a graph of this shortage situation and whether a price floor is a solution 2

4. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 1.2 Oil Cartels Rising oil prices effect the prices of almost everything, and have caused major unemployment problems in the US. Two examples: Transportation costs, US firms have moved furniture making plants abroad close to the raw natural resources of timber forests to reduce shipping costs. US car manufactures are now downsizing to “green” cars and Detroit is shedding jobs. 3

5. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 1.3 Minimum Wage In the market for unskilled labor the minimum wage is a policy solution to the outcome of wages below “living” wage levels. It is controversial because the wage floor (i.e. raising the wage above the equilibrium level) disrupts the market and pits Democrats v Republicans. We will explore the pros and cons of this 4 Return to First Slide

6. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 5 Lecture Outline 1. First Slide of PresentationFirst Slide of Presentation 2. DemandDemand A downward sloping curve 3. SupplySupply A upward sloping curve 4. Market EquilibriumMarket Equilibrium The process of elimination of surplus and shortages, Econ Lab 5. Government InterventionGovernment Intervention Price ceilings and floors, Econ Lab You can continue to the next slide “Definition of Demand Curve”, or select a topic and click the hyperlink.

7. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 2. DEMAND Topics Covered: 2.1 Definition 2.2 Downward Sloping 2.3 Individual & Market Demand 2.4 Move v Shift 2.5 Move 2.6 Shift 2.7 Shift Factors 2.7 Summary Move v Shift Demand is covered in slides 6 to 27, you can click on the subtopics, or simply right mouse click to advance. 6

8. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 7 2.1 Demand Demand indicates how much of a good consumers are both willing and able to buy at each possible price during a given time period, other things constant Emphasis on individual being both willing and able to buy is critical to demand Consumer demand and needs are not the same thing Need focuses on the willingness and again ignores the ability to purchase Need may be a reason society consider income transfers

9. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 8 2.2.a Downward Sloping The law says that: The higher the price, the smaller the quantity demanded The lower the price, the larger the quantity demanded Specifically, why is more demanded when the price is lower? The Substitution Effect The Income Effect

10. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 9 2.2.b Substitution Effect Substitution Effect When the price of a good falls, its new price. which is now cheaper relative to the price of similar goods, makes consumers more willing to purchase this good Alternatively, when the price of a good increases, its new price, which is now more expensive relative to the price of similar goods, makes consumers less willing to purchase this good Remember it is the change in the relative price – the price of one good compared to the prices of other goods – that causes the substitution effect

11. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 10 2.2.c Income Effect Money income is simply the number of dollars received per period of time Real income is person’s income measured in terms of the goods and services it can buy  purchasing power When the price of a good decreases, a person’s real income increases  increased ability to buy a good  increase in quantity demanded When the price of a good increases  real income declines  reduces the ability to buy a good  decline in quantity demanded

12. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 11 2.3.a Demand Schedule & Demand Curve for Pizza (a) Demand Schedule Price per Quantity Demanded Pizza per Week (millions) a) $15 8 b) 12 14 c) 9 20 d) 6 26 e) 3 32 The price is for a 12 inch regular pizza and the time period is 1 week. The demand schedule lists possible prices, along with the quantity demanded at each price. The demand curve at the right shows each price / quantity combination listed in the demand schedule as a point on the demand curve.

13. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 12 2.3.b Individual & Market Demand Individual demand refers to the demand of an individual consumer Market demand is the sum of the individual demands of all consumers in the market Important: the convention is that “demand “ is meant to refer to market demand

14. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 13 2.4 MOVE V SHIFT Change in Quantity Demanded Compared to Change in Demand Change in Quantity Demanded Refers to a move along the demand curve Shifts of the Demand Curve Shifts of the Demand Curve ( change in demand ) Refers to moving the entire demand curve You can click select a topic above, or click here to skip ahead to the summary of this section. here

15. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 14 2.5.a Change in Quantity Demanded: MOVE P r i c e p e r q u a r t 8 14 20 26 32 $15.00 12.00 9.00 6.00 3.00 0 a b c d e D Millions of pizzas per week Demand for pizza is not a specific quantity, but rather the entire relation between price and quantity demanded, and is represented by the entire demand curve An individual point on the demand curve shows the quantity demanded at a particular price For example, at a price of $12, the quantity demanded is 14 million pizzas per week The movement from say, b to c, is a change in quantity demanded and is shown as a movement along the demand curve and can only be caused by a change in price A change in price, other things constant, causes a movement along a demand curve

16. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 15 2.5.b Black Friday: The Super Bowl of Shopping Black Friday, it is the day when thousands of people across America spend hours in line – even camping out -- to get their hands on sharply discounted products, often in the wee hours of the morning. Retailers hope Black Friday sales (and the expanded openings on "Grey Thursday") aren't the equivalent of a Hollywood film that has a strong first weekend and then tanks the next.thousands of people across America spend hours in line During the sale quantity demanded increases After the sale quantity demanded declines Discuss whether this is move along or shift of the demand curve. After Rush, Retailers Try New Shopping Lures By C. TAN, 11/26, 2007 Return to Move V Shift

17. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 16 2.6 Change in Demand: SHIFT The Demand curve shifts when factors other than price, change. Economists also refer to shifts in demand as a “change in demand” Demand can either increase, or decrease as shown in the next 2 slides Return to Move V Shift

18. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 17 2.6.a Shifts (changes) in Market Demand: INCREASE $15 12 9 6 3 Price The original demand curve is given as D, and assumes a certain level of money income. Suppose market demand increases from D to D‘  consumers now are willing to buy more pizza at each price. For example, at a price of $12, the amount of pizza demanded increases from 14 to 20 million per week as shown by the movement from b on demand curve D to point f on demand curve D'. 0 8 14 20 2632 Millions of pizzas per week D b D' f An increase in demand  rightward shift in the demand curve  consumers are willing and able to buy more pizza (by 6 units)at each price. – A change in one of the determinants of demand other than price causes a shift of a demand curve  changing demand

19. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 18 2.6.b Shifts (changes) in Market Demand: DECREASE $15 12 9 6 3 Price The original demand curve is given as D, and assumes a certain level of money income. Suppose market demand decreases from D‘ to D  now consumers are less willing to buy pizza at each price. For example, at a price of $12, the amount of pizza demanded decreases from 20 to 14 million per week as shown by the movement point from f on demand curve D‘ to b on demand curve D. 0 8 14 20 2632 Millions of pizzas per week D b D' f A decrease in demand  leftward shift in the demand curve  consumers are less willing to buy pizza (by 6 units)at each price. – A change in one of the determinants of demand other than price causes a shift of a demand curve  changing demand Return to Shift

20. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 19 2.7 Demand Curve Shift Factors Examples are: 1. Money income of consumersMoney income of consumers Normal Goods Inferior Goods 2. Prices of related goods:Prices of related goods 2a Substitutes, 2b Complements 3. Consumer expectationsConsumer expectations 4. Number and composition of consumers in the marketNumber and composition of consumers in the market 5. Consumer tastesConsumer tastes Click here to Skip ahead to summary of Moves v Shiftshere Return to Shift

21. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 20 2.7.1. Changes in Consumer Income Goods can be classified into two broad categories depending on how the demand for the good responds to changes in money income Normal goods: the demand increases when income increases, and decreases when income decreases Inferior goods: the demand decreases when income increases, and increases when income decreases As income increases, consumers tend to switch from consuming these goods to consuming normal goods McDonald's has been benefitting from the tendency of cash-strapped consumers to "trade down" from more pricey eating-out options in the U.S. WSJ 8/8/2008WSJ 8/8/2008 Return to Shift Factors

22. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 21 2.7.2.a Changes in the Prices of Related Goods The prices of other goods are another of the factors assumed constant along a given demand curve Two general relationships Two goods are substitutes if an increase in the price of one shifts the demand for the other rightward and, conversely, if a decrease in the price of one shifts the demand for the other good leftward Two goods are complements if an increase in the price of one shifts the demand for the other leftward, and conversely, a decrease in the price of one shifts the demand for the other rightward Return to Shift Factors

23. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 22 2.7.2.b.Example of Substitutes Who’s burgers are better?) What about homemade? Return to Shift Factors

24. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 23 2.7.2.c Example of Complements The current run up in the price of gasoline has decreased the demand for the SUV gas guzzlers) “rising prices at the pump are starting to make some Americans think twice before buying a gas- sucking behemoth. Sales of big SUVs took a beating in April” (Business Week May 2004)Business Week May 2004 Return to Shift Factors

25. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 24 2.7.3. Changes in Consumer Expectations A change in consumer expectations with respect to future prices and future incomes is another of the factors which shifts demand: Changes in income expectations If individuals expect income to increase in the future, current demand increases and vice versa Changes in price expectations If individuals expect prices to increase in the future, current demand increases. For example if consumers expect interest rates to rise (as they did on: May 25, 2004) then demand for housing increasesMay 25, 2004 Conversely, it decreases if future prices are expected to decrease Return to Shift Factors

26. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 25 2.7.4. Number or Composition of Consumers Because the market demand curve is the sum of the individual demand curves, a change in the number of consumers changes demand: An increase in the number of consumers  increase in market demand A decrease in the number of consumers  decrease in market demand Demographic changes in the population that consumes pizza, for example, will change the demand for pizza Click Click for News Article McDonald's has been benefitting from new menu items, expanded hours and the tendency of cash-strapped consumers to "trade down" from more pricey eating out options in the U.S. And overseas, it is benefiting from expansion and organic growth in key markets like Australia, China and Japan while getting the currency benefits of the sagging U.S. dollar WSJ 7/23/08WSJ 7/23/08 Return to Shift Factors

27. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 26 2.7.5 Consumer Tastes Sarah Palin's Glasses a Hit Source They're all all the rage and you can thank Sarah Palin for that. The VP nominee's eyeglasses are flying off the shelves all over the country. Yakima's Cascade Eye Center receives several phone calls a week, requesting them. The maker of the glasses is Kazuo Kawasaki and the frame is titanium. Currently the glasses are on back- order right now. Return to Shift Factors

28. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 27 2.8 Summary: shifts v move along Remember the distinction between a movement along a given demand curve and a shift of the demand curve A change in one of the determinants of demand other than price causes a shift of a demand curve  changing demand A change in price, other things constant, causes a movement along a demand curve  changing quantity demanded Return to Shift Factors

29. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 3. SUPPLY Topics Covered: 3.1 Definition 3.2 Upward Sloping 3.3 Individual & Market Supply 3.4 Move 3.5 Shift 3.6 Shift Factors 3.7 Summary Move v Shift Supply is covered in slides 28 to 43, you can click on the subtopics, or simply right mouse click to advance. 28

30. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 29 3.1 Definition of Supply Supply indicates how much of a good producers are willing and able to offer for sale per period at each possible price, other things constant Law of supply states that the quantity supplied is usually directly related to its price, other things constant The lower the price, the smaller the quantity supplied Conversely, the higher the price, the greater the quantity supplied Reasons for Upward Slope Increased Rewards Increased Costs Return to Supply

31. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 30 3.2.a Upward Sloping bec. Higher Rewards Two reasons producers tend to offer more for sale when the price rises First, as the price increases, other things constant, a producer becomes more willing to supply the good Prices act as signals to existing and potential suppliers about the rewards for producing various goods  higher prices attract resources from lower-valued uses

32. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 31 3.2.b Upward Sloping bec. Higher Costs Second, higher prices reflect the producer’s greater cost to supply the good The law of increasing opportunity costs  the marginal cost of production increases as output increases Since producers face a higher marginal cost of production, they must receive a higher price for that output in order to be able to increase the quantity supplied

33. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 32 3.2.c Supply Schedule and Supply Curve for Pizzas 12 16 20 24 28 $15 12 9 6 3 0 S Millions of pizzas per week Both the supply curve and the supply schedule show the quantities of pizza supplied per week at various prices by all the pizza makers in the market. Price Producers offer more for sale at higher prices than at lower prices  the supply curve slopes upward. Price and quantity supplied are directly, or positively related. Supply Schedule Price per Quantity Supplied Pizza per Week (millions) $15 28 12 24 9 20 6 16 3 12 Return to Supply

34. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 33 3.3 Individual Supply and Market Supply Individual supply refers to the supply of an individual producer Market supply is the sum of individual supplies of all producers in the market Unless otherwise noted, we will be referring to market supply Return to Supply

35. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 34 3.4 Change in Quantity Supplied: MOVE 12 16 20 24 28 $15 12 9 6 3 0 S Millions of pizzas per week Price A B C D E Supply of pizza is not a specific quantity, but rather the entire relation between price and quantity supplied, and is represented by the entire supply curve An individual point on the supply curve shows the quantity supplied at a particular price For example, at a price of $9, the quantity supplied is 20 million pizzas per week The movement from say, c to d, is a change in quantity supplied and is shown as a movement along the supply curve and can only be caused by a change in price A change in price, other things constant, causes a movement along a supply curve Return to Supply

36. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 35 3.5.a Shifts of the Supply Curve The Supply curve shifts when factors other than price, change. Economists also refer to shifts in supply as a “change in supply” Click here for “Increase in Supply”hereIncrease in Supply Click here for “Decrease in Supply”here Decrease in Supply Click here to continue ahead to “Shift Factors”hereShift Factors Return to Supply

37. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 36 3.5.b An Increase in the Supply of Pizza $15.00 12.00 9.00 6.00 3.00 0 12 16 20 24 28 Millions of pizzas per week P r i c e p e r q u a r t S g S' h Suppose we begin with the initial supply curve as S. A new high-tech oven bakes pizza in half the time, and the impact of this is that the supply curve shifts from S to S'. The result of the increase in supply is that more is supplied at each possible price. E.g., when the price is $12, the amount supplied increases from 24 million to 28 million pizzas, as shown by the movement from point g to point h. Remember: as with demand, a rightward shift of supply represents an increase in supply Return to Shift

38. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 37 3.5.b Decrease in the Supply of Pizza $15.00 12.00 9.00 6.00 3.00 0 12 16 20 24 28 Millions of pizzas per week P r i c e p e r q u a r t S g S' h Suppose we begin with the initial supply curve as S. A new safety precaution doubles the baking time for a pizza, and the impact of this is that the supply curve shifts to S from S'. The result of the decrease in supply is that less is supplied at each possible price. E.g., when the price is $12, the amount supplied decreases from 28 million to 24 million pizzas, as shown by the movement from point h to point g. Remember: as with demand, a leftward shift of supply represents a decrease in supply Return to Shift

39. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 38 3.6 Supply Curve Shift Factors Examples of shift factors are: 1. State of technologyState of technology 2. Prices of relevant resourcesPrices of relevant resources 3. Producer expectationsProducer expectations 4. Number of producers in the marketNumber of producers in the market Click the topic to view the corresponding slide, or Click here to Skip ahead to summary of Moves v Shiftshere Return to Shift

40. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 39 3.6.1. Changes in Technology If a more efficient technology is discovered, production costs fall  suppliers will be more willing and more able to supply the good  rightward shift of the supply curve Example: Wal-Mart Stores Inc., is eliminating paper payroll checks in the U.S., transferring workers' earnings to a debit card if they decline direct deposit to a bank. A move that it said will save paper and money. It estimates the move will save 257,572 pounds of paper a year. The shift will reduce its payroll costs. (WSJ 9/3/09) Return to shift factors

41. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 40 3.6.2. Changes in the Prices of Relevant Resources Relevant resources are those employed in the production of the good in question For example, pizza if the price of mozzarella cheese falls, the cost of pizza production declines  supply increases  shifts to the right Conversely, if the price of some relevant resource increases  supply decreases  shifts to the left Other examples: Farmers are expected to plant less corn this year (2008) and that could mean higher bills at the grocery store. Hershey again raised wholesale prices (2008), pushing domestic prices up nearly 10%, to offset rising costs for raw materials, fuel and transportation. Return to shift factors

42. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 41 3.6.3 Changes in Producer Expectations Changes in producer expectations about the future can change current supply If pizza suppliers expect higher prices in the future, they may begin to expand today  current supply shifts rightward Conversely, when a good can be easily stored, expecting future prices to be higher may reduce current supply More generally, any change expected to affect future profitability could shift the supply curve Example: Champagne producers agreed to pick 32% fewer grapes this year, leaving billions of grapes to rot on the ground, in a move to counter fizzling bubbly sales around the world amid the economic downturn. WSJ 9/3/09 Return to shift factors

43. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 42 3.6.4. Changes in the Number of Producers Since market supply sums the amounts supplied at each price by all producers, the market supply depends on the number of producers in the market If that number increases, supply increases  shifts to the right If the number of producers decreases, supply will decrease  shift to the left Return to shift factors

44. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 43 3.7 Summary: shifts v move along Remember the distinction between a movement along a given demand curve and a shift of the supply curve A change in one of the determinants of supply other than price causes a shift of a supply curve  changing supply A change in price, other things constant, causes a movement along a supply curve  changing quantity supplied Return to 3. SUPPLY

45. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 4. MARKET EQUILIBRIUM 4.1 The Free Market Dynamic Surplus, Shortage, Stable outcome 4.2 Solo Shifts Shifting one curve holding the other constant, examining the effects on price and quantity 4.3 Simultaneous Shifts Shifting both curves holding the other constant, examining the effects on price and quantity 44

46. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 45 4.1.a Markets A market sorts out the conflicting price perspectives of individual participants – buyers and sellers Market represents all the arrangements used to buy and sell a particular good or service Markets reduce the transaction costs of exchange – the costs of time and information required for exchange The coordination that occurs through markets occurs because of Adam Smith’s invisible hand Surplus, Shortage

47. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 46 4.1.b Surplus Millions of pizzas per week $15.00 12.00 9.00 6.00 3.00 0 c S D Surplus Suppose the initial price is $12  producers supply 24 million pizzas per week as shown by the supply curve while consumers demand only 14 million  excess quantity supplied (or surplus) of 10 million pizzas per week The “invisible hand” goes to work quickly as the suppliers’ desire to eliminate the surplus puts downward pressure on the price, as symbolized by the arrow pointing down in the graph As the price falls, producers reduce their quantity supplied and consumers increase their quantity demanded and the market moves towards equilibrium at point c 162024 Price

48. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 47 4.1.c Shortage Millions of pizzas per week $15.00 12.00 9.00 6.00 3.00 0 c S D Shortage Alternatively, suppose the price is initially $6 per pizza. At this price consumers demand 26 million pizzas but producers supply only 16 million  an excess quantity demanded (or a shortage) of 10 million pizzas per week. The “invisible hand” quickly works as producers notice that the quantity supplied has sold out and those customers still demanding pizzas are grumbling  pressures for higher prices as shown by the arrow As prices increase, producers increase their quantity supplied and consumers reduce their quantity demanded until the equilibrium price of $9 at point c is reached 162026 Price

49. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 48 4.1.d The Invisible Hand at Work A surplus creates downward pressure on the price and a shortage creates upward pressure At a specific price, so long as quantity supplied and quantity demanded differ, prices will tend to change Note that a shortage or a surplus must always be defined at a particular price

50. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 49 4.1.e Stable Outcome When the quantity that consumers are willing and able to pay equals the quantity that producers are willing and able to sell, the market reaches equilibrium  the independent plans of both buyers and sellers exactly match  market forces exert no pressure to change price or quantity In a diagram this occurs at the point where the supply and demand curves intersect. In other words at the middle of the “X” Return to 4. EQUILIBRIUM

51. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 50 4.2.a Solo Shifts Once a market reaches equilibrium, that price and quantity will prevail until one of the determinants of demand or supply changes A change in any one of these determinants will usually change equilibrium price and quantity in a predictable way We will now look at solo shifts, that is shifting one curve and leaving the other constant: Demand Shift Supply Shift Return to 4. EQUILIBRIUM

52. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 51 20 Millions of pizzas per week 9 0 D S $12 D' 2430 The initial equilibrium price is given by D and S  $9 and 20 million pizzas per week. Now suppose that one of the determinants of demand changes in a way that increases demand  demand shifts from D to D'. After demand increases to D', the amount demanded at the initial price of $9 is 30 million pizzas which exceeds the amount supplied of 20 million pizzas  shortage  upward pressure on price. As the price increases, the quantity demanded decreases along the new demand curve, D', and the quantity supplied increases along the existing supply curve S until the two quantities are again equal to each other at a price of $12 and a quantity of 24 million pizzas per week. Price 4.2.b Solo Shift in Demand

53. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 52 4.2.c Summary Thus, given an upward-sloping demand curve, an increase in demand  a rightward shift of the demand curve increases both the equilibrium price and quantity Alternatively, a decrease in demand  a leftward shift of the demand curve reduces both the equilibrium price and quantity

54. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 53 Again, suppose that we begin with S and D as the initial supply and demand curves  the amount demanded at the initial price of $9.00 is 20 million pizzas. Suppose supply now increases as shown by the shift from S to S'. After supply increases, the amount supplied at the initial price of $9 increases from 20 to 30 million pizzas per week  a surplus  downward pressure on the price  the quantity supplied declines along the new supply curve and the quantity demanded increases along the existing demand curve until the new equilibrium is reached at $6 and the quantity is 26 million pizzas per week D S $9 20 S' 26 6 30 Price Millions of Pizzas per Week 4.2.d Solo Shift in Supply

55. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 54 4.2.e Summary An increase in supply  a rightward shift of the supply curve reduces the equilibrium price but increases equilibrium quantity On the other hand, a decrease in supply  a leftward shift of the supply curve increases equilibrium price but decreases equilibrium quantity Return to Solo Shifts

56. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 55 4.3.a Simultaneous Shifts As long as only one curve shifts, we can say for sure what will happen to equilibrium price and quantity If both curves shift, however, the outcome is less obvious The possibilities are shown in the next Exhibit Return to 4. EQUILIBRIUM

57. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 56 Supply increases Supply decreases Demand increasesDemand decreases Change in Demand C h a n g e i n S u p p l y Equilibrium price change is indeterminate. Equilibrium quantity increases. Equilibrium price rises. Equilibrium quantity change is indeterminate. Equilibrium price falls. Equilibrium quantity change is indeterminate. Equilibrium price change is indeterminate. Equilibrium quantity decreases. 4.3.b Effects of Changes in Both Supply and Demand

58. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 57 4.3.c Summary: Shift in same direction If demand and supply shift in the same directions, we can say what will happen to equilibrium quantity It will increase if demand increases and supply increases It will decrease if demand decreases and supply decreases Without reference to the size of the shifts, we cannot say what will happen to equilibrium price

59. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 58 4.3.d Summary: Shift in opposite directions If demand and supply shift in opposite directions, we can say what will happen to equilibrium price It will increase if demand increases and supply decreases It will decrease if demand decreases and supply increases Without reference to the size of the shifts, we cannot say what will happen to equilibrium quantity

60. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 59 p 0 Units per period S D p' Q' S' D' Q The initial supply and demand curves are shown as D and S  p and Q are the initial price and quantity. Suppose that supply and demand both increase  shift to the right. For a determinate effect on Price, further suppose that demand shifts more than supply as shown by D' and S'. In this instance, price and quantity both increase to p' and Q'. Conversely, if both demand and supply were to decrease – for example, from D‘ S‘ to D / S, the equilibrium quantity would decrease and the effect on price would be indeterminate, unless a further assumption is made about which shift dominates. a) Assume: Shift in demand dominates 4.3.e Illustration of Increase in Both Supply and Demand: Indeterminate Effect on Price, Increase in Quantity

61. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 60 p Units per period D S 0 p" Q" D" S" Q Price Alternatively, if both supply and demand decrease with the shift in supply dominating  price will increase and quantity will decrease. Again, suppose both supply and demand increase but in this case, supply shifts by more than demand  price decreases from p to p"and quantity increases. Assume: Shift in supply dominates 4.3.f Illustration of Increase in Both Supply and Demand: Indeterminate Effect on Price, Increase in Quantity

62. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 61 4.3.g Flash Module: Illustrate Simultaneous Shifts D&S Shift: Opposite: P Det. Q Indet. Same: P Indet. Q Det. Back Return to 4. EQUILIBRIUM

63. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 62 5. GOVERNMENT INTERVENTION From time to time, in Capitalist Economies, the People determine that market outcomes are unfair. Two famous examples in our economy are: The market price received by the American Farmer for his/her product is too low. To compensate the Government intervenes and sets a price floor (a minimum price) on agricultural produce. Following WW II, the returning GI faced a situation of a shortage of rental units in urban areas and unaffordable prices. To alleviate the situation the Government intervened and set a price ceiling (a maximum price) for rental units in large cities. In the next 4 slides we analyze the government budget obligation entailed by these commitments. 5.1 Price Floor 5.2 Price Ceiling 5.3 Summary 5.4 Flash ModulePrice FloorPrice CeilingSummaryFlash Module

64. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 63 $2.50 14 19 24 S D Millions of gallons per month Surplus 0 The federal government often regulates the prices of agricultural commodities in an attempt to ensure farmers a higher and more stable income than they would otherwise earn. To achieve higher prices, the federal government sets a price floor  a minimum selling price that is above the equilibrium price Suppose it places a $2.50 per gallon price floor for milk. At this price, farmers supply 24 million gallons per week, but consumers demand only 14 million gallons  a surplus of 10 million gallons This surplus milk will spoil if it sets on store shelves. As a result of this price support program, the government spends billions of dollars buying and storing surplus agricultural products. (Cost = Green and Blue rectangles) Price per gallon $1.90 5.1 Effects of a Price Floor Reduction in Private Market Sales Private Market Sales Price times Increase in Quantity Supplied

65. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 64 $200 $100 40 50 60 D S Thousands of rental units per month 0 Shortage Prices can be kept below the equilibrium levels by establishing a price ceiling, or a maximum selling price, which is below the equilibrium price A common example is rent control in large cities following WW II. Suppose the market-clearing rent is $200 per month with 50,000 rented apartments. Now suppose the government sets a maximum rent of $100. At this ceiling price, 60,000 rental units are demanded, but only 40,000 are supplied (a shortage). Monthly rent 5.2 Effects of a Price Ceiling Decrease in Rent Roll from Private Market Rent Roll from Private Market Rent times Increase in Quantity Demanded To resolve the shortage the Government can construct public housing or subsidizing private construction. (Cost = Green and Blue rectangles). Also it can impose guidelines for the “fair” allocation of the apartments on the private market (Yellow rectangle).

66. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 65 5.3 Summary: Floors & Ceilings To have an impact, a price floor must be set above the equilibrium price and a price ceiling must be set below the equilibrium price The intent of the price ceiling is to make the item more affordable to consumers, the intent of the price floor is to make the item more profitable for producers. However, the effect of price floors and ceilings is to distort markets in that they create a surplus and a shortage, respectively In these situations, the Government can assume a budget obligation to purchase the resulting surplus or produce enough to eliminate the resulting shortage.

67. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 66 5.4 Flash Module: Illustrate Price Controls D&S Shift: Opposite: P Indet. Q Det. Same: P Det. Q Indet. Back

68. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 67 END OF PRESENTATION Clic a pic for review

69. Begin 2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd 68 Begin2 Demand 4 Market Equilibrium5 Government Intervention 3 SupplyEnd