1. Economics Today Chapter 4 Extensions of Demand and Supply Analysis
Roger LeRoy Miller
Economics Today
Chapter 4
Extensions of Demand and Supply Analysis

2. Introduction
Young athletes and computer science students are leaving college before graduation to take very high-paying jobs. Are they grabbing near-term gains at the expense of lower future earnings?

3. 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

4. Learning Objectives Explain the effects of price ceilings
Explain the effects of price floors
Describe various types of government- imposed quantity restrictions on markets

5. Chapter Outline The Price System Exchange and Markets
Changes in Demand and Supply
Price Flexibility and Adjustment Speed
The Rationing Function of Prices

6. 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

7. Did You Know That...
According to the U.S. Customs Service, the second most serious smuggling problem along the Mexican border involves the refrigerant freon?
When an older U.S. air conditioner needs fixing, it is often cheaper to pay a relatively high price for illegally smuggled freon than to modify the unit?

8. 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

9. Exchange and Markets Markets Emphasize voluntary exchange
Determine the terms of exchange
Facilitate exchange

10. Exchange and Markets Voluntary Exchange Terms of 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

11. Exchange and Markets Transaction Cost
The costs associated with exchange
Examples
Price shopping
Determining quality
Determining reliability
Service availability
Cost of contracting

12. 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

13. Exchange and Markets Observation Question
Middle men flourish on the Internet
Question
Since anyone connected to the Internet can find the same information as an Internet middleman, or a shopbot, why would someone pay for the services of an Internet middleman?

14. Changes in Demand and Supply
Changes in supply and demand create a disequilibrium
The market price and quantity adjusts to a new equilibrium

15. The Upside of the Yo-Yo Cycle
Observations
Yo-yo’s are very popular again.
Yo-yo manufacturers cannot keep up with the demand at current prices.
There is a shortage of yo-yo’s.
Question
What is likely to happen to yo-yo prices?

16. Responses to a Shift in Yo-Yo Demand
Figure 4-2

17. Shifts in Demand and Supply: Determinate Results
Increase Demand with Supply Constant S D1 P1 Q1 E1

18. Shifts in Demand and Supply: Determinate Results
Increase Demand with Supply Constant D2 Q3 S E1
At price P1 quantity
demanded exceeds
quantity supplied—
a shortage exists P1 D1 Q1

19. Shifts in Demand and Supply: Determinate Results
Increase Demand with Supply Constant S Q2 E2
Equilibrium price and quantity increase to P2 and Q2 P2 E1 P1 D1 D2 Q1

20. Shifts in Demand and Supply: Determinate Results
Decrease Demand with Supply Constant D1 S E1 Q1 P1 D2
At price P1 quantity
supplied exceeds
quantity demanded—
a surplus exists. Q2

21. Shifts in Demand and Supply: Determinate Results
Decrease Demand with Supply Constant S E1
Equilibrium price
and quantity decrease to P3 and Q3 P1 P3 Q3 E3 D1 D2 Q1

22. Shifts in Demand and Supply: Determinate Results
Increase Supply with Demand Constant S1 D P1 Q1 E1

23. 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

24. Shifts in Demand and Supply: Determinate Results
Increase Supply with Demand Constant S1
Equilibrium price decreases and quantity increases to P2 and Q2 S2 E1 P1 P2 Q2 E2 D Q1

25. Shifts in Demand and Supply: Determinate Results
Decrease Supply with Demand Constant Q2 S3
At price P1 quantity
demanded exceeds
quantity supplied—
a shortage exists S1 D E1 Q1 P1

26. Shifts in Demand and Supply: Determinate Results
Decrease Supply with Demand Constant S3
Equilibrium price decreases and quantity increases to P3 and Q3 Q3 E3 S1 P3 E1 P1 D Q1

27. Changes in Demand and Supply
Summary
Increases in demand increase equilibrium price and quantity.
Decreases in demand decrease equilibrium price and quantity.

28. 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.

29. 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 shift
Either equilibrium price or quantity will be indeterminate

30. Shifts in Demand and Supply: Shortage
Increase Demand > Increase Supply D2 S1 S2 D1 P1 Q1 E1

31. Shifts in Demand and Supply: Shortage
Increase Demand > Increase Supply S1 S2
At price P1 quantity
demanded exceeds
quantity supplied—
a shortage exists E1 P1 D1 D2 Q1 Qs Qd

32. Shifts in Demand and Supply: Shortage
Increase Demand > Increase Supply S1 S2
Equilibrium price increases and quantity decreases to P2 and Q2 P2 E1 Q2 E2 P1 D1 D2 Q1

33. Shifts in Demand and Supply: Shortage
Decrease Demand < Decrease Supply S2 S1 D1 D2 Qd Qs
At price P1 quantity
demanded exceeds
quantity supplied—
a shortage exists P1 Q1 E1

34. Shifts in Demand and Supply: Shortage
Decrease Demand < Decrease Supply S2 S1
Equilibrium price increases and quantity decreases to P2 and Q2 P2 Q2 E2 E1 P1 D2 D1 Q1

35. Shifts in Demand and Supply: Shortage
Increase Demand > Decrease Supply S2 S1 D2 D1 P1 Q1 E1

36. Shifts in Demand and Supply: Shortage
Increase in Demand > Decrease in Supply S2 S1
At price P1 quantity
demanded exceeds
quantity supplied—
a shortage exists E1 P1 D1 D2 Qs Q1 Qd

37. Shifts in Demand and Supply: Shortage
Increase Demand > Decrease in Supply S2 S1 Q2 E2 P2
Equilibrium price increases and quantity decreases to P2 and Q2 E1 P1 D1 D2 Q1

38. Shifts in Demand and Supply: Shortage
Increase Demand < Decrease in Supply S2 S1 D1 D2 P1 Q1 E1

39. Shifts in Demand and Supply: Shortage
Increase Demand < Decrease in Supply S2 S1
At price P1 quantity
demanded exceeds
quantity supplied—
a shortage exists E1 P1 D1 D2 Qs Q1 Qd

40. Shifts in Demand and Supply: Shortage
Increase Demand < Decrease in Supply S2 S1 Q2 E2 P2
Equilibrium price increases and quantity decreases to P2 and Q2 E1 P1 D1 D2 Q1

41. Shifts in Demand and Supply: Surplus
Increase Supply > Increase in Demand S1 S2 D1 D2 P1 Q1 E1

42. Shifts in Demand and Supply: Surplus
Increase Supply > Increase in Demand S1 S2 E1 P1
At price P1 quantity
supplied exceeds
quantity demanded—
a surplus exists D1 D2 Q1 Qd Qs

43. Shifts in Demand and Supply: Surplus
Increase Supply > Increase in Demand S1 S2 E1 P1 Q2 E2
Equilibrium price decreases and quantity increases to P2 and Q2 P2 D1 D2 Q1

44. Shifts in Demand and Supply: Surplus
Decrease Demand > Decrease in Supply S2 S1 D1 D2 Q1 E1 P1

45. Shifts in Demand and Supply: Surplus
Decrease Demand > Decrease in Supply S2 S1
At price P1 quantity
supplied exceeds
quantity demanded—
a surplus exists E1 P1 D1 D2 Qd Qs Q1

46. Shifts in Demand and Supply: Surplus
Decrease Demand > Decrease in Supply S2 S1
Equilibrium price decreases and quantity decreases to P2 and Q2 E1 P1 E2 Qd P2 D1 D2 Q1

47. Shifts in Demand and Supply: Surplus
Increase Supply > Decrease in Demand S1 D1 S2 D2 Q1 E1 P1

48. Shifts in Demand and Supply: Surplus
Increase Supply > Decrease in Demand S1 S2 E1 P1
At price P1 quantity
supplied exceeds
quantity demanded—
a surplus exists D1 D2 Qd Q1 Qs

49. Shifts in Demand and Supply: Surplus
Increase Supply > Decrease in Demand S1 S2 E1 P1 P2
Equilibrium price decreases and quantity decreases to P2 and Q2 Q2 E2 D1 D2 Q1

50. Shifts in Demand and Supply: Surplus
Increase Supply < Decrease in Demand D1 S1 S2 D2 Q1 E1 P1

51. Shifts in Demand and Supply: Surplus
Increase Supply < Decrease in Demand S1 S2 E1
At price P1 quantity
supplied exceeds
quantity demanded—
a surplus exists P1 D2 D1 Qd Q1 Qs

52. Shifts in Demand and Supply: Surplus
Increase Supply < Decrease in Demand S1 S2 E1 P1
Equilibrium price decreases and quantity decreases to P2 and Q2 P2 Q2 E2 D2 D1 Q1

53. 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
Quantity will decrease

54. 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

55. Price Flexibility and Adjustment Speed
Flexibility and indirect adjustment
Quality
Service
Rebates

56. Price Flexibility and Adjustment Speed
Market characteristics influence adjustment speed
Markets may overshoot in the adjustment process

57. The Rationing Function of Prices
When surpluses and shortages exist price adjusts to clear the market.
This adjustment is the rationing function of price.

58. The Rationing Function of Prices
When prices cannot adjust non-price rationing occurs
Rationing by queues
Rationing by lotteries
Rationing by coupons

59. 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

60. The Rationing Function of Prices
Question
If price rationing is the most efficient is it the best way to ration?

61. The Policy of Government-Imposed Price Controls
Government-mandated minimum or maximum prices
Price Ceiling
A legal maximum price
Price Floor
A legal minimum price

62. 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.

63. The Policy of Government-Imposed Price Controls
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

64. Black Markets
Figure 4-3

65. 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

66. 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.

67. The Policy of Controlling Rents
Effects on the existing supply of housing
Property owners cannot recover costs

68. The Policy of Controlling Rents
Rationing the current use of housing
Reduces mobility
New York’s “housing gridlock”

69. The Policy of Controlling Rents
Attempts at evading rent controls
Forcing tenants to leave
Tenants subletting apartments
Housing courts

70. The Policy of Controlling Rents
Who gains and who loses from rent controls?
Losers
Property owners
Low-income individuals
Benefits
Upper-income professionals

71. Price Floors in Agriculture
Support Price
the governmentally established minimum price farmers are to receive for a particular agricultural product.

72. Agricultural Price Supports
Figure 4-4

73. Price Floors in Agriculture
Questions
How could the government keep the price from falling?
Who benefits from agricultural price supports?

74. Price Floors in the Labor Market
Minimum Wage
Lowest hourly wage rate that firms may legally pay their workers

75. The Effect of Minimum Wages
Figure 4-5

76. Quantity Restrictions
Prohibitions on the ownership or trading of a good
Human organs
Drugs
Hospital beds

77. Quantity Restrictions
Import Quota
Supply restriction that prohibits the importation of more than a specified quantity of a particular good in a one-year period

78. Quantity Restrictions
Policy example
Should the legal quantity of cigarettes supplied be set at zero?
1603—Japan prohibited the “evil weed”
17th century—Bans on tobacco existed in Bavaria, Saxony, Zurich, Turkey, and Russia
Why not ban tobacco in the United States?

79. Issues and Applications: Computer Science Students, Like Everyone Else, Respond to Incentives
Despite increasing enrollments, fewer computer science students are finishing their degrees.
Rising Salaries for IT specialists attract students before they finish their degrees.
Question
What is likely to happen to wages for IT specialists over time?

80. The Market for Computer Science Specialists
Figure 4-6, Panel (a)

81. The Market for Computer Science Specialists
Figure 4-6, Panel (b)

82. Web Links
The following Web link appears in the margin of this chapter in the textbook:

83. 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.

84. 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.

85. 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, indeterminate results occur.

86. 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.

87. 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.

88. Summary Discussion of Learning Objectives
Government-imposed restrictions on market quantities
Bans on sale or ownership
Licensing restrictions
Import quotas

89. Shifts in Demand and in Supply: Determinate Results
Figure 4-1

90. End of Chapter
Chapter 4
Extensions of Demand and Supply Analysis