1. Chapter 4 Extensions of Demand and Supply Analysis

2. Slide 4-2 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?

3. Slide 4-3 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. Slide 4-4 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. Slide 4-5 The Price System Exchange and Markets Changes in Demand and Supply Price Flexibility and Adjustment Speed The Rationing Function of Prices Chapter Outline

6. Slide 4-6 The Policy of Government-Imposed Price Controls The Policy of Government-Imposed Price Controls The Policy of Controlling Rents Price Floors in Agriculture Price Floors in the Labor Market Quantity Restrictions Chapter Outline

7. Slide 4-7 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?

8. Slide 4-8 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. Slide 4-9 Exchange and Markets Markets –Emphasize voluntary exchange –Determine the terms of exchange –Facilitate exchange

10. Slide 4-10 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

11. Slide 4-11 Exchange and Markets Transaction Cost –The costs associated with exchange –Examples Price shopping Determining quality Determining reliability Service availability Cost of contracting

12. Slide 4-12 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. Slide 4-13 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?

14. Slide 4-14 Changes in Demand and Supply Changes in supply and demand create a disequilibrium The market price and quantity adjust to a new equilibrium

15. Slide 4-15 Shifts in Demand and Supply: Determinate Results Increase Demand with Supply Constant D1D1 S P1P1 Q1Q1 E1E1 Figure 4-1

16. Slide 4-16 At price P 1 quantity demanded exceeds quantity supplied— a shortage exists Shifts in Demand and Supply: Determinate Results Increase Demand with Supply Constant D1D1 S P1P1 Q1Q1 E1E1 Q2Q2 D2D2 Figure 4-1

17. Slide 4-17 Shifts in Demand and Supply: Determinate Results Increase Demand with Supply Constant P1P1 Q1Q1 S E1E1 D2D2 Equilibrium price and quantity increase to P 2 and Q 2 E2E2 Q2Q2 P2P2 D1D1 Figure 4-1

18. Slide 4-18 At price P 1 quantity supplied exceeds quantity demanded— a surplus exists. Q2Q2 D2D2 S Shifts in Demand and Supply: Determinate Results Decrease Demand with Supply Constant D1D1 E1E1 Q1Q1 P1P1 Figure 4-1

19. Slide 4-19 Shifts in Demand and Supply: Determinate Results Decrease Demand with Supply Constant P1P1 Q1Q1 S E1E1 D3D3 Equilibrium price and quantity decrease to P 3 and Q 3 D1D1 Q3Q3 E3E3 P3P3 Figure 4-1

20. Slide 4-20 S1S1 Shifts in Demand and Supply: Determinate Results Increase Supply with Demand Constant D P1P1 Q1Q1 E1E1 Figure 4-1

21. Slide 4-21 At price P 1 quantity supplied exceeds quantity demanded— a surplus exists Shifts in Demand and Supply: Determinate Results Increase Supply with Demand Constant P1P1 Q1Q1 E1E1 D Q3Q3 S2S2 S1S1 Figure 4-1

22. Slide 4-22 Shifts in Demand and Supply: Determinate Results Increase Supply with Demand Constant P1P1 Q1Q1 E1E1 D Q2Q2 P2P2 E2E2 S2S2 S1S1 Equilibrium price decreases and quantity increases to P 2 and Q 2 Figure 4-1

23. Slide 4-23 At price P 1 quantity demanded exceeds quantity supplied— a shortage exists Shifts in Demand and Supply: Determinate Results Decrease Supply with Demand Constant D S1S1 E1E1 Q1Q1 P1P1 Q2Q2 S3S3 Figure 4-1

24. Slide 4-24 Shifts in Demand and Supply: Determinate Results Decrease Supply with Demand Constant P1P1 Q1Q1 E1E1 D S3S3 S1S1 Equilibrium price decreases and quantity increases to P 3 and Q 3 Q3Q3 P3P3 E3E3 Figure 4-1

25. Slide 4-25 Changes in Demand and Supply Summary –Increases in demand increase equilibrium price and quantity. –Decreases in demand decrease equilibrium price and quantity.

26. Slide 4-26 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.

27. Slide 4-27 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

28. Slide 4-28 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

29. Slide 4-29 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

30. Slide 4-30 Price Flexibility and Adjustment Speed Flexibility and indirect adjustment –Quality –Service –Rebates

31. Slide 4-31 Price Flexibility and Adjustment Speed Adjustment speed –Market characteristics influence adjustment speed –Markets may overshoot in the adjustment process

32. Slide 4-32 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.

33. Slide 4-33 Example: Why Plywood Prices Have Soared Figure 4-2

34. Slide 4-34 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.

35. Slide 4-35 The Rationing Function of Prices When prices cannot adjust non-price rationing occurs –Rationing by queues –Rationing by lotteries –Rationing by coupons

36. Slide 4-36 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

37. Slide 4-37 The Rationing Function of Prices Question –If price rationing is the most efficient is it the best way to ration?

38. Slide 4-38 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

39. Slide 4-39 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.

40. Slide 4-40 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

41. Slide 4-41 Black Markets Figure 4-3 D QeQe PePe QsQs P1P1 P2P2 QdQd S’S’ Implicit supply schedule at P 1 < P e Shortage Price Quantity per Unit Time Period

42. Slide 4-42 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.

43. Slide 4-43 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 Rents

44. Slide 4-44 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 Rents

45. Slide 4-45 Effects on the existing supply of housing –Property owners cannot recover costs The Policy of Controlling Rents

46. Slide 4-46 Rationing the current use of housing –Reduces mobility New York’s “housing gridlock” The Policy of Controlling Rents

47. Slide 4-47 Attempts at evading rent controls –Forcing tenants to leave –Tenants subletting apartments –Housing courts The Policy of Controlling Rents

48. Slide 4-48 Who gains and who loses from rent controls? –Losers Property owners Low-income individuals –Benefits Upper-income professionals The Policy of Controlling Rents

49. Slide 4-49 Price Floors in Agriculture Support Price –the governmentally established minimum price farmers are to receive for a particular agricultural product.

50. Slide 4-50 Agricultural Price Supports Figure 4-4 D PePe QeQe QdQd PsPs QsQs Excess quantity supplied Dollars per Unit Quantity of Peanuts per Time Period S E

51. Slide 4-51 Price Floors in Agriculture Questions –How could the government keep the price from falling? –Who benefits from agricultural price supports?

52. Slide 4-52 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.

53. Slide 4-53 Price Floors in the Labor Market Minimum Wage –Lowest hourly wage rate that firms may legally pay their workers

54. Slide 4-54 The Effect of Minimum Wages Figure 4-5 D WeWe QeQe QdQd WmWm QsQs Wage Rate per Unit Quantity of Labor per Time Period S E ABC Reduction in quantity of labor demanded Excess quantity supplied at wage W m Increase in quantity of labor supplied

55. Slide 4-55 Quantity Restrictions Prohibitions on the ownership or trading of a good –Human organs –Drugs –Hospital beds

56. Slide 4-56 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

57. Slide 4-57 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.

58. Slide 4-58 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. Issues and Applications: Traffic Jams in U.S. Seaports

59. Slide 4-59 Issues and Applications: Traffic Jams in U.S. Seaports Figure 4-7

60. Slide 4-60 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.

61. Slide 4-61 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.

62. Slide 4-62 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.

63. Slide 4-63 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.

64. Slide 4-64 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.

65. Slide 4-65 Summary Discussion of Learning Objectives Government-imposed restrictions on market quantities –Bans on sale or ownership –Licensing restrictions –Import quotas

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