Explorations in Economics Alan B. Krueger & David A. Anderson

Chapter 6: Exploring Economics Module 16: Supply and Demand Module 17: Changes in Supply and Demand Module 18: Shortages, Surpluses, and the Role of Prices

MODULE 16: SUPPLY AND DEMAND KEY IDEA: The interaction of supply and demand determines the price at which a good is sold in the market and the quantity of the good that is exchanged between buyers and sellers. OBJECTIVES: To demonstrate how supply and demand work together to determine the price and quantity of a good. To explain why market equilibrium occurs when the quantity supplied equals the quantity demanded. To recognize how market forces cause the market price and quantity to adjust to equilibrium. Now we must think of demand and supply together. The interaction of supply and demand determines the price.

PUTTING SUPPLY AND DEMAND TOGETHER: MARKET EQUILIBRIUM The market equilibrium is the point at which the quantity supplied equals the quantity demanded. Review the downsloping dermand and the upsloping supply from Chapters 4 and 5. Equilibrium is the happy place for the market.

PUTTING SUPPLY AND DEMAND TOGETHER: MARKET EQUILIBRIUM The equilibrium price is the price that equates the quantity supplied and the quantity demanded. The equilibrium quantity is the quantity that is supplied and demanded at the equilibrium price. The exchange of 5 millions pairs of shorts at the price of $ 30.00 is the agreement of the buyers and the sellers. There is no shortage and no surplus.

PUTTING SUPPLY AND DEMAND TOGETHER: MARKET EQUILIBRIUM When the quantity demanded is larger than the quantity supplied, the difference between them is called excess demand. This creates a SHORTAGE. What is the quantity demanded for pairs of shorts when the price falls to $20? What is the quantity supplied of pairs of shorts when the price falls to $20? 5 millions pairs of shorts is the excess demand. Many unhappy buyers! Describe what happens as indicated by the green arrows? Rather than going without, buyers would gladly pay more to get what they want. At the same time, firms will see shorts disappearing from store shelves, lines forming, and consumers willing to pay higher prices. In response, firms will raise the price of shorts above $20 per pair. As the price of shorts rises, the quantity of shorts demanded will decrease. This follows the law of demand that you learned about in Chapter 4.The result is a leftward movement along the demand curve, away from point A and toward point E. At the same time, the rising price causes the quantity supplied to increase. This follows the law of supply, which you learned about in Chapter 5. The increase in the quantity supplied is seen as a rightward movement along the supply curve, from point B toward point E. These movements along the two curves shrink the gap between them. So as the price rises, the excess demand for shorts gets smaller. This can happen after a natural disaster when stores run out of generators.

PUTTING SUPPLY AND DEMAND TOGETHER: MARKET EQUILIBRIUM When the quantity supplied is larger than the quantity demanded, the difference between them is called excess supply. This creates a SURPLUS. What is the quantity demanded for pairs of shorts when the price falls to $40? What is the quantity supplied of pairs of shorts when the price falls to $40? 5 millions pairs of shorts is the excess supply. Many unhappy firms! Describe what happens as indicated by the green arrows? At $ the 40 price, firms are willing to supply 8 million pairs, as shown by point G on the supply curve. But consumers only want 3 million pairs at this price, as shown by point F on the demand curve. As firms compete with each other to find customers, they will offer shorts at lower and lower prices. So the market price of shorts—which started at $40 per pair—will fall. As the price falls, the quantity demanded rises, causing a movement along the demand curve from point F toward point E. At the same time, the quantity supplied falls, resulting in a movement along the supply curve from point G toward point E.

PUTTING SUPPLY AND DEMAND TOGETHER: MARKET EQUILIBRIUM Equilibrium is reached when there is agreement between buyers and sellers. There is constant movement in the market to maintain that equilibrium.

Module 16 Review What is… A. Equilibrium? B. Equilibrium price? C. Equilibrium quantity? D. Excess demand? E. Excess supply? Have the students add these terms to their vocabulary notebook. Make sure they are writing examples of each of the terms.

MODULE 17: CHANGES IN SUPPLY & DEMAND KEY IDEA: A change in supply or demand, as shown by a shift of the supply or demand curve, causes the equilibrium price and quantity to change in a predictable way. OBJECTIVES: To explain how a change in supply affects the equilibrium price and quantity. To explain how a change in demand affects the equilibrium price and quantity. To explain what is known and what is unknown about the effect of a simultaneous change in both supply and demand. Now, the changes that occur in demand and supply will be addressed. These shifts can cause the equilibrium price and quantity in the market to change.

REVIEW OF DEMAND AND SUPPLY SHIFTERS Great review piece. Challenge students to give examples.

CHANGES IN DEMAND An increase in demand = increase in PRICE and QUANTITY. Think of other increases in demand. Ask students to come to board or on their own paper to draw a market in equilibrium then shift the demand curve. Explain the cause and result.

CHANGES IN DEMAND A decrease in demand = decrease in PRICE and QUANTITY. Think of other decreases in demand. Ask students to come to board or on their own paper to draw a market in equilibrium then shift the demand curve. Explain the cause and result.

A DECREASE IN SUPPLY A decrease in supply = increase in PRICE and a decrease in QUANTITY. Think of other decreases in supply. Ask students to come to board or on their own paper to draw a market in equilibrium then shift the supply curve. Explain the cause and result.

AN INCREASE IN SUPPLY An increase in supply = decrease in PRICE and an increase in QUANTITY. Think of other increases in supply. Ask students to come to board or on their own paper to draw a market in equilibrium then shift the supply curve. Explain the cause and result.

CHANGES IN BOTH SUPPLY AND DEMAND If supply and demand decrease by the same amount, price will be unchanged and the quantity will decrease. Explain the idea that the decrease or increase is ”by the same amount”. Ask students to come to board or on their own paper to draw a market in equilibrium then decrease both the demand and supply curves to the same degree. Explain the cause and result.

CHANGES IN BOTH SUPPLY AND DEMAND If supply decreases less than demand, price will decrease and quantity will decrease. Ask students to come to board or on their own paper to draw a market in equilibrium then decrease the demand curve but decrease the supply curve to a less degree. Explain the cause and result.

CHANGES IN BOTH SUPPLY AND DEMAND If supply decreases more than demand, price will increase and quantity will decrease. Ask students to come to board or on their own paper to draw a market in equilibrium then decrease the demand curve but decrease the supply curves to a greater degree. Explain the cause and result.

CHANGES IN BOTH SUPPLY AND DEMAND If supply increases and demand decreases, the price will decrease and the quantity will not change. Ask students to come to board or on their own paper to draw a market in equilibrium then decrease both the demand and increase the supply curve to the same degree. Explain the cause and result.

SHIFTS IN DEMAND AND SUPPLY AND UNCERTAIN OUTCOMES When both demand and supply curves shift to the left, to the right or in opposite directions, there will be uncertainty in knowing the change on the market equilibrium. This table shows these changes. Shifts Changes in Market Equilibrium Supply Demand Price Quantity Decrease Increase This is a difficult concept for most students. Be sure to use the practice worksheets in the TRM after this module.

MODULE 17 REVIEW What happens to price and quantity when there is… A. An increase in demand? B. A decrease in demand? C. An increase in supply? D. A decrease in supply? E. A decrease in demand and in supply? F. A decrease in demand and an increase in supply? G. An increase in demand and a decrease in supply? H. An increase in both demand and supply? Have the students add these terms to their vocabulary notebook. Make sure they are writing examples of each of the terms.

MODULE 18: SHORTAGES, SURPLUSES, & THE ROLE OF PRICES KEY IDEA: Equilibrium prices provide benefits that are lost when forces prevent markets from reaching their equilibrium price. OBJECTIVES: To show how price ceilings and floors cause shortages and surpluses. To explain the important incentives prices create. To identify problems with rationing as a way of allocating goods and services. Be sure to point out that price ceilings and floors are used from time to time. The most relevant price floor is minimum wage.

SHORTAGES AND SURPLUSES A shortage exists when an excess demand for a product persists for a significant period of time. A SHORTAGE will cause price to INCREASE. Be sure to show how the QS<QD. What is the quantity supplied and quantity supplied at $3? at $2? What is the shortage in the quantity of milk at $2?

SHORTAGES AND SURPLUSES A surplus exists when an excess supply persists for a significant period of time. A SURPLUS will cause price to DECREASE. Be sure to show how the QS<QD. What is the quantity supplied and quantity supplied at $3? at $4? What is the surplus in the quantity of milk at $4?

PRICE CEILINGS A price ceiling is a government- imposed limit on the highest price firms can charge in a market. A price ceiling will cause a SHORTAGE. When a ceiling price holds the price below the equilibrium price, what happens? Quantity demanded is greater than quantity supplied. Using labels on the horizontal axis, describe the shortage when the price is at the ceiling price. Distance between Q2 — Q 1 Use examples like the energy crisis of the ’70s or discuss the effect of rent control.

PRICE FLOORS A price floor is a government- imposed limit below which prices cannot fall. Price floors tend to cause a SURPLUS. When a price floor holds the price above the equilibrium price, what happens? Quantity demanded is less than quantity supplied. Using labels on the horizontal axis, describe the shortage when the price is at the ceiling price. Distance between Q2 — Q 1 Use the example of minimum wage.

STICKY PRICES Sticky prices are prices that move to their equilibrium values very slowly. Can you think of examples of sticky prices? menus in restaurant, housing prices, pressure from blue jeans manufactors like Levi Strauss, other high end products What are the conditions that might cause sticky prices? habits, customs and traditional arrangements; costky to change; stubbornness and disbelief

THE IMPORTANCE OF PRICES Rationing Rationing and the achievement of goals Finding the best level of production Keeping costs low Achieving consumer satisfaction Explain what rationing is and how when things are free people take too much…like a buffet.

What Prices Accomplish Prices guide the economy to the best level of production Prices help keep costs low Prices help achieve consumer satisfaction Prices help prevent shortages After the discussion of the importance of prices, this slide acts as a summary of the that importance. Explain how prices guide us to think about if a product should be purchased or not.

Module 18 Review What is… A. Shortage? B. Black market? C. Price ceiling? D. Price floor? E. Sticky prices? F. Rationing? G. Market failure? H. Surplus? Have the students add these terms to their vocabulary notebook. Make sure they are writing examples of each of the terms.