Introduction: Thinking Like an Economist 1 CHAPTER Using Supply and Demand It is by invisible hands that we are bent and tortured worst. Nietzsche CHAPTER 5 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

1 Using Supply and Demand Chapter Goals Apply the supply and demand model to real-word events Explain the effect of excise taxes and tariffs on a market Demonstrate the effect of a price ceiling and a price floor on a market Explain the effect of quantity restrictions on a market Explain the effect of a third-party payer system on equilibrium price and quantity

1 Using Supply and Demand Application: Apples in the United States D0D0 Quantity The hurricane damage caused the supply curve to shift left Hurricane Irene destroyed a significant portion of the apple crop in the northeastern U.S. S1S1 Price rose from P 0 to P 1 where quantity demanded = quantity supplied Q1Q1 P1P1 S0S0 Price P0P0 Q0Q0 Apples Excess demand

1 Using Supply and Demand 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 Price Quantity Q0Q0 SUVs Excess supply D1D1

1 Using Supply and Demand Application: Edible Oils in the World S0S0 D0D0 Price Quantity 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

1 Using Supply and Demand A Review of Changes in Supply and Demand No change in Supply Supply increasesSupply decreases No change in Demand P same Q same P down Q up P up Q down Demand increases P up Q up P ambiguous Q up P up Q ambiguous Demand decreases P down Q down P down Q ambiguous P ambiguous Q down

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

1 Using Supply and Demand Government Intervention: Price Ceilings 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

1 Using Supply and Demand S0S0 D0D0 P (rental price per month) Q (number of apartments) $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

1 Using Supply and Demand Government Intervention: Price Floors 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

1 Using Supply and Demand Application: A Minimum Wage S0S0 D0D0 P (wage per hour) Q (quantity 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 Q0Q0

1 Using Supply and Demand Government Intervention: 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

1 Using Supply and Demand Application: The Effect of an Excise Tax S0S0 D0D0 Price Quantity $60, 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 $65,000 Tax = $10,000 Luxury Boats $65, $10,000 $70,000

1 Using Supply and Demand Government Intervention: 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

1 Using Supply and Demand 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 (wages per week ) Q (number of licensed taxis) D1D1

1 Using Supply and Demand 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 (price of taxi medallion ) Q (number of taxi of medallions) D1D1 Initial Fee

1 Using Supply and Demand Government Intervention: 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 doesnt pay the entire cost Goods from a third-party-payer system will be rationed through social and political means

1 Using Supply and Demand Application: Third-Party-Payer Markets D emand 10 Health Care $25 Price Quantity $45 $5 S upply 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…

1 Using Supply and Demand 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 Price ceilings, government imposed limits on how high a price can be charged, create shortages 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

1 Using Supply and Demand Chapter Summary Quantity restrictions increase equilibrium price and reduce equilibrium quantity In a third-party-payer market, the consumer and the one who pays the cost differ. Quantity demanded, price, and total spending are greater when a third party pays than when the consumer pays.