copyright © 2010, All rights reserved eStudy.us Chapter 4 Markets in Action

copyright © 2010, All rights reserved eStudy.us Three steps to analyzing changes in equilibrium 1.Decide if the event shifts the supply curve, the demand curve, or both curves 2.Decide if curve shifts to right or to left 3.Use supply-and-demand diagram Compare initial and new equilibrium How the shift affects equilibrium price and quantity Demand and Supply Changes in Demand and Supply

copyright © 2010, All rights reserved eStudy.us Example: A change in market equilibrium due to a shift in demand A cool summer effect on the hamburger market 1.Cool weather - demand curve (tastes) 2.Demand curve shifts to the left (down) 3.Lower equilibrium price; lower equilibrium quantity Supply and Demand

copyright © 2010, All rights reserved eStudy.us Supply D0D0 An abnormally cool summer causes buyers to demand less hamburger (less grilling). The demand curve shifts from D 0 to D 1, which causes the equilibrium price to lower from $2.50 to $2.00 and the equilibrium quantity to lower from 10 to 7 hamburgers Quantity Price 0 $ New equilibrium D1D1 1. Cool weather decreases the demand for hamburger …and a lower quantity sold. Supply and Demand 2. resulting in a lower price

copyright © 2010, All rights reserved eStudy.us Example: A change in market equilibrium due to a shift in supply – Technology improves hamburger processing 1.Change in technology impacts the supply curve 2.Supply curve shifts to the right 3.Lower equilibrium price; higher equilibrium quantity Supply and Demand

copyright © 2010, All rights reserved eStudy.us 6 S0S0 A technology improvement causes sellers to supply more hamburger. The supply curve shifts from S 0 to S 1, which causes the equilibrium price of hamburger to lower from $2.50 to $2.00 and the equilibrium quantity to increase from 4 to 7 hamburgers Quantity Price 0 $2.50 New equilibrium S1S1 1. an improvement in Technology and a higher quantity sold Demand Supply and Demand results in a lower price

copyright © 2010, All rights reserved eStudy.us Example: A change in market equilibrium due to a shift in supply – Labor wages increase – Effect on the market for hamburger? 1.Change in input price impacts the supply curve 2.Supply curve - shifts to the left 3.Higher equilibrium price; lower equilibrium quantity Supply and Demand

copyright © 2010, All rights reserved eStudy.us S0S0 New equilibrium An increase in labor wages (an input price) causes sellers to supply less hamburger. The supply curve shifts from S 0 to S 1, which causes the equilibrium price of hamburger to rise from $2.00 to $2.50 and the equilibrium quantity to fall from 7 to 4 hamburgers Price Quantity Demand 1. an increase in labor wages S1S a smaller quantity sold $ results in a higher price Supply and Demand

copyright © 2010, All rights reserved eStudy.us Price Controls Price ceilings – a legally established maximum price a seller can charge Price floors – a legally established minimum price a seller can be paid

copyright © 2010, All rights reserved eStudy.us 1,600 1, D S Rent Market Rent ceiling 0 Shortage of 4 millions rental units Quantity of Rental Units (millions per month) Month Rent per Unit (dollars)

copyright © 2010, All rights reserved eStudy.us Rent Controls Shortages Illegal markets Less maintenance Discrimination

copyright © 2010, All rights reserved eStudy.us Examples of price floors Minimum wage law Agricultural price supports Price Controls

copyright © 2010, All rights reserved eStudy.us WmWm WeWe QDQD QEQE QSQS D S Labor Market Unemployment Wage Rate (dollars per hour ) Quantity of Unskilled Labor (thousands of workers per year) Minimum wage

copyright © 2010, All rights reserved eStudy.us Market Failure – a situation in which the price system results in too few or too many resources used in the production of a good or service. This inefficiency may justify government intervention. Lack of Competition Externalities Public Goods Income Inequality Market Failure

copyright © 2010, All rights reserved eStudy.us Lack of Competition There must be competition for markets to function properly Adam Smith – The father of modern economics who wrote The Wealth of Nations, published in 1776 Lack of Competition

copyright © 2010, All rights reserved eStudy.us 2, Rigging the Personal Computer Market 1,500 S2S2 1, D Quantity Price 0 Efficient equilibrium Inefficient equilibrium S1S1

copyright © 2010, All rights reserved eStudy.us Externality – A cost or benefit imposed on people other than the consumers and producers of a good or service (third parties). Pollution Negative Externality – an externality that is detrimental to third parties Positive Externality – an externality that is beneficial to third parties Vaccinations Regulation – remove or control the externality

copyright © 2010, All rights reserved eStudy.us P2P2 Q1Q1 External Costs of Pollution P1P1 S1S1 S2S2 Q2Q2 D Excludes external costs of pollution Quantity of Steel Price of Steel Includes external costs of pollution Inefficient equilibrium Efficient equilibrium

copyright © 2010, All rights reserved eStudy.us D1D1 Q1Q1 S External Benefits of AIDS Vaccinations D2D2 P1P1 P2P2 Q2Q2 Excludes Vaccination benefits Includes Vaccination benefits Quantity (number of AIDS vaccinations) Price per Vaccination Efficient equilibrium Inefficient equilibrium

copyright © 2010, All rights reserved eStudy.us Externality Conclusion When externalities are present, market failure gives incorrect price and quantity signals, and resources are misallocated External costs cause the market to overallocate resources, and external benefits cause the market to underallocate resources When the supply curve fails to include external costs, the equilibrium price is artificially low, and the equilibrium quantity is artificially high

copyright © 2010, All rights reserved eStudy.us Examples National defense Public education Highways 21 Public Good – a good that, once produced, has two properties: users collectively consume benefits no one can be excluded (free rider) If public goods are available only in the marketplace, people wait for someone else to pay, and the result is an underproduction or zero production of public goods

copyright © 2010, All rights reserved eStudy.us 22 Income inequality Government transfer programs such as social security, unemployment compensation, food stamps, and minimum wage are examples of programs that redistribute income.