Climbing the Economic Mountain! Section 1 Twelve Key Elements of Economics Supply and Demand Supply and Demand: Applications and Extensions Supply and Demand: Basics Section 2 The Financial Crisis of 2008 Lessons from the Great Depression The Seven Major Sources of Economic Progress Section 3 Ten Elements of Clear Thinking About Economic Progress and the Role of Government Section 4 Twelve Key Elements of Practical Personal Finance

2 Supply and Demand !!!! Basics, Applications, and Extensions

3 Overview 1. Demand the demand curve the demand curve consumer surplus consumer surplus quantity demanded vs. demand quantity demanded vs. demand shifters of demand shifters of demand 2. Supply the supply curve the supply curve producer surplus producer surplus quantity supplied vs. supply quantity supplied vs. supply shifters of supply shifters of supply

4 Overview 3. Market Equilibrium: Efficiency Efficiency Single and double shifts of supply and demand Single and double shifts of supply and demand 4.The resource market (particularly the labor market) 5.Price Controls: price floors and ceilings (surpluses and shortages) 6.Impact of a tax 7.The tax system 8.The Laffer curve 9.Subsidies

5 The Demand Curve Law of demand: There is an inverse (negative) relationship between the price of a good and the quantity that buyers are willing to purchase Results in a downward sloping demand curve.

6 The Demand Curve Ex. Deriving the Demand Curve *Note*: As price increases, quantity demanded decreases.

7 The Demand Curve The height of the demand curve at any quantity shows the maximum price that consumers are willing to pay for an additional unit. Notice that when consumers have more of the good they value it less.

8 Consumer surplus Consumer surplus: The difference between the maximum amount consumers would be willing to pay and the amount that they actually pay. Consumer surplus is the area below the demand curve but above the price. ex. What happens if price falls? rises? ex. What happens if price falls? rises?

9 Demand vs. Quantity Demanded Change in quantity demanded: A movement along the curve Caused by: a change in the price of that good Increase in quantity demanded: movement down the curve (to the right) Increase in quantity demanded: movement down the curve (to the right) Decrease in quantity demanded: movement up the curve (to the left) Decrease in quantity demanded: movement up the curve (to the left)

10 Demand vs. Quantity Demanded Change in demand: a shift of the curve Caused by: a change in anything that affects demand other than the price of the good Increase in demand: curve shifts right Increase in demand: curve shifts right Decrease in demand: curve shifts left Decrease in demand: curve shifts left

11 Shifters of Demand 1. Change in consumer income A. Normal goods (shrimp) B. Inferior goods Ramen Noodles

12 Shifters of Demand 2. Change in number of consumers Ex. Change in class size

13 Change in Number of Consumers

14 Shifters of Demand 3. Change in the price of a related good A. Substitutes (Beef and Chicken) B. Compliments (Milk and Cereal)

15 Shifters of Demand 4. Change in expectations A. Expected change in price B. Expected change in income

16 Shifters of Demand 5. Change in consumer tastes and preferences. Ex. What do you think happened to the demand for Michael Phelps posters?

17 Shifting Demand: change in consumer tastes and preferences

18 Examples What would happen to demand? What would happen to demand? 1. What would happen to the demand for Beef if the price of chicken increased? 2. What would happen to your demand for steak (a normal good) if your income decreased? 3. What would happen to the demand for milk if the price of milk fell?

19 The Supply Curve The law of supply: There is a direct (positive) relationship between the price of a good or service and the amount that suppliers are willing to produce Results in an upward sloping supply curve

20 The Supply Curve Ex. Deriving the Supply Curve *Note*: As price increases, quantity supplied increases.

21 The Supply Curve The height of the supply curve indicates the minimum price necessary to induce producers to supply that additional unit

22 Producer Surplus Producer surplus: The difference between the minimum price suppliers are willing to accept and the price they actually receive. Producer surplus is the area above the supply curve but below price. Producer surplus is the area above the supply curve but below price. ex. What happens if price falls? Rises? ex. What happens if price falls? Rises?

23 Example of consumer and producer surplus

24 Supply vs. Quantity Supplied Change in quantity supplied: a movement along the curve Caused by a change in the price of that good: Increase in quantity supplied: Movement up the curve (to the right) Increase in quantity supplied: Movement up the curve (to the right) Decrease in quantity supplied: Movement down the curve (to the left) Decrease in quantity supplied: Movement down the curve (to the left)

25 Supply vs. Quantity Supplied Change in supply: A shift of the curve Caused by a change in anything that affects supply other than the price of the good Increase in supply: curve shifts right Increase in supply: curve shifts right Decrease in supply: curve shifts left Decrease in supply: curve shifts left

26 Shifters of Supply 1. A change in resource price ex. An increase in the price of steel

27 Shifters of Supply 2. A change in technology ex. The printing press

28 Shifters of Supply 3. Changes in nature and politics ex. Crop Freeze

29 Shifters of Supply 4. Changes in taxes ex. Yacht tax

30 Elasticity Inelastic: Changes in quantity are not sensitive to changes in price (inelastic curves are steeper). Elastic: Changes in quantity are sensitive to changes in price (elastic curves are flatter).

31 Market Equilibrium! A state in which the conflicting forces of supply and demand are in balance. Occurs where the demand curve intersects the supply curve.

32 Market Equilibrium! In market equilibrium: all trades that generate more benefit then costs are undertaken all trades that generate more benefit then costs are undertaken No trades where costs exceed benefits are undertaken No trades where costs exceed benefits are undertaken The combined area of consumer and producer surplus is maximized The combined area of consumer and producer surplus is maximized

33 Market Equilibrium! The market equilibrium is economically efficient. Efficient: no excess supply or excess demand Excess supply: quantity supplied > quantity demanded Excess supply: quantity supplied > quantity demanded Excess demand: quantity demanded > quantity supplied Excess demand: quantity demanded > quantity supplied

34 Changes in Demand Demand changes: Price: moves in same direction Price: moves in same direction Quantity: moves in same direction Quantity: moves in same direction ex. Demand increases Price increases Price increases Quantity increases Quantity increases

35 Changes in Supply Supply changes: Price: moves in opposite direction Price: moves in opposite direction Quantity: moves in same direction Quantity: moves in same direction ex. Supply increases ex. Supply increases Price decreases Price decreases Quantity increases Quantity increases

36 Changes In Both? What happens if supply and demand both change at the same time?

37 The Labor Market Price for labor is called the wage (W) Price for labor is called the wage (W) Quantity of labor is called employment (E) Quantity of labor is called employment (E) *Note: works just like the market for goods, only with a different name for price (wage) and quantity (employment) *Note: works just like the market for goods, only with a different name for price (wage) and quantity (employment)

38 Labor Demand 1. Firms demand labor 2. Labor demand curve is downward sloping because as wage decreases, firms will want to employ more people

39 Changes in Labor Demand 1. An increase in labor demand (labor demand shifts right) 2. A decrease in labor demand (labor demand curve shifts left)

40 Labor Supply 1. Workers supply labor 2. Labor supply curve is upward sloping because as wage increases, people will want to work more.

41 Changes in Labor Supply 1. Increase in labor supply: (labor supply curve shifts right) 2. Decrease in labor supply: (labor supply curve shifts left)

42 Linking the Markets There is a close relationship between the demand for products and the demand for resources used to make those products

43 Linking the Markets when the demand for a product changes, the demand for the resources used to produce it will change in the same direction

44 Price Floor Price floor: A legally established minimum price buyers must pay for a good or resource A price floor above equilibrium price creates a surplus A price floor above equilibrium price creates a surplus A price floor below equilibrium price does nothing A price floor below equilibrium price does nothing

45 Application: Minimum Wage The minimum wage is an example of a price floor. Raising minimum wage increases excess labor supply (unemployment).

Application: Minimum Wage 46

47 Price Ceiling Price ceiling: A legally established maximum price sellers can charge for a good or resource A price ceiling below market equilibrium price creates a shortage A price ceiling below market equilibrium price creates a shortage A price ceiling above market equilibrium price does nothing A price ceiling above market equilibrium price does nothing

48 Application: Disaster Markets

49 Application: Rent Control Rent controls lead to shortages as well as: 1. A decline in the supply of future rental housing 2. A decline in quality of rental housing 3. Non-price methods of rationing 4. Inefficient housing match-ups 5. Black Markets

50 Black Markets Should we legalize drugs? What are the costs and benefits? Should we legalize prostitution? What are the costs and benefits?

51 Impact of a tax – Lessons from Snooki

52 Impact of a Tax A tax on a product will cause the supply curve to shift left by the amount of the tax. 1. Raises the price that buyers pay 2. Reduces the amount sellers receive 3. Reduces the quantity sold 4. Increases government revenue 5. Creates deadweight loss

53 Deadweight loss The loss to society that results from the loss of gains to trade that does not occur because a tax was imposed.

54 Tax Incidence Tax Incidence: The way the burden of a tax is distributed among economic units (also known as the tax burden) (also known as the tax burden) It does not depend on whom the tax is imposed.

55 Tax Incidence Tax incidence does depend on elasticity: The burden of the tax will fall on those who are relatively inelastic. Deadweight loss will be lower if taxes are placed on goods that are relatively inelastic.

56 The Tax System Average tax rate (ATR): the percentage of income paid in taxes ATR = tax liability / taxable income

57 The Tax System 3 possibilities: 1. Progressive tax: average tax rate rises with income 2. Regressive tax: average tax rate falls with income 3. Proportional tax: average tax rate is the same at all income levels

58 The Tax System Marginal tax rate (MTR): The additional tax liability a person faces divided by his or her additional taxable income. MTR = change in tax liability / change in taxable income *Note: Marginal tax rates are what is important in personal decision making.

59 Fairness and Efficiency 1. Is the progressive tax system economically efficient? 2. Is the progressive tax system fair?

60 The Laffer Curve The Laffer Curve: A curve illustrating the relationship between the tax rate and tax revenue. Higher tax rates will not always lead to more tax revenue!!

61 Subsidies Subsidy: A payment the government makes to either the buyer or seller when a good or service is purchased or sold. ex. Subsidizing treadmills *Note: Subsidies are costly

62 Farm Subsidies

63 Review 1. Know why supply curve is upward sloping and demand curve is downward sloping and demand curve is downward sloping 2. Find producer and consumer surplus 3. Know the shifters of demand 4. Know the shifters of supply 5. Know the characteristics of market equilibrium 6. Be able to do single and double shifts of demand and supply curves demand and supply curves

64 Review 7. Know why the labor demand curve is downward sloping and the labor supply is upward sloping 8. Know the effects of price controls 9. Understand the impact of a tax 10. Be able to calculate average tax rate and marginal tax rate 11. Understand the Laffer Curve 12. Understand the impacts of a subsidy