Chapter 4: Extensions of Demand and Supply Analysis ECON 152 – PRINCIPLES OF MICROECONOMICS Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.

2 The Price System Price System or Market System  An economic system in which relative prices are constantly changing to reflect changes in supply and demand Prices signal what is relatively scarce and relatively abundant. Prices provide information to individuals and businesses.

3 Exchange and Markets Markets  Emphasize voluntary exchange  Determine the terms of exchange  Facilitate exchange

4 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

5 Exchange and Markets Transaction Cost  The costs associated with exchange  Examples Price shopping Determining quality Determining reliability Service availability Cost of contracting

6 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

7 Changes in Demand and Supply Changes in supply and demand create a disequilibrium The market price and quantity adjust to a new equilibrium

8 Shifts in Demand and Supply: Determine Results Increase Demand with Supply Constant D1D1 S P1P1 Q1Q1 E1E1 Figure 4-1

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

10 Shifts in Demand and Supply: Determine 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

11 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

12 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

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

14 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

15 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

16 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

17 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

18 Changes in Demand and Supply Summary  Increases in demand increase equilibrium price and quantity.  Decreases in demand decrease equilibrium price and quantity.

19 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.

20 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

21 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

22 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

23 DemandSupplyPriceQuantity Increase Decrease IncreaseDecreaseIncrease DecreaseIncreaseDecrease DemandSupplyPriceQuantity Increase UnknownIncrease DecreaseIncreaseUnknown DecreaseIncreaseDecreaseUnknown Decrease UnknownDecrease Change in demand or supply Change in both demand and supply

24 Price Flexibility and Adjustment Speed Prices quite flexible in unfettered markets can be less flexible in other market scenarios.  May experience indirect adjustments such as hidden payments, quality changes  May not reach equilibrium right away

25 Adjustment speed  Market characteristics influence adjustment speed.  Markets may overshoot in the adjustment process.  Markets are subject to energy shocks, labor strikes, severe weather.

26 The Rationing Function of Prices When surpluses and shortages exist, the price adjusts to clear the market. Synchronization of decisions of buyers and sellers will lead to equilibrium. This adjustment is the rationing function of price.

27 The Rationing Function of Prices When prices cannot adjust non-price rationing occurs  Rationing by queues  Rationing by lotteries  Rationing by coupons

28 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

29 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

30 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

Black Markets

32 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

33 Effects on the existing supply of housing  Property owners cannot recover costs The Policy of Controlling Rents Rationing the current use of housing  Reduces mobility New York’s “housing gridlock”

34 Who gains and who loses from rent controls?  Losers Property owners Low-income individuals  Benefits Upper-income professionals The Policy of Controlling Rents

35 Price Floors in Agriculture Support Price  the governmentally established minimum price farmers are to receive for a particular agricultural product.

36 Agricultural Price Supports

37 Price Floors in the Labor Market Minimum Wage  Lowest hourly wage rate that firms may legally pay their workers

38 The Effect of Minimum Wages

39 Quantity Restrictions Prohibitions on the ownership or trading of a good  Human organs  Drugs  Hospital beds

40 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

Chapter 4: Extensions of Demand and Supply Analysis ECON 152 – PRINCIPLES OF MICROECONOMICS Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.