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.

PUTTING SUPPLY AND DEMAND TOGETHER: MARKET EQUILIBRIUM The market equilibrium is the point at which the quantity supplied equals the quantity demanded.

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.

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.

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! 12/13/2015Chapter 6-Modules 16-18

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. 12/13/2015Chapter 6-Modules 16-18

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.

SURPLUS: EXCESS SUPPLY 12/13/2015Chapter 6-Modules 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!

BRINGING SURPLUS DOWN TO EQUALIBRIUM 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. 12/13/2015Chapter 6-Modules 16-18

PUTTING SUPPLY AND DEMAND TOGETHER: MARKET EQUILIBRIUM

Module 16 Review What is… A. Equilibrium? B. Equilibrium price? C. Equilibrium quantity? D. Excess demand? E. Excess supply?

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.

REVIEW OF DEMAND AND SUPPLY SHIFTERS

CHANGES IN DEMAND An increase in demand = increase in PRICE and QUANTITY.

CHANGES IN DEMAND A decrease in demand = decrease in PRICE and QUANTITY.

A DECREASE IN SUPPLY A decrease in supply = increase in PRICE and a decrease in QUANTITY.

AN INCREASE IN SUPPLY An increase in supply = decrease in PRICE and an increase in QUANTITY.

CHANGES IN BOTH SUPPLY AND DEMAND If supply and demand decrease by the same amount, price will be unchanged and the quantity will decrease.

CHANGES IN BOTH SUPPLY AND DEMAND If supply decreases less than demand, price will decrease and quantity will decrease.

CHANGES IN BOTH SUPPLY AND DEMAND If supply decreases more than demand, price will increase and quantity will decrease.

CHANGES IN BOTH SUPPLY AND DEMAND If supply increases and demand decreases, the price will decrease and the quantity will not change.

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.

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?

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.

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.

SHORTAGES AND SURPLUSES A surplus exists when an excess supply persists for a significant period of time. A SURPLUS will cause price to DECREASE.

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.

Price Ceiling 12/13/2015Chapter 6-Modules Rent Control 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 Q 2 — Q 1

Problems with Price Ceilings: Rent Control Although they are usually designed to help the poor, the beneficiaries are sometimes the rich. Rent control, everyone pays lower rent, including those who are well off. Another problem with price ceilings is that—because they create shortages– some people who want a good at the current price cannot get it. Leads to black market__ because an item becomes scarce, in the black market the item could be higher than the equilibrium price 12/13/2015Chapter 6-Modules 16-18

PRICE FLOORS A price floor is a government- imposed limit below which prices cannot fall. Price floors tend to cause a SURPLUS.

Price Floor: Minimum Wage 12/13/2015Chapter 6-Modules When a price floor holds the price above the equilibrium price, what happens? Quantity demanded is less than quantity supplied. Distance: Q1-Q2 Surplus minimum wage.

Problems with Price Floors An effective price floor either creates a surplus or necessitates government spending of tax dollars to buy up the excess supply of a good. Price support programs like those for agriculture products benefits all farmers who produce the supported products (even if they are wealthy) Consumers have to pay more for products like milk, peanut butter, and sugar Price floors are not favored as a way to help farmers. 12/13/2015Chapter 6-Modules 16-18

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 manufactures like Levi Strauss, other high end products What are the conditions that might cause sticky prices? habits, customs and traditional arrangements; costly to change; stubbornness and disbelief

THE IMPORTANCE OF PRICES Rationing: of a good is to give a fixed quantity to each person. (During WWII, the U.S. government wanted to free up resources to use for military production by decreasing production of consumer goods. Rationing and the achievement of goals: Rationing produces a way to allocate goods when the price is below equilibrium (price ceiling) Rationing does a poor job of the following: Finding the best level of production Keeping costs low (for example: government would have to set up new agencies to buy and distribute items) Achieving consumer satisfaction (if clothing were rationed, it would be poorly allocated among households) people who really love clothes would want to consumer more than allotted.

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

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?