Presentation on theme: "Extensions of Demand and Supply Analysis"— Presentation transcript:
1 Extensions of Demand and Supply Analysis Chapter 4Extensions of Demand and Supply Analysis
2 IntroductionThe global demand for water doubles every 20 years, so there will likely be pressure of its equilibrium price to rise.In fact, inflation-adjusted prices of water havebarely increased because government controls keep water prices lower than they otherwise would be.In this chapter, you will learn why such regulations have contributed to shortages of water in some nations.
3 Learning Objectives Discuss the essential features of the price system Evaluate the effects of changes in demand and supply on the market price and equilibrium quantityUnderstand the rationing function of prices
4 Learning Objectives (cont'd) Explain the effects of price ceilingsExplain the effects of price floorsDescribe various types of government- imposed quantity restrictions on markets
5 Chapter Outline The Price System and Markets Changes in Demand and SupplyThe Rationing Function of PricesThe Policy of Government-Imposed Price ControlsThe Policy of Controlling RentsPrice Floors in AgriculturePrice Floors in the Labor MarketQuantity Restrictions
6 Did You Know That ...Nearly 90,000 U.S. residents seek kidney transplants each year, but only about 20,000 kidney transplants occur?Despite the high demand for kidney transplants, selling a kidney is illegal, so the maximum price of a kidney—called a price ceiling—is $0.
7 The Price System and Markets Price System or Market SystemAn economic system in which relative prices are constantly changing to reflect changes in supply and demandThe prices are signals as to what is relatively scarce and relatively abundantPrices provide information to individuals and businesses
8 The Price System and Markets (cont'd) Voluntary ExchangeAn act of trading between individuals in the price systemMakes both parties to the trade subjectively better off
9 The Price System and Markets (cont'd) Transaction CostsAll of the costs associated with exchangeIncluding:The informational costs of finding out the price and quality, service record, and durability of a productThe cost of contracting and enforcing that contract
10 The Price System and Markets (cont'd) The role of middlemenMiddlemen (intermediaries) or brokers reduce transaction costs by providing information to buyers and sellersExamplesReal estate brokersStock brokersConsignment shopsCar dealerships
11 International Example: Assisting Scattered Emigrants Who Want to Help Kin at Home About 25 million people have left India to work in other nations around the globe.To assist Indian emigrants who desire to help family members back home, a company called Sahara Care House offers a suite of 60 products and services, including delivering flowers and dropping off good and clothing to emigrants’ families in India.By performing tasks for family members on behalf of Indian expatriates, this company acts as a middleman.
12 Changes in Demand and Supply Changes in supply and demand create a disequilibrium.The market price and quantity adjust to a new equilibrium.
13 Figure 4-1 Shifts in Demand and in Supply: Determinate Results, Panel (a)
14 Figure 4-1 Shifts in Demand and in Supply: Determinate Results, Panel (b)
15 Figure 4-1 Shifts in Demand and in Supply: Determinate Results, Panel (c)
16 Figure 4-1 Shifts in Demand and in Supply: Determinate Results, Panel (d)
17 Changes in Demand and Supply (cont'd) SummaryIncreases in demand increase equilibrium price and quantityDecreases in demand decrease equilibrium price and quantity
18 Changes in Demand and Supply (cont'd) SummaryIncreases in supply decrease equilibrium price and increase equilibrium quantityDecreases in supply increase equilibrium price and decrease equilibrium quantity
19 Changes in Demand and Supply (cont'd) When both demand and supply changeIf both the supply and demand curves shift simultaneously, the outcome is indeterminate for either equilibrium price or equilibrium quantityThe resulting effect depends upon how much each curve shifts
20 Changes in Demand and Supply (cont'd) When both demand & supply increaseChange in equilibrium price is indeterminateEquilibrium quantity increases unambiguouslyWhen both demand & supply decreaseEquilibrium quantity decreases unambiguously
21 Changes in Demand and Supply (cont'd) When supply decreases & demand increasesEquilibrium price increasesThe change in the equilibrium quantity is uncertain without more informationWhen supply increases & demand decreasesEquilibrium price decreases
22 International Example: What Accounts for Rising Pork Prices in China? Since the early 2000s, Chinese pork prices have surged. Why?Pork is a normal good, so that rising Chinese incomes had raised the demand for pork.Meanwhile, rising prices of feed for hogs and higher prices of land to raise hogs contributed to a reduction in the supply of pork.
23 Figure 4-2 The Effects of a Simultaneous Decrease in Pork Supply and Increase in Pork Demand
24 Changes in Demand and Supply (cont'd) Price FlexibilityPrices quite flexible in some markets can be less flexible in other market scenarios.May take the form of subtle adjustments such as hidden payments, quality changesMay not reach equilibrium right away
25 Changes in Demand and Supply (cont'd) Adjustment speedMarket characteristics influence adjustment speedMarkets may overshoot in the adjustment processMarkets are subject to energy shocks, labor strikes, severe weather
26 The Rationing Function of Prices Synchronization of decisions of buyers and sellers that leads to equilibrium is called the rationing function of prices
27 The Rationing Function of Prices (cont'd) Methods of non-price rationingRationing by queues (waiting in line)Rationing by random assignment or coupons
28 The Rationing Function of Prices (cont'd) The essential role of rationingImplied by the presence of scarcityPrice vs. non-price rationing mechanism:Price rationing leads to the most efficient use of available resourcesAll gains from mutually beneficial trade are captured in a freely rationing price system
29 The Policy of Government-Imposed Price Controls Government-mandated minimum or maximum pricesPrice CeilingA legal maximum pricePrice FloorA legal minimum price
30 The Policy of Government-Imposed Price Controls (cont'd) Price ceiling and black marketsA price ceiling may prevent the equilibrium price from being achieved if it is above the ceiling priceA price ceiling that is set below the market clearing price creates a shortage
31 The Policy of Government-Imposed Price Controls (cont'd) Non-Price Rationing DevicesAll methods used to ration scarce goods that are price-controlledBlack MarketA market in which price-controlled goods are sold at an illegally high price
32 Figure 4-3 Black Markets for Portable Electric Generators
33 International Example: The Rice Must Be White! In Venezuela, there is a legal ceiling price of white rice of about 1 cent per kilogram, which is about half of the price at which most Venezuelan rice sellers are willing to offer white rice.What would you suppose that rice sellers in Venezuela could do to avoid the effect of the government’s price controls on white rice?
34 The Policy of Controlling Rents The functions of rental pricesPromote the efficient maintenance and construction of housingAllocate existing housingRation the use of housing
35 The Policy of Controlling Rents (cont'd) Rent controls and constructionControls discourage constructionWith a 16% vacancy rate and no controls, Dallas recently built 11,000 new rental unitsWith a 1.6% vacancy rate and controls, San Francisco recently built 2,000 new rental units
36 The Policy of Controlling Rents (cont'd) Effects on the existing supply of housing and current use of housingProperty owners cannot recover costsMaintenance, repairs, capital improvementsRations the current use of housingReduces mobility, e.g., New York’s “housing gridlock”
37 The Policy of Controlling Rents (cont'd) Attempts to evade rent controlsForcing tenants to leaveTenants subletting apartmentsHousing courts
38 The Policy of Controlling Rents (cont'd) Who gains and who loses from rent controls?LosersProperty ownersLow-income individualsGainersUpper-income professionals
39 Why Not … require owners of residential buildings to provide low-cost housing so that all U.S. residents can “afford” roofs over their heads?The result of a legal price ceiling for residential housing set lower than the market clearing price would be a shortage of residential housing.More people would want to purchase or rent housing at the ceiling price than owners of residential housing would desire to supply.39
40 Price Floors in Agriculture Support PriceThe government chooses a price floor for a product and then acts to ensure that the price of the product never falls below the support levelAssociated with many agricultural productsA price floor that is set above the market clearing price results in a surplus.
45 Policy Example: Bad Timing for Increasing the Minimum Wage In 2007, Congress decided to increase the hourly minimum wage in 3 steps from $5.15 to $7.25 inBy 2008, the unemployment rate was 5.8 percent. When the final $0.70-per hour increase was added in 2009, the U.S. economy was experiencing an economic downturn with a 9.4 unemployment rate.If the imposition of a minimum wage currently generates unemployment, what happens to the unemployment rate when the demand for labor declines?
46 Quantity Restrictions Governments can impose quantity restrictions, most obvious—banning ownership or trading of a goodHuman organsDrugsHospital bedsGold from 1933 to 1973
47 Quantity Restrictions (cont'd) Government Prohibitions and Licensing RequirementsSome commodities cannot be purchased at all legally; others require a licenseImport QuotaSupply restriction that prohibits the importation of more than a specified quantity of a particular good
48 You Are There: “Cash for Clunkers” Subsidies and the Market for “Liquid Glass” “Liquid glass” is a sodium-silicate chemical that auto mechanics use for stopping leaks in engine gaskets.In 2009, that chemical rose from less than $2.50 per quart to nearly $3.50 per quart.What effect did the federal government’s “Cash for Clunkers” program, which offered subsidies for people to trade in energy-inefficient vehicles, have on the demand and the market clearing price of liquid glass?48
49 Issues & Applications: Contemplating Two Ways to Tackle Water Shortages What can be done to help the roughly 20 percent of the world’s human population who are unable to obtain as much usable freshwater as they desire?Ending government-mandated price ceilings on of usable freshwater is one way to eliminate water shortages.Another way to cut shortages is to remove salt from seawater.
50 Figure 4-6 Two Methods of Eliminating a Water Shortage, panel (a)
51 Figure 4-6 Two Methods of Eliminating a Water Shortage, panel (b) 51
52 Summary Discussion of Learning Objectives Essential features of the price systemA price system (market system) allows prices to respond to changes in supply and demand for different commoditiesPrices are communicated in markets that tend to minimize transactions costs
53 Summary Discussion of Learning Objectives (cont'd) How changes in demand and supply affect market price and equilibrium quantityIncreases in demand increase equilibrium price and quantity; decreases in demand decrease equilibrium price and quantityIncreases in supply decrease market price and increase equilibrium quantity; decreases in supply increase market price and decrease equilibrium quantity
54 Summary Discussion of Learning Objectives (cont'd) How changes in demand and supply affect equilibrium price and equilibrium quantityWhen both demand and supply shift at the same time, the outcome is indeterminate for either equilibrium price or equilibrium quantity
55 Summary Discussion of Learning Objectives (cont'd) The rationing function of pricesIn a market system, prices ration scarce goods and servicesOther ways of rationing include first come, first served; political power; physical force; random assignment; and coupons
56 Summary Discussion of Learning Objectives (cont'd) The effects of price ceilingsA price ceiling set below the market clearing price results in a shortageThe resulting shortage can lead to non-price rationing devices and black markets
57 Summary Discussion of Learning Objectives (cont'd) The effects of price floorsIf the price floor is set above the market clearing price, a surplus resultsA price floor can take the form of a government-imposed price support or minimum wage
58 Summary Discussion of Learning Objectives (cont'd) Government-imposed restrictions on market quantitiesBans on sale or ownershipLicensing restrictionsImport quotas
59 Appendix B: Consumer Surplus The difference between the total amount that consumers would have been willing to pay for an item and the total amount that they actually pay59
61 Appendix B: Producer Surplus The difference between the total amount that producers actually receive for an item and the total amount that they would have been willing to accept for supplying that item61
63 Appendix B: Gains from Trade within a Price System The sum of consumer surplus and producer surplus63
64 Figure B-3 Consumer Surplus, Producer Surplus, and Gains from Trade 64
65 Appendix B: Price Controls and Gains from Trade How do price controls affect gains from trade?Consumer surplus and producer surplus are both lowerEither a price ceiling or a price floor reduces gains from trade65