1. McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, All Rights Reserved Chapter 4 Supply and Demand

2. 1-2 Chapter Objectives At the end of this lesson, you will be able to: Define and explain demand in a product or service market Define and explain supply Determine the equilibrium point in the market for a specific good, given data on supply and demand at different price levels Understand what causes shifts in demand and supply Understand how price ceilings cause shortages Understand how price floors cause surpluses Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

3. 1-3 Demand The schedule of quantities of a good or service that people are willing and able to buy at different prices Sometimes a schedule is also called a table Demand shows how much quantity of a good or service can be sold at different prices People pay for goods or services according to how many benefits those goods or services will yield Generally less quantity will be demanded as prices increase since people will find relatively less expensive substitutes to provide similar levels of benefits Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

4. 1-4 Demand Schedule and Curve Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 Price $250 Quantity 30,000 Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

5. 1-5 Shifts in Demand A change in the price of a good or service moves us along a given demand schedule/curve Shifts in supply move us along a given demand schedule/curve A change in the demand schedule results in a shift of the demand schedule/curve If consumer preferences change for whatever reason that will shift the demand curve either outward or inward depending upon the nature of the change Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

6. 1-6 Demand Curve Shift Out When a demand curve shifts outward people are willing to buy more goods or services at the same price Preferences change and the product or service is perceived to yield more benefits than before If scientific studies come out that show DVDs increase peoples life expectancy, we may expect an outward shift Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

7. 1-7 Demand Curve Shift In When a demand curve shifts inward, people are willing to buy fewer goods at previous prices Preferences change and the good or service is perceived to yield fewer benefits than before If scientific studies demonstrated those who consumed pizza had fewer dates than those who did not, we could expect an inward shift of the demand curve Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

8. 1-8 Questions for Thought and Discussion Why do markets show that people demand fewer goods at higher prices? What would happen to demand for the various services and products under the following scenarios? Will the curve shift and in which direction? Oprah Winfrey expresses concern about mad cow disease and beef. What happens to the demand for hamburgers? The National Institute for Health releases a study that shows mandarin oranges reduce the probability of getting cancer. What happens to demand for mandarin oranges? The manufacturers of Frisbees discover a new, less expensive polymer to make Frisbees. What happens to the demand for Frisbees? Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

9. 1-9 Supply Is the schedule of quantities of a good or service that people are willing to sell at different prices In general, the higher the price, the more of a good or service individuals are willing to supply. As price increases so does quantity provided This happens because different producers face different opportunity costs and as the price increases or decreases, producing a good or service becomes more or less attractive to producers at the margins Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

10. 1-10 Supply Schedule Quantity Supplied is a point on the curve Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

11. 1-11 Shifts in Supply Changes in the demand schedule (consumer behavior) moves us along an existing supply schedule (the market with the producers who could respond relatively quickly to consumer behavior) Changes in the cost of factors of production or increases in productivity shift the supply curve Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

12. 1-12 Supply Curve Shift Inwards When a supply curve shifts inwards, businesses will only supply what they did before the shift at higher prices As costs change for businesses, opportunity cost change If the cost of oil hits 100 dollars a barrel that would shift the supply curve in and raise prices for gas assuming demand remains the same Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

13. 1-13 Supply Shift Outwards When a supply curve shifts outwards businesses are willing to supply the same amount that they did before the shift at lower price levels Improvements in technology, lower resource costs, or higher factor productivity can result in this sort of shift If gasoline refiners could find a good substitute for oil to produce gasoline that was less costly, this would result in an outward shift in the gasoline supply curve Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

14. 1-14 Equilibrium Equilibrium price is the price at which quantity demanded equals quantity supplied. A surplus occurs when the market price is above equilibrium price. A shortage occurs when the market price is below equilibrium price. Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

15. 1-15 A Picture of Equilibrium Equilibrium occurs at the point where supply equals demand In others words, costs for the marginal producer equal the benefits of the marginal consumer If price were higher than equilibrium, more producers would want to produce goods or services than consumers would want to consume If the price were lower, more consumers would want to consume goods or services than producers would want to produce Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

16. 1-16 Shifts and Equilibrium If there are shifts in demand or supply a new equilibrium point will be found on the basis of new perceived benefits or changes in costs In this instance a demand driven increase for I phones pushes price up and the quantity of subscriptions up

17. 1-17 Questions for Thought and Discussion Why is equilibrium viewed to be efficient? What happens if price is not at an equilibrium point? What do prices represent to producers and consumers?

18. 1-18 Government and the Market The government may ensures the smooth operation of the markets by protecting property rights, guaranteeing enforcement of legal contracts, and issuing a supply of money that buyers and sellers readily accept Property rights are essential to a free and prosperous nation Government sometimes interferes with the free operation of the markets by Imposing prices floors and price ceilings This creates the problems of shortages and surpluses While governmental interference with the market system can have adverse affects, the government does have a substantial supportive role to play in a market economy.

19. 1-19 Price Floors Sometimes producers do not like the price they are getting for their product They may lobby the government to put in a price floor A price floor results in a surplus being supplied at the higher price Suppliers end up supplying more than consumers want to buy Minimum wage is a classic example of a price floor QE

20. 1-20 Minimum Wage as a Price Floor If you note, workers want to supply QS worth of themselves at 10 dollars an hour Employers want to hire QD at that price The end result is QD workers are hired at 10 dollars an hour Fewer workers are hired with a price floor than would be hired under market equilibrium conditions at a wage rate of 7 dollars an hour

21. 1-21 Who Benefits and Who Is Hurt by the Minimum Wage Everybody who would be making seven dollars an hour but is now getting ten dollars an hour benefits from minimum wage Everybody who would have been employed at seven dollars an hour but is now unemployed at ten dollars an hour is hurt Consumers who could have purchased the good or service produced at a lower price but cannot because of the higher cost of making the good or service are hurt Most economists generally believe efficiency is a good thing and distorting the price mechanism that gives us this efficiency does more harm than good Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

22. 1-22 Questions for Thought and Discussion How do you think price floors for agricultural commodities would impact the market for these commodities? Does the minimum wage help the poor? How do you think the minimum wage impacts your life? Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

23. 1-23 Price Ceilings Sometimes buyers do not like the price they need to pay for a good or service They may lobby government to put a price cap on what sellers can charge A classic example of a price ceiling is rent control Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

24. 1-24 Rent Control as a Price Ceiling When rent control is in place producers can not charge a price above P1. At P1 landlords (producers) are only willing to supply QS but potential renters want QD at this price A shortage results and instead of having QE units of housing rented, only QS units of housing are rented Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

25. 1-25 Who Benefits and Who Is Hurt by Rent Control People who live in rent controlled properties get their housing at bargain prices People looking for housing will have a harder time finding housing and will have to put up with more inconveniences in the housing market because rent control reduces the incentives of business people to provide quality housing options Rent control can misallocate a scarce resource (housing) to people who value the resource less than market value Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

26. 1-26 Questions for Thought and Discussion If price floors and price ceilings are inefficient why do politicians make laws that create these inefficiencies? Can you think of any time when rent control would be a good policy choice for a government? Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

27. 1-27 Gasoline Markets and Price – Hurricane Katrina Case Study Hurricane Katrina and the market solution Temporarily shut down off shore wells Briefly put 10% of our refineries out of commission Result – a sudden drop in oil supply The government took a hands off approach Gasoline prices rose sharply – duh? People could buy all they wanted at sharply increased prices with no wait at the pumps Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

28. 1-28 Gasoline Markets and Price: Oil Embargoes and a Government Response Case Study Oil crises in the 1970s Middle east countries curtailed oil shipments to the United States Resulted in reduced oil supply Governments solution – restrict purchases and hold down prices The result – long gas lines in many parts of the country People paid less but waited much longer to purchase gas at moderately higher prices (sometimes one to two hours) Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

29. 1-29 Summation of Market Outcomes to Reduction in Supply Short Run Prices Rise Many people cut back on their driving Long Run People buy more gas efficient cars Higher prices encourage greater exploration for oil Higher prices encourage the development of alternative energy sources Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

30. 1-30 Summation of Government Intervention Solution to Supply Reduction Short Run Prices are held down or climb slowly People cut back on their driving very little if any Significant waits at the gas pumps occur and time becomes the rationing method for gasoline Long Run People have little incentive to buy more gas efficient cars Lower prices discourage greater exploration for oil Threat of government interference in energy sector discourages the development of alternative energy sources Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

31. 1-31 Closing Comments Most economists probably believe price ceilings do more harm than good in the long run Most people probably think in the short run and want government to do something about higher prices Government probably is inclined to get involved Corporate greed probably can and will influence government actions The result... who knows? But past history indicates it probably wont be good for the consumer Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

32. 1-32 Questions for Thought and Discussion Was allowing the price mechanism to allocate gas more fair than forcing people to wait in lines or buy gas on days based upon the numbers on their license plates? Would corporations have incentives to lobby the government for price floors or ceilings? Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.