1. Market Model Supply and Demand

2. Markets Institutions that allow buyers and sellers to exchange Demand Supply Examples Posted-price Haggling Auctions Equilibrium Price/Quantity

3. Demand Curve Demand: how much consumer are willing and able to buy at different prices Dew Auction

4. Market Equilibrium quantity price D1D1 S1S1 P1P1 Q1Q1 At P 1 : Q d = Q s The market clears Note: Change in Quantity Demanded: movement along curve Change in Demand: shift of entire curve

5. quantity price D1D1 S1S1 P1P1 Q1Q1 P Hi P Lo QsQs QdQd Surplus QdQd QsQs Shortage Market Disequilibrium At P Hi : Q d < Q s Surplus Pressure on price to fall At P Lo : Q d > Q s Shortage Pressure on price to rise

6. Demand Shifters Preferences Population Income Normal goods Inferior goods Price of Related Goods Substitutes Complements Expectations Preferences Population Income Normal goods Inferior goods Price of Related Goods Substitutes Complements Expectations If income rises, demand rises If income rises, demand falls If P x rises, demand for Y rises If P x rises, demand for Y falls

7. Supply Shifters Number of firms Cost of inputs Technology Expectations Number of firms Cost of inputs Technology Expectations

8. In the fall of 1903 Ohio Tech students for the first time had to pay to attend university football games; as a result, every game had many empty seats. This decline in attendance suggests that: a)the demand for football games declined. b)attending football games is an inferior good. c)attending football games is a normal good. d)the quantity demanded of football games fell. a)the demand for football games declined. b)attending football games is an inferior good. c)attending football games is a normal good. d)the quantity demanded of football games fell.

9. A newspaper story recently reported that the price of new cars has increased, and the quantity of new cars sold has dropped. The price and quantity changes were probably caused by: a)a decrease in buyers' incomes. b)an increase in buyers' incomes. c)an increase in production costs. d)a decrease in production costs. a)a decrease in buyers' incomes. b)an increase in buyers' incomes. c)an increase in production costs. d)a decrease in production costs.

10. Consider the market for computers. Suppose that the price of plastic decreases and the income of consumers decreases. What may we conclude about the equilibrium price and quantity of computers? a)price will fall and quantity is indeterminate. b)quantity will rise and price is indeterminate. c)quantity will rise and price will rise. d)both price and quantity will be indeterminate. a)price will fall and quantity is indeterminate. b)quantity will rise and price is indeterminate. c)quantity will rise and price will rise. d)both price and quantity will be indeterminate.

11. Elasticity adding (quantitative) meat to the bones of supply and demand

12. Suppose the price of gas rises by 10% over the next month. By how much will Ohio drivers cut back on their purchases of gasoline? a) 0 percent (no cut back) b) 1 to 5 percent c) 6 to 10 percent d) 11 to 20 percent e) More than 20 percent a) 0 percent (no cut back) b) 1 to 5 percent c) 6 to 10 percent d) 11 to 20 percent e) More than 20 percent

13. Price Elasticity of Demand Measures the price sensitivity of buyers E d = $ Gasoline $2.50 $2.00 280300 D %ΔQ%ΔQ %ΔP%ΔP

14. Midpoint Formula E d = = E d = = -0.32 Degree of Sensitivity Elastic: |E d | > 1 Unit: |E d | = 1 Inelastic: |E d | < 1 $ Gasoline $2.50 $2.00 280300 D %ΔQ%ΔQ %ΔP%ΔP

15. a) -1.57; inelastic b) -1.57; elastic c) -0.64; inelastic d) -0.64; elastic a) -1.57; inelastic b) -1.57; elastic c) -0.64; inelastic d) -0.64; elastic When the price of an iPod Nano is $130, consumers buy 500 units per week. When the price rises to $150, consumers buy only 400 units per week. What is the midpoint elasticity of demand and how would you classify it? E d = E d = -.22/.14 = -1.57

16. Determinants of Elasticity Number of substitutes The greater the # substitutes, the greater the elasticity The narrower the definition of the market, the greater the elasticity Items share of consumer budget The greater the share of budget, the greater the elasticity

17. D1D1 D2D2 gasoline $ P0P0 Q0Q0 P1P1 Q1Q1 Q2Q2 short run long run Time: Short Run v. Long Run The longer the time horizon, the greater the elasticity Gasoline Demand: E LR > E SR Determinants of Elasticity

18. Perfectly Inelastic E d = Examples? Perfectly Elastic E d = Examples? $ Q $ Q D1D1 P1P1 P2P2 Q1Q1 D1D1 P1P1 0 Extreme Cases of Price Elasticity

19. Good Price elasticity Inelastic demand Eggs - 0.10 Beef - 0.40 Stationery- 0.50 Gasoline - 0.50 Elastic demand Housing - 1.20 Restaurant meals - 2.30 Airline travel - 2.40 Foreign travel - 4.10 Good Price elasticity Inelastic demand Eggs - 0.10 Beef - 0.40 Stationery- 0.50 Gasoline - 0.50 Elastic demand Housing - 1.20 Restaurant meals - 2.30 Airline travel - 2.40 Foreign travel - 4.10 Some Estimated Price Elasticities of Demand

20. Suppose that the price elasticity of demand for a Marietta College education is estimated to be E = -0.80. Based on this information, if the college were to raise tuition by 5%, then: a)enrollment will fall by 6.25% and tuition revenues will increase. b)enrollment will fall by 4% and tuition revenues will increase. c)enrollment will fall by 6.25% and tuition revenues will decrease. d)enrollment will fall by 4% and tuition revenues will decrease. a)enrollment will fall by 6.25% and tuition revenues will increase. b)enrollment will fall by 4% and tuition revenues will increase. c)enrollment will fall by 6.25% and tuition revenues will decrease. d)enrollment will fall by 4% and tuition revenues will decrease.

21. Elasticity and Total Revenue $ Computers $1200 $1000 100200 D TR = $120,000 TR = $200,000 400500 $600 $400 E = - 3.67 E = - 0.56 TR = P x Q TR = $240,000 TR = $200,000

22. Elasticity and Total Revenue Elastic Demand P x Q = TR Inelastic Demand P x Q = TR TR = P x Q E d = Quantity effect dominatesPrice effect dominates

23. Suppose that the price elasticity of demand for a Marietta College education is estimated to be E = -0.80. Based on this information, if the college were to raise tuition by 5%, then: a)enrollment will fall by 6.25% and tuition revenues will increase. b)enrollment will fall by 4% and tuition revenues will increase. c)enrollment will fall by 6.25% and tuition revenues will decrease. d)enrollment will fall by 4% and tuition revenues will decrease. a)enrollment will fall by 6.25% and tuition revenues will increase. b)enrollment will fall by 4% and tuition revenues will increase. c)enrollment will fall by 6.25% and tuition revenues will decrease. d)enrollment will fall by 4% and tuition revenues will decrease.

24. According to recent studies at M.I.T. and the University of Michigan, a 10% increase in the price of cigarettes leads to a 14% drop in sales to teenagers. What is the elasticity of demand for cigarettes among teenagers? Would you expect it to be this high for older smokers? Explain. a)-0.71 b)-1.40 c)+1.40 d)+0.71 a)-0.71 b)-1.40 c)+1.40 d)+0.71

25. Other Demand Elasticities Cross-Price Elasticity E xy = Income Elasticity E I = Substitutes: E xy > 0 Complements: E xy < 0 Normal Goods: E I > 0 Inferior Goods: E I < 0

26. Examples of cross-price elasticities CommodityWith respect to price of Cross-Price elasticity BeefPork 0.28 ButterMargarine 0.67 ElectricityNatural gas 0.20 Natural gasFuel oil 0.44 ClothingFootwear- 0.01 Dairy productsMeat products- 0.15 EntertainmentFood- 0.72

27. Examples of income elasticities CommodityIncome elasticity Automobiles2.46 Furniture1.48 Restaurant Meals1.40 Water1.02 Tobacco0.64 Gasoline0.48 Margarine-0.20 Pork-0.20 Public transportation-0.36

28. In August 1990, East German taxicab drivers were on strike demanding lower cab fares. What must the drivers have believed about the price elasticity of demand for taxi rides? a)The demand was elastic. b)The demand was inelastic. c)The demand was perfectly elastic. d)The demand was perfectly inelastic. a)The demand was elastic. b)The demand was inelastic. c)The demand was perfectly elastic. d)The demand was perfectly inelastic.

29. Market Efficiency Invisible Hand Theorem Adam Smith: Wealth of Nations (1776) Competitive, free markets will maximize social welfare Social Welfare = ? It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages....every individual…neither intends to promote the public interest, nor knows how much he is promoting it…he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention…By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. Adam Smith

30. Consumer Surplus Net gain to consumers from buying at a single price CS = Buyer Value - Price Demand quantity 5 $50 Buyer Values (or WTP) Price $25 1 Consumer Surplus Total Expenditure Market price

31. Net gain to sellers from selling at a single price PS = Price – Seller Cost Producer Surplus Supply quantity Price 3 $25 Total Cost Producer Surplus Seller Costs $10 Market price

32. Which of the following is an example of consumer surplus? a)Holly buys a hamburger for $2 and tells you she would not have paid a penny more. b)Youtian believes the price he paid for his computer was too high. c)Willy buys a paper tablet for $2 and finds the same good at another store for $1.50 d)Katelyn would have paid $20 for a new compact disc but paid only $15. a)Holly buys a hamburger for $2 and tells you she would not have paid a penny more. b)Youtian believes the price he paid for his computer was too high. c)Willy buys a paper tablet for $2 and finds the same good at another store for $1.50 d)Katelyn would have paid $20 for a new compact disc but paid only $15.

33. Social Welfare CS Free Market Outcome: P*, Q* Maximizes social welfare: SW = CS + PS Free Market Outcome: P*, Q* Maximizes social welfare: SW = CS + PS Supply Demand quantity Price Q* P* PS Deadweight Loss

34. AdamEve 120 93 55 48 0 Garden of Eden Adam and Eve in the Garden of Eden, by Titian (c. 1550)

35. Which allocation would you choose? 1.Choice One 2.Choice Two 3.Choice Three 4.Choice Four 5.Choice Five AdamEve 120 93 55 48 0 Tradeoff: Efficiency vs. Equity

36. Demand Supply

37. Session 1 Session 2 Session 3 Session 4

38. Government Intervention Why does government intervene? Market failures Monopoly Externalities Public goods Fairness How does government intervene? Price Controls Quantity Controls Regulations Why does government intervene? Market failures Monopoly Externalities Public goods Fairness How does government intervene? Price Controls Quantity Controls Regulations All generate some DWL

39. Price Ceiling: Rent Control Free Market: R 1, Q 1 Govt imposes rent ceiling at R 0 At R 0 : Q D > Q S shortage Non-Price Rationing? Black Market (Bribes) Discrimination Wait / Search Lottery Free Market: R 1, Q 1 Govt imposes rent ceiling at R 0 At R 0 : Q D > Q S shortage Non-Price Rationing? Black Market (Bribes) Discrimination Wait / Search Lottery Apartments Rent D1D1 S1S1 R1R1 Q1Q1 R0R0 QSQS QDQD Shortage RFRF DWL

40. Other Examples of Price Ceilings Gasoline (1970s) Usury laws Diagnostic Related Groups (DRGs) Nominal Price Real Price

41. In 1979 a revolution overthrew the government of Iran, disrupting oil production and causing the price of crude oil to increase by 300 percent. In most of the world, which did not have price controls, this price increase: a)led to severe shortages of gasoline b)did not lead to shortages c)led to substantial surpluses d)did not affect supply or demand for gasoline substantially

42. Fair Labor Standards Act (1938) 1938: $0.25 2009: $7.25 Price Floor: Minimum Wage Ohios minimum wage went up to $7.30 this past January

43. States with minimum wage rates higher than the Federal rate States with minimum wage rates the same as the Federal rate States with minimum wage rates lower than the Federal rate States with no minimum wage law As of January 1, 2010

44. minimum wage in 2010 dollars minimum wage in current dollars

45. Minimum Wage Relative to the Average Hourly Wage Rate 1965-2010

46. Characteristics of Minimum Wage Workers, 2009 At or Below $7.25Total # Hourly Workers3.6 million72.6 million % Employment4.9%100% Gender Male Female 38.0 62.0 48.5 51.5 Race White Black Hispanic Asian 80.0 13.9 17.4 3.3 80.7 12.8 17.5 3.7 Age 16-19 25 + 22.9 51.4 6.1 80.2 Hours of Work Part-time Full-time 63.9 35.6 27.6 72.2 Occupation Sales Service 20.5 63.0 27.4 24.4 Industry Retail Leisure & Hospitality Manufacturing 14.9 51.6 3.0 14.4 12.2 11.5 Education Less than HS HS only BA + 29.0 30.9 8.3 14.1 35.4 16.2 140m

47. 2009 Poverty Guidelines (48 Contiguous States and DC) Persons in FamilyPoverty Threshold 1$10,830 2$14,570 3$18,310 4$22,050 5$25,790 6$29,530 7$33,270 8$37,010 For families with more than 8 persons, add $3,740 for each additional person. Source: http://aspe.hhs.gov/poverty/09poverty.shtml

48. Labor Market Free Market: W 1, Q 1 no unemployment: Q D = Q S (full-time income?) Govt imposes min. wage at W 2 at W 2 : Q D < Q S Unemployment occurs How can employers offset impact? Reduce hours of work Reduce fringe benefits Raise price Reduce quality Hire illegal aliens Free Market: W 1, Q 1 no unemployment: Q D = Q S (full-time income?) Govt imposes min. wage at W 2 at W 2 : Q D < Q S Unemployment occurs How can employers offset impact? Reduce hours of work Reduce fringe benefits Raise price Reduce quality Hire illegal aliens Labor Wage D1D1 S1S1 Q1Q1 W 2 = $7.25 unemployment new entrantslayoffs W 1 = $6 QDQD QSQS WB DWL

50. Suppose that the equilibrium wage in the low-skilled labor market is $8.00. Further, suppose the federal government raises the minimum wage to $7.75 an hour from its present level of $7.25. The governments action of increasing the minimum wage will result in: a)a decrease in unemployment b)an increase in unemployment c)a shortage of low-skilled labor. d)neither a shortage nor a surplus of labor in the low-skilled labor market. a)a decrease in unemployment b)an increase in unemployment c)a shortage of low-skilled labor. d)neither a shortage nor a surplus of labor in the low-skilled labor market.

51. Agricultural Price Supports Free Market: P 1, Q 1 Govt imposes price floor at P 2 at P 2 : Q D < Q S Surplus of milk results Govt must buy the surplus to keep price at P 2 Cost to taxpayers = P 2 (Q 3 -Q 2 ) Free Market: P 1, Q 1 Govt imposes price floor at P 2 at P 2 : Q D < Q S Surplus of milk results Govt must buy the surplus to keep price at P 2 Cost to taxpayers = P 2 (Q 3 -Q 2 ) Milk $ D1D1 S1S1 Q1Q1 P 2 = $3 P 1 = $2 Q2Q2 Q3Q3 Surplus Free MarketPrice Floor CSA+B+CA PSF+GB+C+E+F+G Tax Payers--(C+E+G+H+I+J) SWA+B+C+F+GA+B+F-H-I-J DWL--C+G+H+I+J A B C E F G H IJ E

52. Taxes Sales Tax: percentage of sales Excise Tax: fixed dollar amount per unit Sin Taxes?

53. Suppose the government imposes a $10 excise tax on the sale of sweaters by charging suppliers $10 for each sweater sold. Based on economic analysis, we would predict that: a)The price of sweaters will increase by $10. b)The price of sweaters will increase by more than $10. c)Consumers of sweaters will bear the entire burden of the tax. d)The price of sweaters will increase by less than $10. e)(a) and (c) are true. a)The price of sweaters will increase by $10. b)The price of sweaters will increase by more than $10. c)Consumers of sweaters will bear the entire burden of the tax. d)The price of sweaters will increase by less than $10. e)(a) and (c) are true.

54. Excise Tax: Cigarettes Free market: P = $4.00 Q = 27.4 b Consumer Spending $110 b Govt imposes tax = $1/packtax Supply shifts upward by $1 Price rises (by less than $1) Quantity falls cigarettes price D1D1 S1S1 4.00 27.4 S2S2 4.40 3.40 tax = $1 buyer pays seller keeps 25.8 Tax Revenue (Billions of packs) Assume that E D = -0.60 E D = = -0.60 Economic burden of tax is split between buyers and sellers %ΔQ D = - 6.0%

59. Suppose the government imposes a $10 excise tax on the sale of sweaters by charging suppliers $10 for each sweater sold. Based on economic analysis, we would predict that: a)The price of sweaters will increase by $10. b)The price of sweaters will increase by more than $10. c)Consumers of sweaters will bear the entire burden of the tax. d)The price of sweaters will increase by less than $10. e)(a) and (c) are true. a)The price of sweaters will increase by $10. b)The price of sweaters will increase by more than $10. c)Consumers of sweaters will bear the entire burden of the tax. d)The price of sweaters will increase by less than $10. e)(a) and (c) are true.

60. In the figure below, the amount of tax revenue is: a)$2000 b)$4000 c)$6000 d)$8000 a)$2000 b)$4000 c)$6000 d)$8000

61. Quantity Controls Quotas International trade: agricultural goods, textiles Taxis, liquor licenses Prohibition What goods and services are illegal to trade? Why prohibit trade? Victimless crime? Immoral? Externalities? Drugs Prostitution Body organs Babies Guns Exotic animals Gambling

62. War on Drugs Intrinsic Effects Health Damages Spousal/Family abuse DUI Lower worker productivity Black Market Effects Crime Property Murder Overdose Uncertain product quality Binge consumption Clogged prisons Corruption Reduced civil liberties Tradeoff: Intrinsic Effects v. Black Market Effects Alcohol: 125m users-----85,000 annual deaths Tobacco: 70m users-----400,000 annual deaths Marijuana: 15m users-----0 annual deaths Cocaine: 2m users---- Heroin: 0.2m users---- 17,000 annual deaths

63. Marijuana Market Prohibition: P 1, Q 1 Legalization: P 2, Q 2 Consumption will rise (how much?) Prohibition: P 1, Q 1 Legalization: P 2, Q 2 Consumption will rise (how much?) Marijuana (lbs.) price D1D1 S1S1 $2500 = P 1 Q1Q1 S2S2 Q2Q2 P2P2 Tradeoff: > More intrinsic costs > Less black market effects Tradeoff: > More intrinsic costs > Less black market effects What happens in the market for substitutes? What happens in the market for complements? What happens in the market for substitutes? What happens in the market for complements?

64. a)the price of the good falls as does the quantity purchased. b)the price of the good falls, but the quantity purchased may increase or decrease. c)the price of the good rises, but the quantity purchased may increase or decrease. d)the quantity purchased of the good decreases, but the price may rise or fall. a)the price of the good falls as does the quantity purchased. b)the price of the good falls, but the quantity purchased may increase or decrease. c)the price of the good rises, but the quantity purchased may increase or decrease. d)the quantity purchased of the good decreases, but the price may rise or fall. When a government imposes penalties on both sellers and buyers of an illegal good,