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

MarketsEmphasize voluntary exchangeDetermine the terms of exchangeFacilitate exchange

4

Exchange and Markets

Voluntary ExchangeActs of trading between individuals

that make both parties to the trade subjectively better off

Terms of ExchangeThe prices we pay for the desired items

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Exchange and Markets

Transaction CostThe costs associated with exchangeExamples

Price shopping Determining quality Determining reliability Service availability Cost of contracting

6

Exchange and Markets

The role of middlemenMiddlemen (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

D1

S

P1

Q1

E1

Figure 4-1

9

At price P1 quantitydemanded exceedsquantity supplied—a shortage exists

Shifts in Demand and Supply: Determine Results

Increase Demand with Supply Constant

D1

S

P1

Q1

E1

Q2

D2

Figure 4-1

10

Shifts in Demand and Supply: Determine Results

Increase Demand with Supply Constant

P1

Q1

S

E1

D2

Equilibrium price and quantity increase to P2 and Q2

E2

Q2

P2

D1

Figure 4-1

11

At price P1 quantitysupplied exceedsquantity demanded—a surplus exists.

Q2

D2

S

Shifts in Demand and Supply: Determinate Results

Decrease Demand with Supply Constant

D1

E1

Q1

P1

Figure 4-1

12

Shifts in Demand and Supply: Determinate Results

Decrease Demand with Supply Constant

P1

Q1

SE1

D3

Equilibrium priceand quantity decrease to P3 and Q3

D1

Q3

E3

P3

Figure 4-1

13

S1

Shifts in Demand and Supply: Determinate Results

Increase Supply with Demand Constant

D

P1

Q1

E1

Figure 4-1

14

At price P1 quantitysupplied exceedsquantity demanded—a surplus exists

Shifts in Demand and Supply: Determinate Results

Increase Supply with Demand Constant

P1

Q1

E1

D

Q3

S2

S1

Figure 4-1

15

Shifts in Demand and Supply: Determinate Results

Increase Supply with Demand Constant

P1

Q1

E1

D

Q2

P2

E2

S2

S1Equilibrium price decreases and quantity

increases to P2 and Q2

Figure 4-1

16

At price P1 quantitydemanded exceedsquantity supplied—a shortage exists

Shifts in Demand and Supply: Determinate Results

Decrease Supply with Demand Constant

D

S1

E1

Q1

P1

Q2

S3

Figure 4-1

17

Shifts in Demand and Supply: Determinate Results

Decrease Supply with Demand Constant

P1

Q1

E1

D

S3

S1

Equilibrium price decreases and quantity

increases to P3 and Q3

Q3

P3

E3

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

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Demand Supply Price Quantity

Increase Increase Increase

Decrease Decrease Decrease

Increase Decrease Increase

Decrease Increase Decrease

Demand Supply Price Quantity

Increase Increase Unknown Increase

Increase Decrease Increase Unknown

Decrease Increase Decrease Unknown

Decrease Decrease Unknown Decrease

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.

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The Rationing Function of Prices

When prices cannot adjust non-price rationing occursRationing by queuesRationing by lotteriesRationing by coupons

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The Rationing Function of Prices

The essential role of rationingWith scarcity rationing must occurWe must choose the rationing mechanism:

price or non-pricePrice rationing is the most efficient

Further trades could not occur without making somebody worse-off

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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

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The Policy of Government-Imposed Price Controls Non-Price Rationing Devices

All methods used to ration scarce goods that are price-controlled

Black MarketA market in which price-controlled goods are

sold at an illegally high price

Black Markets

32

The functions of rental pricesPromote the efficient maintenance

and construction of housingAllocate existing housingRation the use of housing

The Policy of Controlling Rents

33

Effects on the existing supply of housingProperty owners cannot recover costs

The Policy of Controlling Rents

Rationing the current use of housingReduces 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 WageLowest 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 goodHuman organsDrugsHospital 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.