© 2000 Claudia Garcia-Szekely 1 Supply Claudia Garcia-Szekely.

© 2000 Claudia Garcia-Szekely 1

Supply

Claudia Garcia-Szekely

2

Perfectly Competitive Producers are Price Takers

•Do not set prices.•Take prices as a given.

The supply curve tells us how producers react to

different prices

3

Quantity Supplied The number of units of a

good that a firm would be willing and able to offer for sale at a given price during a given time period


Factors Determining a Firm’s Quantity Supplied:

The price of the product ONLY!All other factors affecting

production are assumed to remain constant.

5

The Law of Supply

There is a positive relationship between the QUANTITY SUPPLIED and the price.

Price

Quantity Supplied

5

4

3 7

Supply

Th

e h

igh

er

the p

r ic e

The more units will be brought for sale

6

Soybean Supply Schedule

Price

per bushel

$ 1.50

1.75

2.25

3.00

4.00

Bushels

per year

0

10,000

20,000

30,000

45,000

$4.00

30

$3.00

$2.25

$1.75

$1.50

4020100

Quantity supplied (1,000s)

PriceS

50

7

Soybean Supply

Change in price from $1.75 to $2.25 cause a change in quantity supplied from 10 to 20 units.

Price$4.00

30

$3.00

$2.25

$1.75$1.50

4020100

Quantity supplied (1,000s)

S

50

8

Supply in Output Markets

A firm’s decision about what quantity of a product to supply depends on a number of factors...

9

Factors Determining Firm Supply

1. COST of producing the product (Prices of required inputs)o The firm would need to receive a higher price for

each unit sold in order to cover higher costs.

2. Environmental Conditionso Weather, insects, natural disasters

3. Technology used to produce the producto If more output can be produced from the same

amount of inputs, manufactures will supply more of the good at every price.

10

Factors Determining Firm Supply

4. Taxes levied on producerso Act as an increase in cost of production.

5. Expectationso Threat of trade restrictions on wheat and rice

exports to Cuba, Iran, Iraq, Libya, and North Korea (the largest importers of these US crops).

6. Prices of other goodso Substitutes in production – goods for which

producing more of one implies producing less of the other: Different types of crops: opium and rubber, tea and other crops.

o Complements in production – pairs of goods that must be produced together: beef and leather,

11

Changes in Quantity Supplied vs. Changes in Supply:

Changes in quantity supplied imply movement along a supply curve.

Changes in supply imply a shift in the entire supply

curve.

The result of a change in market price

The result of a change in costs, expectations, taxes, environment, technology, prices of other

goods

12

From the Firm’s Supply to the Market Supply

The supply of a good or service can be defined for an individual firm, or for a group of firms that make up a market or an industry.

13

Market Supply• The sum of the quantities

supplied by all the firms in the market.

• Is the horizontal sum of the individual firms’ supply curves.

14

Draw the Market Supply

1

3

2

10 30 50 100 200 30 50 10020

15

Choose the arrow that best represents the effect

a

h

d

cb

e

f

g

a. Increase in demand

b. Increase in quantity demanded

c. Decrease in quantity demanded

d. Decrease in demand

e. Increase in quantity supplied

f. Increase in supply

g. Decrease in supply

h. Decrease in quantity supplied

16

1. Chemical companies discover a new, more efficient technology for producing benzene (It is used as an additive in gasoline, and in the production of drugs, plastics, synthetic rubber, and dyes) How would this affect the supply of benzene?

2. The high prices of grain have increased the costs of dairy farmers and beef producers. How would this affect the supply of beef and milk?

3. The price of mozzarella cheese falls. What is the effect on supply of pizza.

4. Oil producers expect prices to triple by the end of next month on news of impending war between Iran and Iraq. What is the effect on supply of oil TODAY?

5. "Seven years after a two-day freeze devastated the Florida citrus crop, growers in the state are expecting their biggest crop ever, in large part because trees planted after that freeze are maturing and bearing fruit." How would this affect the supply of oranges?

6. New legislation increasing the minimum wage comes into effect. Increases in minimum wage tend to cause a wave of increases through the salary scale (wages are a cost of production). How would this affect the supply curve in the garment industry?

7. The price of jet fuel rises (a cost of production). How would this affect the supply of airplane trips?

8. Assume that farmers can easily switch from growing coffee to growing coca leaves. The price of coffee decreases to record low levels. How would this affect the supply of coffee? And the supply of coca?

9. An increase in corn prices increases the cost of production of ethanol (a liquid fuel made from corn or other agricultural products such as sugar cane ). How would this affect the supply of ethanol?

10.How would a natural disaster like Katrina affect the supply of gasoline in the U.S?

11.An insect that is resistant to currently used pesticides has infested the cotton crop. How would this affect the supply of cotton?

19

12. A fertilizer that increases the yield per acre of tobacco is discovered. What is the effect on supply of tobacco.

13. Wages of steel workers fall. What is the effect on supply of steel?

20

a

h

d

cb

e

f

g

21

Prices are Determined by Supply and Demand

Price Changes are the RESULT of either a change in supply alone, a change in demand alone or a simultaneous change in both demand and supply .


Market Equilibrium• The condition that exists when the

quantity firms want to sell is equal to quantity consumers want to purchase.

• Equilibrium is characterized by a price and a quantity.

• At equilibrium, there is no tendency for the market price to change.

23

Equilibrium may be good or bad…

25

Consider the market for Soybeans

P

0

Want to buy

Want to sell

35

$3.50

4525

$1.50

$2.50

Excess Demand

Excess Supply

EQUILIBRIUM

25 45

Demand

Supply


Excess Demand

The condition that exists when quantity demanded exceeds quantity supplied at the current price

27

Pri

ce

QuantityDemanded

QuantitySupplied

Supply

DemandShortagePo

A Shortage

5030

20

Shortages occur because the price

is “too” low

28

The Effect of a Shortage

QuantityDemanded

QuantitySupplied

S

DPo

Shortage

P1

Q Supplied=Q demanded

Q demanded decreases

Q supplied increases

Shortage eliminated

A shortage causes a

price increase

20

Q Supplied=Q demanded504030


Excess Supply

The condition that exists when quantity supplied exceeds quantity demanded at the current price.

30

Pri

ce

QuantityDemanded

QuantitySupplied

Supply

DemandSurplus

Po Surplus

A SurplusA surplus

occurs because the price is “too”

high

31

The Effect of a Surplus

QuantityDemanded

QuantitySupplied

Supply

Demand

Po Surplus

P1

Surpluscause

a price drop

Q Supplied=Q demanded

Q demanded increases

Q supplied decreases

Surplus eliminated

32

D

S

300

40

280

320

340

20

260

60

1. Identify the equilibrium price and quantity:

Price = __;Quantity = ___2. If the price is $280 is the

market in equilibrium? Will there be a surplus or a

shortage? 3. If so, what is the size of

the surplus or shortage? 4. Given your answer to the

previous question, will you expect the price to increase or decrease? Answer. In one or two sentences explain why?

33

1.Fill in the values for the Market Supply and the Market Demand 2.Find the equilibrium price and quantity: Price = ______;Quantity = _____ 3.If the price is $280 is the market in equilibrium? 4.Will there be a surplus or a shortage? 5.If so, what is the size of the surplus or shortage? 6.Given your answer to the previous question, will you expect the price to increase or decrease?. In one or two sentences explain why?

A&E's Supply of

good X

Bob's Supply of

good X

Rose Inc. Supply of

good XMarket Supply

Kyle's Demand

for good X

Ann's Demand

for good X

Jason's Demand

for good X

Mark's Demand

for good XMarket DemandPrice of X

120 0 0 0 100 35 25 20

160 20 10 10 95 30 20 15

200 30 20 30 90 25 15 10

240 60 25 35 85 20 10 5

280 80 35 45 75 17 5 3

320 95 40 65 65 10 3 2


Changes in EquilibriumPrice and Quantity

When Demand and/or Supply shift, a surplus or a shortage appears.

Surpluses and shortages cause changes in equilibrium price.

The market equilibrium price and quantity will

change when demand and/or supply SHIFT.

35

Consider the market for coffee in equilibrium.

Price per pound

0 Pounds

D

S

$1.20

13.2

What will happen to the equilibrium price and quantity of coffee exchanged?

A severe freeze in coffee

producing Brazil

36

Moving to a new equilibrium:

Price per pound

0 Pounds

D0

S0

$1.20

13.2

Supply shifts left

$2.40

9.9

Shortage

A shortage appears

Price increases

Quantity exchanged decreases

S P QS1

37

Consider the market for coffee in equilibrium.

Price per pound

0 Pounds

D0

S0

$1.20

13.2


Starbucks invents the very

popular cold coffee drinks

38


0 Pounds

S$2.20

13.2

Demand shifts right

$1.20 A shortage appears

Price increases

Quantity exchanged increases

D P Q

14

Shortage

D1D0D0

39

Consider the market for coffee.

Price per pound

0 Pounds

D

S

$1.20

13.2

Newspaper headline: “Coffee

contaminated with

poisonous chemical”


40


0 Pounds

S

$0.90

13.2

Demand shifts left $1.20

A surplus appears

Price decreases

Quantity exchanged decreases

D P Q

10

Surplus

D1

D0D0

41

Consider the market for coffee.

Price per pound

0 Pounds

D

S

$1.20

13.2

Unusually good

weather increases the size of the coffee

crop


42


0 Pounds

S0

$1.20

15

Supply shifts right

$0.9

A surplus appears

Price decreases

Quantity exchanged increases

S P Q

13.2

D0

S1Surplus

43

Applications

• Exchange Rates• Unemployment• Rent Control

44

What would cause the following

Quantity drops and price dropsQuantity increases and price dropsQuantity drops and price increasesQuantity increase and price

increases

45

Use Supply and Demand to Explain:

• Why do roses cost more on Valentine’s day than during the rest of the year?

• Why do TV ads cost more during the Super Bowl than during the rest of the year?

• Why do hotels in Phoenix cost more in February than in August?

• Why do engineers earn more than social workers?

46

Your answer and graph must include:1. Changes in supply and/or demand if

any2. Whether the shift causes a surplus

or a shortage? Identify surplus/shortage in your graph.

3. Effect of the surplus/shortage on equilibrium price

4. Effect on equilibrium quantity.Remember your graph must be

properly labeled. Showing clearly the original situation and the new situation.

47

1. A sharp increase in the price of beef leads many consumers to switch from beef to chicken.

2. A bumper grain crop cuts the cost of chicken feed in half.

3. Extraordinary cold weather destroys a significant number of chickens

4. A sudden interest in Eastern religions converts many chicken eaters to vegetarians.

5. Increases in income and population.

48

When both supply and demand increase

0

S0

$1.20

15

$0.9

13.2

D0

S1Surplus

0

S0$2.20

13.2

$1.20

14

Shortage

D1D0

S P Q

D P Q

Effect on price is

indeterminate

Quantity increases

P? Q

49

When both supply and demand decrease

D0

D P QP? Q

0

D

S

$1.20

13.2

$2.40

9.9

Shortage

Effect on price is

indeterminate

S P Q

0

S

$0.90

13.2

$1.20

10

Surplus

D1

Quantity decreases

50

When supply increase and demand decrease

0

S0

$1.20

15

$0.9

13.2

D0

S1Surplus

D0

D P QQ?P

0

S

$0.90

13.2

$1.20

10

Surplus

D1

S P Q Effect on quantity is

indeterminate

Price decreases

51

When supply decrease and demand increase

0

D

S

$1.20

13.2

$2.40

9.9

Shortage

S P Q

0

S0$2.20

13.2

$1.20

14

Shortage

D1

D P Q

Price increases

P

Effect on quantity is

indeterminate

Q?

52

In two separate graphs, show the effect of these two events. In each graph, show the following:

1. Changes in supply and/or demand if any

2. Whether the shift causes a surplus or a shortage? Identify the surplus/shortage in your graph.

3. Effect of the surplus/shortage on equilibrium price

4. Effect on equilibrium quantity.

Put these effects together and write your answer.

Remember your graphs must be properly labeled. Showing clearly the original situation and the new situation.

53

1. A sharp increase in the price of beef leads many consumers to switch from beef to chicken. High prices of grain have increased the costs of raising chickens. How would this affect the market for chicken?

2. ``Alaska is awash in salmon. Huge fish runs have been building here, adding to the growing output from sources like Chilean fish farms and Russian fishing fleets.'' News report warns consumers of possible salmon contamination: “Widespread contamination of salmon with toxic mercury cast a shadow over the nutritional benefits of fish.” How would this affect the market for salmon?

3. New legislation decreasing the minimum wage comes into effect. A successful “buy American” campaign shifts consumers’ preferences towards clothes made in America. How would this affect the garment industry in the U.S.?

4. A two-day freeze over the weekend devastated the Florida citrus crop. Growers in the state are expecting their smallest crop ever. The new wave of diets low in carbohydrates has reduced consumption of orange juice. How would this affect the market for oranges?

Use Supply and Demand to Explain:

Through the 1980s, enforcement apparently became much tougher, and the risk of being imprisoned as the result of being a regular dealer probably

quintupled. Yet prices fell by about half.

54

55

Role of Government in Financial Markets

In addition to imposing capital controls and regulating interest rates, the government controls both

• the set of firms that can sell equity on the domestic or foreign stock markets,

• the amount they can sell. – One reason behind the sell-off in China was speculation that

Beijing would impose a capital gains tax or other measures to rein in the surging market and economy, which grew 10.7 percent in 2006.


Consumer Surplus

The difference between the price you actually pay and the price you are willing to pay for one unit.

57

Willingness to Pay

D

1

10W

illi

ngn

ess

to p

ay

2 3

8

6

$10 for one unit

$8 for the second unit

$6 for the third unit

$24$24

58

Willingness to Pay

D

60

0.55

60 60

0.45

0.35

Consumer Surplus = 81 – 63= 18

If the price is $0.35

$33$27

$21$81

Consumer Actually

pays $0.35 x 180 = $63

59

Willingness to Pay

D30

0.55

30 30

0.45

0.35

Consumer Surplus

If the price is $0.35

0.60

0.50

0.40

Consumer Actually

pays

60

The Demand Curve for Long Distance Service

D

Wil

lin

gnes

s to

pay

$ 0.65 for the first minute $ 0.64 for the second minute

$ 0.63 for the third minute etc…

1 Minute intervals

0.650.640.63

Area below

the demand

line

3 hours

D60

0.55

60 60

0.45

0.35

$33$27

$21

D30

0.55

30 30

0.45

0.35

0.60

0.50

0.40

D1 Minute intervals

0.650.640.63

3 hours

62

Consumer surplus in a Perfectly Competitive market:

D

Units of output, Q

Supply = Cost

Q = 4000

Consumer Surplus

10

5

2

63

Consumer surplus in a Perfectly Competitive market:

D

Units of output, Q

Supply = Cost

Q = 4000

CS = Area of triangle

10

5

2

Triangle Area = Base x Height x ½Triangle Area = 4000 x (10-5) x 1/2


Producer Surplus

The difference between the per unit price the producer

receives and his/her per unit cost.

65

Producer Surplus

S = Cost

2

4

6

1 2 3

If The market price is $6

Producer Surplus = 18 – 12 = 6

Cost=12

TR = $18

PS = 6

66

Producer Surplus under Perfect Competition

D

MR

MC

2000Qm

4000Qpc

C S

Lost CS

P SPS

10

5

2

67

Producer Surplus under Perfect Competition

D

MR

MC

2000Qm

4000Qpc

C S

Lost CS

P SPS = Triangle Area

10

5

2

Triangle Area = Base x Height x ½Triangle Area = 4000 x (5-2) x 1/2

68

Perfect Competition

D

Q

$

MC

Qe=4000

C S

P S

10

5

2

69

When a shortage occurs…

D

Q

S

P=$3

C S

P S

Qd =6000

Shortage

Qs =2000

CS

PS

Consumer surplus when

only 2000 units are purchased

due to shortage

4000

Lost consumer and producer surplus when

only 2000 units are purchased and sold at

$3

Producer surplus when only 2000

units are purchased due to

shortage

Producer surplus when 4000 units are purchased at

equilibrium

Consumers purchase 2000 at

$3 per unit

Consumer surplus when 4000 units are purchased at

equilibrium

10

5

2

70

The Effect of a Price Ceiling

D

S

600

3,900

2,200

CS

300

CS

Gain to consumerLoss to Consumer7,300

1000

7,000

900

71

PS

The Effect of a Price Ceiling

D

S

PS

Loss to Producer

3,900

2,200

600300

1000

7,3007,000

900

72

CS

A subsidy to Consumers and a Tax to Producers

Loss to Producer

D

S

600

3,900

2,200

300

CS

PS

Gain to consumer

D

S

600

3,900

2,200

CS

300

73

Welfare Loss From Price Ceiling

D

Q

$

S

P=$2

4

C S

P S$1

CS

PS

Welfare Loss

74

Welfare Loss From Price Ceiling

D

Q

S

$6

40

C S

P S$4

$8

$10

20

$2

75

In 1985 a woman wrote this letter to the New York Daily News: “I recently moved to New York and I pay almost $1,200 a month for a nice little apartment on the lower East Side. When I found out at a tenants' meeting that 30 of the building's 34 apartments rent for below $300 and that most of the tenants in those cheap apartments make more money that I do, I was a bit outraged. I understand protecting the old people, but protecting fellow yuppies with bargains?”

76

The following letter appeared in the New York Times:

Where are the voices of all those who do not share the benefits of rent control but who actually suffer from it?

For the past seven years my husband and I have been killing ourselves to pay our exorbitant market rent for a small one-bedroom apartment in order to stay in this city. I know too many people who live in rent-controlled apartments who also own country homes. One person (whose apartment we tried to rent at the legal rate) moved to Florida and now rents out his apartment, illegally, at the market price, subsidizing his new life style. If rent decontrol would mean a fairer, less insane market, then it is a just cause.

77

Most governments around the world intervene actively in the operation of their agricultural markets.

Governments in poor Third World countries routinely impose price controls to keep food prices artificially low.

They do so to gain favor with their more politically powerful urban residents. Though numerous (and partly because they are numerous), peasant farmers do not organize politically and therefore have much less political power than their urban brethren.

The irony of this situation is that by artificially depressing the price of food, Third World governments reduce incentives for farmers to produce and reduce the availability of food from domestic sources.

78

When a surplus occurs…

D

Q

SP=$8

C S

P S

Qs =6000

Surplus

Qd =2000

PS

Consumer surplus when

only 2000 units are purchased due to price

above equilibrium

4000

Producer surplus when only 2000

units are sold due to price above

equilibrium

Producer surplus when 4000 units are purchased at

equilibrium

Consumers purchase 2000 at

$8 per unit

Consumer surplus when 4000 units are purchased at

equilibrium

Lost consumer and producer surplus when

only 2000 units are purchased and sold at

$8

10

5

2

79

The Effect of a Price Floor on Consumer Surplus

D

S

4

2

CS

2

3Loss to Consumer

CS

6

80

PS

The Effect of a Price Floor on Producer Surplus

D

S

4

2

2

3Loss to Producer

PS

Gain to Producer

6

81

D

S

4

2

CS

2

3CS

PS

D

S

4

2

2

3

PS

A subsidy to Producers and a Tax to Consumers

Loss to Consumer

Gain to Producer

82

D

S

4

2

CS

2

3CS

PS

D

S

4

2

2

3

PS

Loss of Surplus to Society

Loss to Consumer

Loss to Producer

83

Welfare Loss from Price Floor

D

Q

$

S

P=$2

4

$5C S

P SP SWelfare

Loss

C S

84

Welfare Loss from Price Floor

D

Q

S

50

$8C S

$4

$6

$10

30

$2

85

D

S

30

100

20

40

50

50

10

150

Calculate Consumer and Producer Surplus and welfare loss:1. At equilibrium2. When the government imposes a price floor at $40. This floor is equivalent to a tax on

_____and a subsidy to _________ the size of this tax/subsidy is equal to __________3. When the government imposes a price ceiling at $20. This ceiling is equivalent to a tax

on _____and a subsidy to _________ the size of this tax/subsidy is equal to _________

Figure 1

86

D

S

30

100

20

40

50

50

10

150

Figure 1

87

D

S

15

1000

10

20

25

500

5

1500

Figure 2

Calculate Consumer and Producer Surplus and welfare loss:1. At equilibrium2. When the government imposes a price floor at $20. This floor is equivalent to a tax on

_____and a subsidy to _________ the size of this tax/subsidy is equal to __________3. When the government imposes a price ceiling at $10. This ceiling is equivalent to a tax

on _____and a subsidy to _________ the size of this tax/subsidy is equal to _________

88

Fair Trade Coffee

• Agricultural prices are low because there is overproduction.

• To solve overproduction, only the most efficient farmers should remain in business.

• The market mechanism ensures that only those with lower costs (the most efficient) remain in business.

• If prices are held high artificially, farmers will not have an incentive to leave this industry and find alternatives.

• Fair trade prices perpetuate the surplus…not so good for the farmers after all.

89

Why Price Supports?

• Rural districts have greater political power.– Rural districts tend to have more legislative representatives.

• Farmers are often viewed as disadvantaged. – Rural communities lack many of the amenities that cities have.– Because labor productivity is lower in agriculture than in

manufacturing, wage rates are lower.– Technological change tends to expand agricultural production faster

than consumption, reducing the price of farm products.In 1870, for example, the price of wheat was over eleven dollars per bushel. Today, it is

only about four dollars per bushel, a drop of over 60 percent. Although consumers gain by paying lower prices, the incomes of farmers drop.

• Farm prices are volatile. – Weather conditions, over which farmers have no control, are an

important determinant of how much a farmer harvests in a given year. The resulting variability of production in the face of relatively stable demand causes farm prices, and farmers' incomes, to vary from year to year. This may cause economic hardship for farm families in a bad year

90

Other Forms of Price Supports2. Legislating a minimum legal price below which a

good cannot be sold rarely works. So instead of legislating minimum prices,

governments sometimes try to raise prices artificially by limiting production.

Each farmer may be issued a quota that stipulates how much he can sell in a given year.

This is done with peanuts in the United States and milk in Canada.

Limiting supply can raise market prices as long as government inspectors monitor the market to ensure that no production beyond the quota is sold for a lower price.

Leftward shift in Supply

91

Forms of Price Supports

3. Requiring (or paying) farmers to take land out of production. This "set-aside" approach rarely is very effective at supporting agricultural prices.

Farmers are profit maximizers: they set aside their least productive land first.

Furthermore, a policy that creates artificial scarcity of land induces farmers to intensify their production practices on each acre that remains in production, increasing supply.

Leftward shift in Supply

92

D

Q

S0

$1.5

4020 60

Effect of a Leftward shift in Supply*-

$0.5

$1

Price paid by consumers increasesQuantity decreases

S1

$2

93

Forms of Price Supports4. (Most common) government agency to buy any

quantity of a product offered by the country's farmers at the guaranteed "support price."

A U.S. example is dairy products, which the CCC (Commodity Credit Corporation) buys to support the farm price of milk.

The CCC disposes of the commodities it buys in ways that will not depress the domestic market price.

For example, dairy products are often given away to low-income people, in the school lunch program, and as foreign aid.

A price floor

94

D

Q

S

$1.5

4020

$2

60

Effect of a Price Floor

$0.5

$1

Surplus = 60-20 = 40No transactions allowed below $2

Price paid by consumers increasesQuantity decreases

95

Forms of Price Supports

5. A variant of this policy is designed to stabilize market prices.

The CCC buys grain at the support price, stores it, and releases it back into the market if the market price rises to a prescribed trigger level of, say, 140 percent of the support price.

In this manner the policy protects growers against the risk of low prices but also protects consumers against unusually high prices.

96

D0

Q

S0

$1.5

4020

$2

60

Purchase and Release

$0.5

$1

Government purchase the surplus at $2

D1

If the price in the market rises above $2

$2.5 S1

The government releases the surplus until the price is $2

97

Forms of Price Supports6. The United States currently uses a hybrid approach

to price supports that also involves loans. At harvest the CCC gives grain farmers nine-month

loans equal to their production times the support price. The support price is called the "loan rate."

The CCC accepts the grain as collateral for the loan. • If, during the term of the loan, the market price

rises above the support price, farmers repay the loans with interest and sell the grain in the market.

• If the market price remains at or below the loan rate, farmers forfeit the grain to the CCC, keep the money, and have no further obligation.

98

D0

Q

S0

$1.5

4020

$2

60

Purchase and Release

$0.5

$1D1

If the price in the market falls below $2, the farmer forfeits the grain and does not repay the loan

$2.5

If the price in the market rises above $2, farmers sell their crop at the higher price and repay the loan.

Government loan= Production x $2(support price)

99

Farmers compete against one another for the finite amount of farmland, bidding up its price.

•In this way the value of the price supports is incorporated into land prices. Thus, it is the owners of farmland, and not farmers per se, who are the principal beneficiaries of agricultural price supports.

Price supports cause larger production and smaller consumption (since consumers will buy less of any good as its price rises), resulting in overproduction at the support price.

The only way for the price support agency to get rid of its inventories is to use export subsidies to make them cheap enough that foreigners will buy them: Is subsidizing foreign consumption a proper use of taxpayer money?

•The EC uses this approach for grains. From the mid seventies to early eighties, internal EC grain prices were 150 to 200 percent of the prices at which other countries were willing to buy their grain. Subsidies to agriculture account for over two-thirds of the total EC budget.

Effect of Price Supports

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Will this announcement cause a shift or a Movement Along the Demand Curve?

16.You are watching a national news broadcast. It is reported that a typhoon is heading for the Washington coast and that it will likely destroy much of this year’s apple crop. Your roommate says, “If there are going to be fewer apples available, I’ll bet that apple prices will rise. We should buy enormous quantities of apples now and put them in storage. Later we will sell them and make a killing.”

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1. Equilibrium price is: ______ Equilibrium quantity is __________2. If the price is $20, there would be a (surplus/shortage)_________ of size__________3. Given your answer to #2 above, you expect the price to (increase/decrease/remain the

same) to _________4. Draw a supply and demand diagram showing the effect of an increase in cost of

production. Be sure to label properly old and new values (P0, Q0, P1,Q1 etc), show shortage/surplus and write your answer.

Quiz # 3 Name ___________

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© 2000 Claudia Garcia-Szekely 1 Supply Claudia Garcia-Szekely.

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Transcript of © 2000 Claudia Garcia-Szekely 1 Supply Claudia Garcia-Szekely.