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Exploring EconomicsExploring Economics3rd Edition3rd Edition

by Robert L. Sextonby Robert L. SextonCopyright © 200Copyright © 20055 Thomson Learning, Inc. Thomson Learning, Inc.

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A Lecture PresentationA Lecture Presentation

Bringing Supply and Bringing Supply and Demand TogetherDemand Together

Chapter 5Chapter 5

5.1 Market Equilibrium 5.1 Market Equilibrium Price and QuantityPrice and Quantity

The The market equilibriummarket equilibrium is found at the is found at the point at which the market supply and point at which the market supply and market demand curve intersect.market demand curve intersect.

The price at the intersection of the The price at the intersection of the market demand curve and the market market demand curve and the market supply curve is called the supply curve is called the equilibrium equilibrium priceprice. .

The quantity at the intersection of the The quantity at the intersection of the market demand curve is called the market demand curve is called the equilibrium quantityequilibrium quantity..

At the equilibrium price, the quantity At the equilibrium price, the quantity demanded equals the quantity supplieddemanded equals the quantity supplied—the amount that buyers are willing —the amount that buyers are willing and able to buy is exactly equal to the and able to buy is exactly equal to the amount that sellers are willing and able amount that sellers are willing and able to produce. to produce.

If the market price is at any other If the market price is at any other price, their will be a shortage or a price, their will be a shortage or a surplus.surplus.

At a price greater than the equilibrium At a price greater than the equilibrium price, a price, a surplussurplus, or excess quantity , or excess quantity supplied, would exist. supplied, would exist.

Sellers would be willing to sell more Sellers would be willing to sell more than demanders would be willing to than demanders would be willing to buy.buy.

Frustrated suppliers would cut their Frustrated suppliers would cut their price and cut back on production, price and cut back on production, and consumers would buy more.and consumers would buy more.

This would eliminate the unsold This would eliminate the unsold surplus and return the market to surplus and return the market to equilibrium.equilibrium.

At a price less than the equilibrium At a price less than the equilibrium price, a price, a shortageshortage, or excess quantity , or excess quantity demanded, would exist. demanded, would exist.

Buyers would be willing to buy more Buyers would be willing to buy more than sellers would be willing to sell. than sellers would be willing to sell.

Frustrated buyers would compete for Frustrated buyers would compete for the existing supply, causing the price the existing supply, causing the price to rise, and producers to increase the to rise, and producers to increase the quantity supplied.quantity supplied.

This would decrease the quantity This would decrease the quantity demanded, eliminate the shortage, demanded, eliminate the shortage, and return the market to equilibrium.and return the market to equilibrium.

5.2 Changes in Equilibrium 5.2 Changes in Equilibrium Price and Quantity Price and Quantity

Demand curves shift when any of the other Demand curves shift when any of the other factors that affect buyers' behavior change factors that affect buyers' behavior change (but not the price of the good itself).(but not the price of the good itself).

Supply curves shift when any of the other Supply curves shift when any of the other factors that affect sellers' behavior change factors that affect sellers' behavior change (but not the price of the good itself). (but not the price of the good itself).

These changes (shifts) in the demand and These changes (shifts) in the demand and supply curves will lead to changes in the supply curves will lead to changes in the equilibrium price and equilibrium quantity.equilibrium price and equilibrium quantity.

An increase in demand results in a An increase in demand results in a greater equilibrium price and a greater equilibrium price and a greater equilibrium quantity. greater equilibrium quantity.

Conversely, a decrease in demand Conversely, a decrease in demand results in a lower equilibrium price results in a lower equilibrium price and a lower equilibrium quantity.and a lower equilibrium quantity.

The supply of strawberries is larger The supply of strawberries is larger during in-season than out-of-season. during in-season than out-of-season.

At the higher winter price for At the higher winter price for strawberries there would be a surplus strawberries there would be a surplus of strawberries in-season. This of strawberries in-season. This surplus forces the in-season price surplus forces the in-season price down to Pdown to Psummersummer..

Very often, supply and demand will Very often, supply and demand will both shift in the same time periodboth shift in the same time period. .

That is, supply and demand will shift That is, supply and demand will shift simultaneously.simultaneously.

Notice that in both Exhibit 1 and Notice that in both Exhibit 1 and Exhibit 3 that the seasonal increases Exhibit 3 that the seasonal increases in demand led to a shortage at the in demand led to a shortage at the original (out of season) price.original (out of season) price.

When a shortage exists the price When a shortage exists the price will rise until the new equilibrium will rise until the new equilibrium is reached. In this case, at the is reached. In this case, at the intersection of the in-season demand intersection of the in-season demand curve and the the supply curve. curve and the the supply curve.

A decrease in supply results in a A decrease in supply results in a higher equilibrium price and a lower higher equilibrium price and a lower equilibrium quantity. equilibrium quantity.

Conversely, an increase in supply Conversely, an increase in supply results in a lower equilibrium price results in a lower equilibrium price and a higher equilibrium quantity.and a higher equilibrium quantity.

When supply and demand move at the When supply and demand move at the same time, we can predict the change in same time, we can predict the change in one variable (price or quantity), but we are one variable (price or quantity), but we are unable to predict the direction of effect on unable to predict the direction of effect on the other variable. the other variable.

This change in the second variable, then, This change in the second variable, then, is said to be indeterminate, because it is said to be indeterminate, because it cannot be determined without additional cannot be determined without additional information about the relative changes in information about the relative changes in supply and demand. supply and demand.

We can predict what will happen to We can predict what will happen to equilibrium prices and equilibrium equilibrium prices and equilibrium quantities in situations where both quantities in situations where both supply and demand change.supply and demand change.

We can predict this by breaking them We can predict this by breaking them down into their individual effects, then down into their individual effects, then putting together the price and quantity putting together the price and quantity effects that each of the shifts would effects that each of the shifts would have separately.have separately.

An increase in supply decreases the An increase in supply decreases the equilibrium price and increases the equilibrium price and increases the equilibrium quantity. equilibrium quantity.

A decrease in demand decreases both A decrease in demand decreases both the equilibrium price and quantity. the equilibrium price and quantity.

Taken together, they will decrease Taken together, they will decrease the equilibrium price, but result in an the equilibrium price, but result in an indeterminate change in the indeterminate change in the equilibrium quantity. equilibrium quantity.

The change in quantity will depend The change in quantity will depend on the relative changes in supply on the relative changes in supply and demand. and demand.

If the decrease in demand is greater If the decrease in demand is greater than the increase in supply, the than the increase in supply, the equilibrium quantity will decrease. equilibrium quantity will decrease.

If the increase in supply is greater If the increase in supply is greater than the decrease in demand, the than the decrease in demand, the equilibrium quantity will increase.equilibrium quantity will increase.

An increase in demand increases the An increase in demand increases the equilibrium price and equilibrium equilibrium price and equilibrium quantity. quantity.

An increase in supply decreases the An increase in supply decreases the equilibrium price and increases the equilibrium price and increases the equilibrium quantity. equilibrium quantity.

Together, they increase the Together, they increase the equilibrium quantity. equilibrium quantity.

The change in equilibrium price The change in equilibrium price depends on the relative sizes of the depends on the relative sizes of the demand and supply shifts.demand and supply shifts.

If supply shifted more than demand, If supply shifted more than demand, the equilibrium price would drop.the equilibrium price would drop.

The eight possible changes in demand and/or The eight possible changes in demand and/or supply are presented, along with the supply are presented, along with the resulting changes in equilibrium price and resulting changes in equilibrium price and equilibrium quantity.equilibrium quantity.

College Enrollment and the College Enrollment and the Price of Going to CollegePrice of Going to College

How is it possible that the price of college How is it possible that the price of college education has risen over the last 35 years, education has risen over the last 35 years, yet many more students are attending yet many more students are attending college? college?

Does this defy the law of demand?Does this defy the law of demand? The answer is that demand and supply are The answer is that demand and supply are

changing—demand is increasing changing—demand is increasing (population and income) and supply is (population and income) and supply is decreasing (costs are rising—maintenance, decreasing (costs are rising—maintenance, new equipment, buildings and so on).new equipment, buildings and so on).

5.3 Price Controls5.3 Price Controls While non-equilibrium prices can occur While non-equilibrium prices can occur

naturally in the private sector, reflecting naturally in the private sector, reflecting uncertainty, they seldom last for long. uncertainty, they seldom last for long.

Governments, however, may impose non-Governments, however, may impose non-equilibrium prices for significant time equilibrium prices for significant time periods.periods.

Price controls involve the use of the power Price controls involve the use of the power of the state to establish prices different of the state to establish prices different from the equilibrium prices that would from the equilibrium prices that would otherwise prevail.otherwise prevail.

The motivations for price controls vary The motivations for price controls vary with the market under consideration. with the market under consideration.

A A price ceilingprice ceiling, or a legal maximum , or a legal maximum price, is often set for goods deemed price, is often set for goods deemed important to low income households, like important to low income households, like housing. housing.

A A price floorprice floor,, or a legal minimum price, or a legal minimum price, may be set on wages because wages are may be set on wages because wages are the primary source of income for most the primary source of income for most people.people.

Under rent control the price (or rent) Under rent control the price (or rent) of an apartment is held below market of an apartment is held below market rental rates, over the tenure of an rental rates, over the tenure of an occupant. occupant.

When an occupant moves out, the When an occupant moves out, the owner can usually, but not always, owner can usually, but not always, raise the rent to a near-market level raise the rent to a near-market level for the next occupant.for the next occupant.

Price Ceilings: Rent ControlsPrice Ceilings: Rent Controls

Because living in rent controlled Because living in rent controlled apartments is a good deal, one which apartments is a good deal, one which would be lost by moving, tenants are would be lost by moving, tenants are very reluctant to move and give up very reluctant to move and give up their governmentally granted right to their governmentally granted right to a below-market rent apartment.a below-market rent apartment.

Results of Rent ControlsResults of Rent Controls

Because the rents received by Because the rents received by landlords are constrained at below landlords are constrained at below market levels, the rate of return on market levels, the rate of return on housing investments falls compared housing investments falls compared to that on other forms of real estate to that on other forms of real estate not subject to rent controls, reducing not subject to rent controls, reducing the incentives to construct new rental the incentives to construct new rental housing.housing.

Where rent controls are truly Where rent controls are truly effective, there is generally little new effective, there is generally little new construction going on and a shortage construction going on and a shortage of apartments that persists and grows of apartments that persists and grows over time.over time.

Since landlords are limited in what rent Since landlords are limited in what rent they can charge, there is little incentive they can charge, there is little incentive to improve or upgrade rental to improve or upgrade rental apartments in order to get more rent. apartments in order to get more rent.

In fact, there is some incentive to avoid In fact, there is some incentive to avoid routine maintenance, thereby lowering routine maintenance, thereby lowering the cost of apartment ownership to a the cost of apartment ownership to a figure approximating the controlled figure approximating the controlled rental price.rental price.

Rent controls promote housing Rent controls promote housing discrimination. discrimination.

With rent controls, there are likely to With rent controls, there are likely to be many families wanting to rent a be many families wanting to rent a controlled apartment, some desirable controlled apartment, some desirable and some undesirable, as seen by the and some undesirable, as seen by the landlord, because the rent is at a landlord, because the rent is at a below-equilibrium price. below-equilibrium price.

The landlord can indulge in his “taste” The landlord can indulge in his “taste” for discrimination in favor of for discrimination in favor of “desirable” renters without any “desirable” renters without any additional financial loss beyond that additional financial loss beyond that required by the controls.required by the controls.

Since 1938, the federal government Since 1938, the federal government has, by legislation, made it illegal to has, by legislation, made it illegal to pay most workers an amount below a pay most workers an amount below a legislated minimum wage (price for legislated minimum wage (price for labor services).labor services).

Price Floors: The Minimum WagePrice Floors: The Minimum Wage

Because it would produce willing workers Because it would produce willing workers who will be unable to find jobs, an who will be unable to find jobs, an increase in the minimum wage would increase in the minimum wage would create additional unemployment for low create additional unemployment for low skill workers.skill workers.

The unemployment impact of the The unemployment impact of the minimum wage falls mainly on the least minimum wage falls mainly on the least experienced, least skilled persons, often experienced, least skilled persons, often teenagers, holding the lowest paying jobs. teenagers, holding the lowest paying jobs.

Results of the Minimum WageResults of the Minimum Wage

They lose their jobs or are unable to get They lose their jobs or are unable to get them in the first place, and suffer a them in the first place, and suffer a decline in earnings, not a gain.decline in earnings, not a gain.

Those who continue to hold jobs with the Those who continue to hold jobs with the same hours and working conditions after same hours and working conditions after the minimum wage is increased gain the minimum wage is increased gain substantially, and therefore are substantially, and therefore are supporters of efforts to increase the supporters of efforts to increase the minimum.minimum.

The analysis does not “prove” The analysis does not “prove” minimum wages are “bad.” minimum wages are “bad.”

There is an empirical question of how There is an empirical question of how much unemployment is caused by much unemployment is caused by minimum wages. minimum wages.

Some might believe that the cost of Some might believe that the cost of unemployment resulting from unemployment resulting from a minimum wage is a reasonable a minimum wage is a reasonable price to pay for assuring that those price to pay for assuring that those with jobs get a decent wage. with jobs get a decent wage.

But they do impose a cost.But they do impose a cost. It falls not only on low skilled workers It falls not only on low skilled workers

and employers, but also on and employers, but also on consumers of products that were consumers of products that were made more costly by the minimum made more costly by the minimum wage.wage.

Most U.S. workers are not affected by Most U.S. workers are not affected by the minimum wage because in the the minimum wage because in the market for their skills. They earn market for their skills. They earn wages that exceed the minimum wages that exceed the minimum wage. wage.

In this case, the minimum wage is not In this case, the minimum wage is not binding. This is shown in the next binding. This is shown in the next slide.slide.

When markets are altered for policy When markets are altered for policy reasons, it is wise to remember that the reasons, it is wise to remember that the actual results of actions are not always actual results of actions are not always as intended, as seen in the cases of rent as intended, as seen in the cases of rent control and the minimum wage. control and the minimum wage.

We must always look for We must always look for unintended unintended consequencesconsequences, the secondary effects , the secondary effects of an action that may occur along with of an action that may occur along with the intended effects. the intended effects.

Unintended ConsequencesUnintended Consequences

The unintended effects may The unintended effects may sometimes completely undermine sometimes completely undermine the intended effects.the intended effects.