Principles of Microeconomics: Supply Curve Shifts, Price Controls, and the Invisible Hand

1. Welcome to Day 4 Principles of Microeconomics

2. What we did last class:1) Law of demand and demand curves.2) Law of supply and supply curves.3) Equilibrium.4) Things that shift the demand curve.5) Importance of Incentives.6) New equilibrium when the demandcurve shifts.

3. Goals for Today1) What shifts the supply curve.2) New Equilibrium when the supply curve shifts.3) Price controls.4) The invisible hand.5) Elasticity.

4. What causes the supply curve to shift? P Q

5. Do we have a list of things that move the supply curve like we have a list of things that move the demand curve? 1. Prices of Inputs.2. Technology.3. Taxes and Regulations.4. Seller Expectations.5. Natural Conditions.

6. 1. Price of an input changes.When the price of an input rises, the cost of making the good goes up.

7. Old Cost New Cost1st pizza $4.50 $7.50 2nd pizza $5.50 $8.503rd pizza $6.50 $9.504th pizza $7.50 $10.505th pizza $8.50 $11.50Now how many pizzas will you make for $8.00?

8. Decrease in supply because of rise in price of an input. Supply curve shifts left. P Q

9. The difference between a change in quantity demanded and a change in demand is the same on the supply side. Moving up and down the supply curve because the price changes is a change in quantity supplied. Shifting the curve so more or less is made at the same price is a change in supply.

10. 2. Technology Technology S1 Technology usually lowers cost and so usually increases supply.

11. 3. TaxesPutting a $3 dollar tax on producing or selling an item increases its cost of production just like the $3 rise in the price of cheese did for pizza. The response is the same. Higher taxes cause a decrease in supply, lower taxes cause an increase in supply.

12. Notice that the first 3 things on the list all do the same thing – they change the cost of production. It is a general rule that things that raise the cost of production lower supply and things that raise the cost of production increase supply.

13. 4. Seller Expectations.Iraq invades Kuwait in August 1990. Gas prices go from $1.88 in July to $2.35 by October. Why? People expect higher prices in the future. P Q

14. 5. Natural Conditions.Japan Tidal Wave(CNN) -- Toyota has announced drastic production cuts in North America and China due to difficulty in supplying parts following the massive earthquake and tsunami in Japan.

15. Previously, Toyota Motor Engineering and Manufacturing North America, Inc. (TEMA), had said it would suspend production on Mondays and Fridays between April 15 and April 25. That will continue through June 3, the company said in a statement."During the same period, production will run at 50% on Tuesday, Wednesday and Thursday," the statement said.

16. The 5 factors that affect supply (again). 1. Prices of Inputs.2. Technology.3. Taxes and Regulations.4. Seller Expectations.5. Natural Conditions.

17. What if there is a rise in the price of cloth used to make umbrellas? Q1

18. Rise in price of resource decreases supply. Q2 Q1

19. What happens to gasoline if there is an expectation of a higher price? Q1

20. Assuming buyers can not store gas, only supply decreases. Q2 Q1

21. Sometimes people do not like the equilibrium price. Buyers may not like it because they think it is too high and sellers may think it is too low. In this case, the government may put in price controls.

22. Price Controls A legal maximum or minimum selling price set by the government.

23. For cheddar cheese in blocks, not less than $1.13 per pound; For cheddar cheese in barrels, not less than $1.10 per pound; For butter, not less than $1.05 per pound and;For nonfat dry milk, not less than $0.80 per pound. Dairy Price Supports

24. A Price Control Above Equilibrium Price Causes a Surplus Quantity Dry Milk QD QS

25. By 2003, the U.S. government had stockpiled 1.28 billion pounds of dry milk to keep the price high.

26. Since then we have been “lucky” enough to have milk prices rise, and the government has gotten rid of much of the stockpile.

27. New York renters want to pay a lower rent. New York City has rent control.

28. A Price Control Below Equilibrium Price Causes a Shortage QS QD N.Y. Apartments

29. Do New York City landlords have the evil gene?

30. The businesses now have more customers than they wish to serve. How do you think this affects how they treat the customers?How do you make the most money in a situation like this?

31. We want our economy to produce what we want and to be able to adjust to changes in the world. Will a market economy do that? How does a business make money?Producing a lot of what people want the most and selling it.

32. The better a business correctly estimates what its customers value, and makes a lot of those things, the higher its profit.And of course, we want the economy to be able to adjust to changing circumstances. Will a market economy do that?

33. Rainy Winter Increases Demand Q1 Q2

34. Can a command economy do this? The incentive problem and the information problem.

35. The Incentive ProblemWhat does an umbrella businessman get if he gets umbrellas quickly out to a rainy area?What does the 2nd undersecretary of umbrellas in Washington get if he gets umbrellas quickly out to a rainy area?

36. The Information ProblemHow does the 2nd Undersecretary of Umbrellas know we need more umbrellas in Bakersfield?How do private business owners of umbrella companies know?

37. Every time you go shopping, it is a transfer of information fest!!!

38. You are letting sellers know what you want.Sellers are letting you know what they can make at what cost.

39. The Invisible Hand Adam Smith – 1776 The Wealth of Nations Because trades are voluntary, in helping yourself, you help others also.

40. The way for the businessman to make money is to most effectively serve his customers. In doing what is best for him, he is being lead, as if by an “invisible hand” to help society.

41. Incentive Problem – The problem of getting people to do things that help other people in the society.Information Problem – The problem of knowing what other people want me to do to help them.Invisible Hand – Business owners being lead to do the things most beneficial to others in their own pursuit of profit.

42. Sometimes it’s not enough to know that purchases go down when price goes up. Sometimes you want to know how much they go down, a lot or a little. The most common measure to answer this question is Elasticity.

43. Elasticity measures the responsiveness of one variable to changes in another variable.

44. Price elasticity is the ratio of the percent change in quantity demanded to the percent change in price. Price Elasticity of demand = percent change in quantity demanded divided by percent change in price.Ed = %Qd % P

45. So a t-shirt shop notices that when they raise their price by 5%, they lose 10% of their customers. What is their elasticity of demand?-10% = -25%

46. What does the -2 mean?For every 1 percent they raise their price, their sales drop by 2%. The elasticity of demand number always means that for every 1% they raise their price, their sales drop by X%

47. Another store checks their data and sees when they raise their price by 10%, they lose 5% of their sales. What is their elasticity of demand?-5% = -0.510%

48. For every 1% they raise their price, they lose 0.5% of their sales. What if the stores lowered their price? Then a store with an elasticity of -2 should gain 2% in sales for every 1% drop in price. A store with an elasticity of -0.5 should gain 0.5% more sales with every 1 percent drop in price.

49. Unfortunately, the data does not usually come in percentage terms. Usually you know the starting and ending prices, and the starting and ending quantities, and have to convert these to percentages.

50. Here’s how to do that.%Qd = (Q2-Q1)/[(Q2+Q1)/2] %P= (P2-P1)/[(P2+P1)/2]