Chapter 4

1. Chapter 4 Supply and Demand – An Initial Look The free enterprise system is absolutely too important to be left to the voluntary action of the marketplace. RICHARD KELLY

2. The Invisible Hand • Invisible hand • Adam Smith • People pursue own self-interests • “Led by an invisible hand” • Promote wellbeing of community

3. Demand and Quantity Demanded • Quantity demanded • Number of units • Consumers • Willing • Can afford to buy • Specified period of time

4. Demand and Quantity Demanded • Quantity demanded • Depends on price • Also depends on • Population size • Consumer incomes • Tastes • Prices of other products

5. Demand and Quantity Demanded • Demand schedule - Table • Period of time • Quantity demanded changes • As price changes • All other determinants – constant • All other determinants constant • As price rises • Quantity demanded falls • As price falls • Quantity demanded rises

6. Table 1 Demand schedule for beef

7. Demand and Quantity Demanded • Demand curve • Graphical depiction of demand schedule • Quantity demanded – changes • Price – changes • Period of time • All other determinants – constant

8. Figure 1 Demand curve for beef $7.50 D 7.40 7.30 7.20 Price per Pound 7.10 B F G H E C A 7.00 6.90 D 0 45 50 55 60 65 70 75 Quantity Demanded in Millions of Pounds per Year

9. Demand and Quantity Demanded • Change in price • Movement along demand curve • Change in other determinants • Shifts entire demand curve • Consumers - buy more (any & all prices) • Demand curve – shifts right/outward • Consumers – buy less (any & all prices) • Demand curve – shifts left/inward

10. Figure 2 Movement along versus shift of a demand curve D0 D1 $7.30 Price per Pound 7.10 F C D0 D1 0 Quantity Demanded in Millions of Pounds per Year

11. Demand and Quantity Demanded • Consumer income - increase • Demand – increase • Outward shift • Population – increase • Demand – increase • Outward shift • Consumer preferences – in favor • Demand – increase • Outward shift

12. Figure 3 Shifts of the demand curve D2 D1 S D0 D0 Price Price E M S D1 D0 D0 D2 Quantity Quantity demanded (a) (b)

13. Demand and Quantity Demanded • Prices & availability of related goods • Price of substitutes – increase • Demand – increase • Shift right • Price of complements – increase • Demand – decrease • Shift left

14. Supply and Quantity Supplied • Quantity supplied • Number of units • Sellers - want to sell • Specified period of time • All other determinants constant • As price rises • Quantity supplied rises • As price falls • Quantity supplied falls

15. Supply and Quantity Supplied • Supply schedule - Table • Period of time • Quantity supplied changes • As price changes • All other determinants – constant

16. Table 2 Supply schedule for beef

17. Supply and Quantity Supplied • Supply curve • Graphical depiction of supply schedule • Quantity supplied – changes • Price – changes • Period of time • All other determinants – constant

18. Figure 4 Supply curve for beef S $7.50 7.40 7.30 7.20 Price per Pound 7.10 g b a f c e h 7.00 6.90 S 0 30 40 50 60 70 80 90 Quantity Supplied in Millions of Pounds per Year

19. Supply and Quantity Supplied • Change in price • Movement along supply curve • Change in other determinants • Shifts entire supply curve • Size of industry • Technological progress • Prices of inputs • Prices of related outputs

20. Figure 5 Movement along versus shift of a supply curve S0 S1 $7.30 Price per Pound 7.10 c f S1 S0 0 Quantity Supplied in Millions of Pounds per Year

21. Supply and Quantity Supplied • Size of industry • Increase • New firms - enter • Existing firms - expand • Supply – increase • Outward shift • Technological progress • Reduces costs • Supply – increase • Outward shift

22. Figure 6 Shifts of the supply curve D S0 S1 S0 S2 Price Price V U E S0 S1 S0 S2 D Quantity Quantity (a) (b)

23. Supply and Quantity Supplied • Prices of inputs – increase • Supply – decrease • Inward shift • Prices of related outputs - change • Supply – shift

24. Supply and Demand Equilibrium • Supply-demand diagram • Graph: Supply & Demand curves • Determines • Equilibrium price • Equilibrium quantity • Shortage • Excess quantity demanded • Over quantity supplied

25. Supply and Demand Equilibrium • Surplus • Excess quantity supplied • Over quantity demanded • Equilibrium • No inherent forces that produce change • Equilibrium change • “Outside events”

26. Table 3 Determination of equilibrium price & quantity of beef

27. Figure 7 Demand curve for beef D S $7.50 7.40 7.30 7.20 Price per Pound 7.10 E g G A a 7.00 6.90 D S 0 30 40 50 60 70 80 90 Quantity in Millions of Pounds per Year

28. Supply and Demand Equilibrium • Law of Supply and Demand • Free market • Forces: supply & demand • Push the price - equilibrium level • Quantity supplied = quantity demanded • May be disobeyed • Long term • Shortages • Surpluses • Prices - fail to move toward equilibrium

29. Demand shifts & supply-demand equilibrium • Demand curve - shift outward / right • Supply curve – no change • Equilibrium price – rise • Equilibrium quantity – rise • Demand curve - shift inward / left • Supply curve – no change • Equilibrium price – fall • Equilibrium quantity – fall

30. Figure 8 The effects of shifts of the demand curve Price per pound Price per pound D0 D0 D1 D2 S S $7.30 7.10 $7.20 7.20 E E T R L M D1 D2 S S D0 D0 60 60 70 50 45 75 (a) (b) Quantity Quantity

31. Supply shifts & supply-demand equilibrium • Supply curve - shift outward / right • Demand curve – no change • Equilibrium price – fall • Equilibrium quantity – rise • Supply curve - shift inward / left • Demand curve – no change • Equilibrium price – rise • Equilibrium quantity – fall

32. Figure 9 The effects of shifts of the supply curve S0 D D S0 Price per pound S1 S2 $7.40 7.10 Price per pound $7.20 7.20 J E E V U I S0 S0 S1 D D 60 60 37.5 78 50 65 S2 (a) (b) Quantity Quantity

33. Application: Who really pays that tax? • New tax on product: 10 cents gasoline tax per gallon • Firms • Decrease supply • Pay part of tax • Consumers • Pay part of tax • What if consumers have an inelastic demand for gasoline?

34. Figure 10 Who pays for a new tax on products? D S0 S1 Price per gallon $2.64 2.54 2.60 M E1 E0 S1 S0 Q2 Q1 D 50 30 Millions of gallons per year

35. The Market Fights Back • Battling the invisible hand • Legally imposed constraints on prices • Price ceilings • Legal maximum • Equilibrium price – above it • Price floors • Legal minimum • Equilibrium price – below it

36. Price Ceilings • Keep price – below free-market level • Consequences • Shortage – persistent • Quantity demanded > quantity supplied • Illegal or “black” market • Black market prices – higher • Portion of revenues – illicit supplier • Investment – dries up

37. Case study: Rent controls in New-York city • Rent control • To protect consumers • Long run - worse off • Shortage – long waiting list, high search cost • Poor maintenance • Black market – bribes • Only some benefit, and they defend the rent control

38. Figure 11 Supply-demand diagram for rental housing D S Market rent Rent per month Rent ceiling $2,000 1,200 B E C S D 3 3.5 2.5 Millions of dwellings rented per month

39. Price Floors • Keep price – above free-market level • Symptoms • Surplus • Problem of disposal for regulated goods • Motivate sellers provide disguised and unwanted discounts • Overinvestment in industry

40. Case study: Farm price supports; Sugar prices • Farm price supports • Introduced 1933 - “temporary” • Prices – inflated • Surplus – unsellable • Purchases by government • Taxpayer pays • Higher prices • Taxes

41. Case study: Farm price supports; Sugar prices • Sugar industry • Producers • Low-interest loans • Enforced price floor • Limit domestic production • Limit foreign imports • Supply curve – left shift • Industry – benefits • Consumers – pay

42. Figure 12 Supporting the price of sugar S0 S1 D 50¢ Price 25¢ S0 S1 D Quantity

43. Summary • Movement along the D or S curve vs. shift of the whole curve • Supply meets demand → equilibrium • Price control is a bad idea